Pack Your Bags for the Orient Express

Carrefour, Europe’s biggest retailer, has seen the future and it looks like this: plastic bins filled with dried squid tentacles. A traffic jam of shopping carts shaped like Volkswagen Beetles. Live mandarin fish packed so densely that they jump from their tanks and flap onto the floor. That was the scene last week at a Carrefour hypermarket in Beijing, one of 53 the French company now operates in China. Since it arrived in the mid-1990s, and particularly since the introduction of new retail regulations three years ago, the company’s growth rate has been torrid. Chinese sales now amount to $1.6 billion annually — double those of its biggest rival, America’s Wal-Mart — and they’re increasing by 33% per year. Carrefour expects to open 15 new hypermarkets annually for the next few years, and recently launched a chain of smaller supermarkets in Shanghai and Beijing. The appeal for Chinese customers and authorities alike is rigorous hygiene, a carefully selected mix of local products and European brands, and stores around the country — from bustling Shanghai to Urumqi, the capital of the remote northwestern province of Xinjiang. “Carrefour is scientific and progressive,” says Zhang Jinbao, a former soldier, scooping up rice from an open bin in the Beijing store. “They sell everything, and it doesn’t smell bad.”

Europe’s relations with China have never been so sweet — or so profitable. As the two enjoy a new political lovefest (see previous story), their trade and business relationship is also blossoming. Over the past few years, while politicians focused on bringing the former communist states of Eastern Europe into the European Union, European business was looking further East. After overtaking Japan in 2002, China moved past Switzerland last year to become the E.U.’s second-largest trading partner. It’s still behind the U.S., but it’s catching up fast. Bilateral trade has more than doubled since 1999 to $125 billion last year; it now totals the annual economic output of new E.U. members Estonia, Latvia, Lithuania, Slovenia and Malta combined.

All of which helps explain why, as French President Jacques Chirac embarked last week on his tour of the world’s fastest-growing economy, traveling with him were 52 executives, including Noël Forgeard, the president of Airbus, which hopes to beat Boeing to win new aircraft contracts, and the ceo of financially troubled Alstom, which makes TGV fast trains. Alstom is lobbying the Chinese to pick the TGV for a $12 billion high-speed Shanghai-to-Beijing rail line that the Chinese are building for the 2008 Olympics. Over the weekend, Alstom announced that Chinese authorities awarded it $1.6 billion in other contracts, including one for 60 regional trains. Also in town this week is Scottish First Minister Jack McConnell, whose itinerary includes a visit to the Beijing factory of Clyde Blowers Ltd., a Glasgow-based heavy-engineering firm that makes equipment for power stations. “In the U.K. there are 22 power stations that have been built,” says Dean Reilly, the firm’s marketing development manager. “In China they’re building more than that every year.”

Other European firms have already racked up mind-boggling results. Danone today sells more of its local Wahaha water in China than it sells Evian worldwide. European automakers — including Volkswagen, Peugeot and Fiat — have Chinese plants with the capacity to produce 1.3 million cars per year, and plan to double that by 2010. China is the one bright spot for Germany’s beleaguered engineering industry, which sold $6.8 billion worth of machine tools and other equipment there last year. And shortly before Christmas, the Italian luxury menswear company Ermenegildo Zegna, which already has 50 outlets in China, will open a cavernous showcase in Shanghai that is almost as big as its flagship store in Manhattan. Paolo Zegna, co�chief executive and grandson of the company’s founder, speaks for many European business leaders when he says: “We’re astounded by the speed with which it’s growing.”

There’s no doubt that China is undergoing one of the largest economic booms the world has ever seen. In little more than a decade and a half, 50 million Chinese have leaped into the middle class, while the country is on course to overtake Japan as the world’s second-largest economy in just 10 years’ time. The richest of China’s budding capitalists are voracious consumers, and luxury-goods companies such as Louis Vuitton and Ferrari are tapping their wealth. Vuitton expanded its flagship store in Shanghai in September and will open two more stores in China this year, bringing the total to 13. Yves Carcelle, Vuitton’s president, says sales are growing by at least 50% every year and that, worldwide, mainland Chinese are now the firm’s fourth-largest customers. “They have an incredible appetite for consumption,” he says.

But China is far more than just a big market for European goods; it also provides an opportunity to cut costs at home. A growing number of companies, from Italian fashion houses to French telecommunications operators, have shifted their manufacturing to China or are outsourcing it to firms there. Late last year, France’s Thomson gave up making televisions and handed the task to a Chinese competitor, TCL, through a joint venture that is set to become the world’s largest TV manufacturer. Its brands include the fabled RCA. Thomson’s TV business lost more than $100 million last year, while TCL’s posted profits of about $70 million. A few months later, in June, Alcatel inked a similar deal with TCL over production of its mobile-phone handsets. Carrefour alone is seeking to buy $3.7 billion of Chinese-made goods to sell in its stores in Europe and elsewhere this year. Jean-Luc Chéreau, Carrefour’s general manager for China, says the firm set up a global sourcing bureau in Shanghai last year and has 11 offices around the country that hunt for products to purchase. China “has become the workshop of the world,” says Christian Henriot, director of France’s Institute of East Asian Studies.

