three question

Journal of Strategic Management Education 2(1): 55-82. © 2005, Senate Hall Academic Publishing.

Lenovo: The Leading Chinese Computer Company Enters Global Competition Daniel F. Spulber1 Kellogg School of Management, Northwestern University

Abstract. Lenovo stunned observers with its acquisition of IBM’s personal computer division. The case examines the Lenovo group from the time the company was established and considers how Lenovo became the leading Chinese computer company. The case considers the challenges faced by the company with increasing trade liberalization in China and details the initial stages of Lenovo’s international strategy. The case concludes with Lenovo’s acquisition of IBM’s personal computer business and considers the issues that must be addressed as Lenovo enters into global competition.

Keywords: international business, global competition, China, personal computers.

1. Introduction

The shock in international business circles was palpable. The New York Times asked “Lenovo. Who?” under a headline that read “An Unknown Giant Flexes Its Muscles.”2 China’s Lenovo Group had purchased IBM’s personal computer (PC) business for US $1.75 billion in cash, stock and debt. The acquisition created shock waves in part because the purchaser was a Chinese company, and perceptions in developed economies had not fully adjusted to the growth of Chinese businesses or to the technological progress taking place in China. Some were startled because of IBM’s exit from the PC business despite having pioneered its development in the early 1980s. Known as Big Blue, IBM had played a key role in establishing PC industry standards through its alliances with Intel in microprocessors and with Microsoft in operating system software.

Lenovo vaulted from being the eighth-largest PC maker in the world to the third-largest, after Dell and Hewlett-Packard (HP). At a stroke, Lenovo gained an internationally-recognized brand name, access to customers, skilled managers, advanced technology, and a powerful partner. Buying IBM’s PC division transformed Lenovo from a leading domestic player in China to a major global

1. Daniel F. Spulber is the Elinor Hobbs Distinguished Professor of International Business and the Director of the International Business & Markets Program at the Kellogg School of Management. Daniel F. Spulber prepared this case study to illustrate an issue in management strategy for the purpose of class discussion. Aaron M. Spulber provided valuable research assistance.

2. David Barbosa, “An Unknown Giant Flexes Its Muscles,” New York Times, December 4, 2004, p. B1.

© 2005, Senate Hall Academic Publishing. All Rights Reserved.

56 Lenovo: The Leading Chinese Computer Company Enters Global Competition

company. How did Lenovo make such a great change so quickly? How did the acquisition fit into Lenovo’s overall strategy? How would Lenovo adapt its strategy and organization to become an effective global competitor?

Yang Yuanqing took the helm of the Lenovo Group (formerly Legend Group) as the People’s Republic of China (hereafter China) prepared for its accession to the World Trade Organization (WTO). He was concerned about the company’s prospects for the future in the face of intensified competition from global computer companies. Foreign computer giants such as Dell, HP, IBM, Acer, Samsung, Sony and Toshiba already were establishing plants in China and making deals with local partners for a renewed run at Chinese consumers and business customers. Dell Computer opened a large-scale manufacturing plant in Xiamen, Fujian province and brought its direct-sales approach to China.

Computer companies operating in China had been cutting their PC prices and Lenovo expected further price pressures. How should the company adjust its pricing strategies and distribution policies to handle competition from world-class marketers? Could the company maintain its domestic leadership position in an environment of rapid cost cutting and technological change? What mix of cooperation and head-to-head competition would continue the company’s successful performance? The company’s managers considered competing against global computer companies in overseas markets and weighed the costs and benefits of expanding outside of China. Yang believed that Lenovo could meet the challenges and become a successful global player.

Lenovo’s founder and then-Chairman Liu Chuanzhi observed, “Legend Group is a young and dynamic enterprise born amidst the tidal wave symbolizing China’s reform and open door policy. We have grown in a market of intense competition, and witnessed the vigorous speed at which China’s information industry has developed.”3 Lenovo’s corporate culture statement emphasized that the company was “Achieving greatness with ambition and determination.” Yang told Business Week, that the company planned to be among the global top 10 of personal computer (PC) makers.4 Within a year of Yang’s announcement of the company’s plans, Lenovo had effectively achieved its objective thanks to its acquisition of IBM’s PC business. Many new challenges lay ahead as a transformed Lenovo entered into the global arena.