But every gold rush has winners and losers, and just turning up in China doesn’t guarantee success. European executives, like others who are braving the China market, complain about the difficulties of navigating the country’s bureaucracy with its ever-changing rules. As firms such as Nokia have found out to their sorrow, trying to sell the same product around China can quickly run afoul of huge differences in regional taste and custom. Competition between the foreigners flocking to China is now intense, and many are discovering that there’s a wide gulf between the rhetoric about huge market potential and the reality of endless hassles and paltry returns on investment. “Of all the countries I’ve worked in, China is the most difficult, with bureaucracy gone mad,” says Steve Clark, who recently returned to Britain after a 10-year stint, during which he set up a factory for AWBS Ltd., a Yorkshire-based manufacturer of steel buildings. “Any company going to manufacture in China now, unless they have a unique product or niche market, would find it very, very difficult to compete.”

That’s certainly true for the automakers who have piled into the country. Car sales have gone off a cliff since rising 70% in the first quarter of this year, and in the end will likely have risen by only 10% for the year as a whole. Production capacity, however, could expand by up to 30%, says Michael Dunne, president of Bangkok-based Automotive Resources Asia Ltd. That has forced down car prices as Chinese buyers hold off purchases to await even lower stickers. Shanghai Volkswagen, which started making cars in China in 1985, now builds 1 out of every 4 domestic cars sold in China at its two joint-venture plants. Yet in the past two years it has slashed prices of its top- selling model by 30%. And the Europeans aren’t just being squeezed by big Americans like General Motors, which controls 11.5% of the market through its joint venture in Shanghai. Chinese companies like Geely, which used to make refrigerator parts, and BYD, which still makes artillery shells, are stamping out compacts so cheaply that they’ve forced nearly every maker to follow Volkswagen’s lead and slash prices. “The Europeans are under a lot of pressure to hold their ground in China,” says Dunne.

The growing push to produce and source in China is also making waves back home. Already, the E.U.’s trade deficit with China, which it says ballooned to $62 billion last year, is by far the biggest with any trading partner. And while Chinese imports mean lower prices for European consumers, they also threaten some European jobs in vulnerable labor-intensive sectors such as toys, low-end consumer electronics and textiles. On Jan. 1, a worldwide agreement governing textile trade is set to expire, and many European clothing firms are bracing for a surge of Chinese exports that could hurt them and their suppliers in countries such as Tunisia and Morocco. If those firms can show that such a surge is causing big job losses, they can demand that the E.U. invoke a “safeguard clause” and curb Chinese clothing imports. Already, the European Commission responds with fines when it believes Chinese imports are being “dumped” on the European market at below-cost rates. In the past, China has faced global action for its exports of handbags, color televisions, bicycles and cigarette lighters. But the number of new antidumping cases dwindled last year to just three, and a Commission spokeswoman says that less than 1% of Europe-China trade is affected by such cases.

Amid calls for tougher action, some are taking matters into their own hands. The Valencian town of Elche was long the capital of the Spanish shoe industry. But over the past two years, more than 50 shoe factories have closed because they couldn’t compete with low-cost imports. Last month, hundreds of laid-off workers took to the streets in protest, some of them reportedly chanting “Chinese out.” They attacked a truck full of shoes and set fire to a warehouse belonging to Chen Jiusong, a Chinese importer. Chen had arrived in Spain just two months earlier with hopes of starting a successful shoe-importing business like the one he and his wife had already set up in Poland. The fire gutted Chen’s warehouse and destroyed everything. Tens of thousands of pairs of shoes, worth an estimated $1.2 million, now lie in blackened piles of ash. “Why did they burn my shoes? Spain is a democracy, I could not imagine this could happen here,” says Chen, 47, who wasn’t insured and is now $124,000 in debt to his suppliers. “This is a problem with globalization, but there is no reason to destroy my shop, my career.” Fifteen people were arrested for taking part in the incident.

While some European firms, from Vuitton to Volkswagen, have had a presence in China for years, most date the current acceleration of business ties to 2001, when China joined the World Trade Organization. That spurred Beijing to begin liberalizing its markets and lay down clearer and fairer rules for all firms, Chinese and foreign alike. Now, business leaders hope that strengthening political ties will further spur trade — and give them an edge against American companies whose trade with China is a hot-button topic in the U.S. presidential campaign. Four of the ceos on Chirac’s plane are from companies that make defense equipment, including Laurent Dassault, whose Dassault Group manufactures the Rafale fighter plane.