3. Chairman’s Message, Legend Group, 2003, http://www.legendgrp.com/cgi-bin/ main.cgi?section=about&sub_section=chair_message

4. Dexter Roberts, with Joyce Barnathan and Bruce Einhorn, “How Legend Lives Up to Its Name,” Business Week, February 15, 1999, pp. 75-76. See also Tony Jordan, “Mastering the Market,” Asian Business, February, 1999.

Journal of Strategic Management Education 2(1) 57

2. Company History

At the beginning of the 21st century, Lenovo found itself the leading computer supplier in China, the fastest-growing market for computers in the world. Housed in new, high-tech facilities, the company had long passed a major milestone, producing its millionth computer. Majority-owned by the Chinese government at its founding, the company operated with considerable flexibility and was listed on the Hong Kong Stock Exchange, quoted on the London Stock Exchange’s SEAQ system, and traded in the United States through American Depository Receipts (ADRs). How did Lenovo become China’s leading computer company?

Lenovo emerged from academia with a rocky start. The company began in 1984 as an experimental state-owned enterprise housed in a small bungalow at the Chinese Academy of Sciences (CAS). Liu Chuanzhi and 10 colleagues at the CAS started Lenovo with 200,000 renminbi (approximately US $24,000) in seed money from the CAS. The company would be privately operated despite government ownership. Engineers and scientists at the CAS had focused on designing microprocessors for military applications and on developing satellites, rockets and heavy machinery. Lenovo initially sold and distributed computer products of companies like IBM and HP.

In the company’s early years, the greatest challenge faced by its managers was learning basic business concepts. As Liu admitted “I won’t say that we became successful straight away, in fact we went through a very difficult period between 1984 and 1988.” Liu observed that “The major reason for our success is our background in the CAS – our background in research. But since 1984 the focus of our efforts was on marketing and management. When we started, the main focus was not so much on research but on how to manage an enterprise. Much of our efforts went into researching management. This might sound strange to Westerners but, for us, the major issue was how to open up the market and how to finance our production, so it was very important to study strategy.”5 According to Liu, in understanding marketing and the organization of sales channels, “HP was our earliest and best teacher.”6 Liu applied this knowledge to establish an intricate and entrenched distribution network that helped Lenovo gain its substantial market share.

Because Lenovo had initially distributed foreign companies’ computers, Liu had to convince government officials that Lenovo was capable of making computers. Lenovo’s first products were digital watches and Chinese-language computer input devices. Lenovo did not have its own brand of computers until 1990.

Although the Chinese government had a controlling ownership share and provided funding, the company had sufficient autonomy to compete as an independent entity. A division of the company, Legend Holdings Limited was

5. Tony Jordan, “In the Beginning,” Asian Business, February, 1999. 6. Bill Powell, “The Legend of Legend,” Fortune, September 16, 2002, pp. 34.

58 Lenovo: The Leading Chinese Computer Company Enters Global Competition

incorporated in Hong Kong in 1988 and listed on the Hong Kong Stock Exchange in 1994.7 Still, for Liu, government reforms that made independent state enterprises possible were a basis for the company’s success: “The CAS provided an ideal environment in which to develop. We received money from the state and were given freedom in terms of personnel management training and financing. In addition to salaries, we were able to give bonuses or shares to our staff. These incentives are an important factor in employee motivation.”8 Lenovo focused on training and attracting qualified personnel. Liu noted that “At Legend, we try to merge the goals and ideals of personal development with that of the company. Since we are a listed company in Hong Kong we are allowed to set aside 10% of the group’s shares for stock options for staff members, this gives staff a real incentive to see the company perform well.”9 The focus on diligence and effort was summarized by an early company motto: “We are making progress every day.”

The company developed and manufactured a wide range of computers, including laptops, desktop PCs, servers and workstations. In the 1990s, the company also distributed computer products from over 20 foreign vendors, including Cisco and Sun Microsystems. Lenovo offered successful computer products for the home market. Lenovo’s computers included the Happy Family software for consumers and the My Office software for commercial users.