Anne Lauvergeon is also accompanying the French President. She’s the ceo of Areva, a French nuclear-technology firm that is locked in a fierce competition with the U.S. company Westinghouse over an $8 billion contract to provide four next-generation nuclear reactors to China. Beijing is embracing nuclear power as an alternative energy source to coal and oil, and plans to build two reactors per year for the next 15 years. By 2020, China’s energy czars estimate nuclear power will account for 4% of national electricity consumption, and installed nuclear reactors will be able to generate a whopping 36,000 MW — enough power to meet peak summer demand for the entire state of New York. The successful bidder is expected to reap a windfall of future contracts as the country moves to standardize its nuclear-power generation. Both Areva and Westinghouse have brand-new reactors on the market, but Areva has the advantage of having already sold one to Finland. “There’s a lot at play,” says Westinghouse president and ceo Steve Tritch. “We usually sell them in pairs, and at over a billion dollars a reactor, that’s a lot of business for us.”

The politics of the deal are particularly complex. Last April Vice President Dick Cheney talked up the merits of U.S. nuclear-power companies to his Chinese counterpart, Vice President Zeng Qinghong. Westinghouse has long been sidelined from full market participation by U.S. government wariness; the company in recent years has been allowed to provide limited nuclear-related technology and gear to China, but not to sell or build reactors. That policy has shifted, says Tritch, and after decades of waiting, he believes approval to sell reactors to China is close to a done deal. Meanwhile, Areva and the state-owned utility Electricité de France, which have faced no such restrictions, have been building reactors in China since 1987, when they broke ground on China’s first nuclear plant, Daya Bay 1. Bids on the new contract are due in February, and Paul Felten, the executive in charge of Areva’s bid, says Lauvergeon won’t be haggling over details on her trip. Still, he says: “One can always count on the support of the President.”

Politics play a key role in everyday business, too. Carrefour’s Chéreau explains that navigating the arcane Chinese bureaucracy is a long and complex process involving multiple negotiations with local authorities as well as regional and central government officials. “Once you know the people, you can accelerate,” he says. Indeed, Carrefour’s good political connections may help explain why it’s beating Wal-Mart. “They’re more politically astute,” says Linda Yueh, a China expert at the London School of Economics, who says the French firm appears to be better able to maneuver through the regulatory system to get permits for new stores.

Given China’s historic antipathy to foreign interference, it’s crucial for Western businesses to persuade the authorities that they have the interests of Chinese consumers at heart. When the French cosmetics giant L’Oréal entered the market in 1997, it started up a big manufacturing plant in Suzhou. Paolo Gasparrini, general manager for China, says the plant helped the firm get off the ground because it demonstrated L’Oréal’s long-term commitment. The firm now employs 3,700 people in China and its sales are taking off: last year, they rose 69% to $180 million, putting L’Oréal in the No. 2 slot behind Proctor & Gamble, which has been in China twice as long. L’Oréal is pushing to catch up. In the past 11 months, it has acquired two Chinese companies, including one that makes cheaper skin creams than L’Oréal’s existing brands. The goal: to expand its potential market in China from 100 million young urban women to an eye-popping 500 million consumers.

Others are also trying to broaden their appeal. Zegna, the Italian menswear firm, last year set up a joint venture with a clothing firm in Wenzhou called SharMoon Garments. The aim is create a local Chinese menswear brand to be launched next year. “We think the consumer potential is much bigger than what we could reach with Zegna imports,” says Zegna. “In three to five years, we hope the new brand will be a point of reference” for Chinese consumers. It’s a risky strategy. The Chinese market is notoriously fickle, and many foreign firms have trouble tailoring their products to it.

That was Nokia’s problem last year. Long the market leader for mobile phones in China, the Finnish company fell behind rivals Motorola and Chinese maker Ningbo Bird because its basic phone design, the “candy bar,” failed to satisfy shifting Chinese taste. “In 2003, domestic handsetmakers came into their own and started to steal market share by tailoring models to China’s diverse regions,” says Sean Debow, a technology strategist for UBS Investment Research in Hong Kong. “In Harbin they were making brick-style handsets with large buttons; in Guangzhou they had tiny phones; in Shanghai, the rhinestone, Liberace look was the fashion.” Nokia did an abrupt about-turn, and this year will launch roughly 30 new handset types in China, up from 15-20 last year. It also redoubled its efforts with domestic distributors to get its handsets into stores in smaller cities and towns, and is investing heavily in new R. and D. facilities. To woo customers, it started using “phone girls” — young women dressed in fetching Nokia outfits who ply customers in department stores and electronics shops. The marketing trick has helped put Nokia back at the top of the heap. This year it regained the market leader slot. Why the effort? In part, because China sets the world trend for mobile phones: up to 40% of Nokia’s handsets sold globally in coming years will be designed in Beijing. Says Duncan Clark, managing director of Beijing-based tech consultancy BDA China: “If they lose China, they lose the world.”

Back at the Beijing Carrefour, shoppers with a taste for Europe head to a section called La Maison de la Femme. It’s upstairs, past the Moulinex coffee makers and Siemens refrigerators. This is where the lingerie is for sale: thongs with red roses sewn on the crotch and padded bras to create something from very little. “People love to come look at them,” says saleswoman Zhang Jing, “but they don’t buy much. Chinese are more modest than people in Europe.” In a land of miniskirted phone girls, that’s arguable. What’s certain is that no European firm has come to China to be modest.