Lenovo experienced rapid growth in sales and by 1997, it had the leading share of the computer market in China. The company’s PC sales of 1.8 million units in 2000 represented an increase of almost 90% from the previous year.10 Under CEO Yang, the company launched a variety of new products including PCs aimed at four different age groups of home users: Tianhui for children; Future Pioneer for high school students; Tianlu for adults; and Tianle for the middle-aged and the elderly.11

Lenovo and other companies in the high-tech sector continued to benefit from association with the Chinese Academy of Sciences. The Chinese government announced in 1998 that it would send 400 researchers from the CAS to conduct R&D at Lenovo.12 Domestic competitors had similar ties, with Founder Electronics associated with Beijing University and Great Wall having been established by the Ministry of the Electronics Industry.13 Lenovo also benefited

7. According to Ms. Mary Ma, chief financial officer and senior vice president of the publicly- traded unit, “the Chinese government owns 65 per cent of the parent company, which in turn owns 57 percent of the Hong Kong operations”, see Keith Bradsher, “Chinese Computer Maker Plans a Push Overseas,” New York Times, February 22, 2003, p. B1.

8. Jordan, In the Beginning, id. 9. Jordan, In the Beginning, id. 10. Ariel Tam, Yang Yuanqing – The PC Mogul, ZD Net India, April 2, 2001,

www.zdnetindia.com/biztech/people/columnists. 11. Tam, id. 12. Dexter Roberts, id. 13. Kenneth L. Kraemer and Jason Dedrick, “Enter the Dragon: China’s Computer Industry, IEEE

Computer, volume 35, February, 2002, pp. 28-36.

Journal of Strategic Management Education 2(1) 59

from its association with the Chinese government. About 25% of Lenovo’s sales were to the Chinese government during the mid-1990s.14 However, by 2001, the company’s sales to corporate customers, including state-owned enterprises, accounted for less than 25% of Lenovo’s sales as Lenovo increased its focus on the consumer and commercial markets.15

Lenovo in its early years benefited from Chinese government trade restrictions, which included quotas, tariffs, value added taxes on imports, restrictions on foreign companies’ access to distribution, and restrictions on ownership and investment. These trade restrictions conferred potential competitive advantages on Chinese computer makers. For various economic reasons including the relative costs of production in China versus the rest of the world, exports of computers far exceeded imports, see Table 1.

Table 1: China’s Imports and Exports 1997-2001 of Computer Equipment (Product group 752) (US $ ‘000)

Source of data: International Trade Centre (UNCTAD/WTO)

Yet, trade liberalization in China took place as part of the process of being considered for WTO membership. Beginning in 1992, there was a reduction in average nonagricultural tariffs from over 42% to 17% by 1998. For microprocessing equipment, the tariff for those countries with whom China had exchanged most-favored-nation trading status was 15% by 1998. At that time, the Value-Added Tax (VAT), which was levied on the combined value of imported products plus tariff charges, was 17%, which magnified the effects of tariffs.16 In the year 2000, tariffs on U.S. information technology (IT) products imported by China averaged 13%.

Greater international competition in China’s IT market accompanied these reforms. Chinese imports of U.S. high-tech products expanded by 500% between 1990 and 1998.17 Further changes in trade regulations would have additional impacts on the Chinese market. In 1998, the U.S. and China concluded an Information Technology Agreement with important implications for the Chinese

14. Dexter Roberts, id. 15. Bruce Einhorn, “Legend’s Home Field Advantage,” Business Week Online, June 10, 2001,

www. businessweek.com.

1997 1998 1999 2000 2001

Imports 1,135,129 1,821,250 3,253,327 4,516,388 4,980,964 Exports 5,361,766 7,066,626 7,921,950 10,994,084 13,093,809

16. Based on data from the Customs Import and Export Tariffs of the People’s Republic of China, 1998 Edition, from Peggy Lim and Ivan Trinh, “Personal Computers & Peripherals,” U.S. & Foreign Commercial Service, U.S. Department of State, 1999.

17. White House Fact Sheet on US-China WTO Accession Deal, March 1, 2000, http:// www.usconsulate.org.hk/uscn/wh/2000/030102.htm.

60 Lenovo: The Leading Chinese Computer Company Enters Global Competition

information technology (IT) market. In November of 1999, the United States and China subsequently negotiated a trade agreement that helped to pave the way for China’s accession to the WTO in 2001. The agreement granted foreign IT companies rights to engage in distribution by 2003, including wholesaling, retailing, transporting, warehousing and servicing. Also, the agreement reduced Chinese IT tariffs by two-thirds before 2003 and fully eliminated them by 2005, and abolished IT import quotas upon accession to the WTO. The agreement further opened Chinese markets to investment and services while providing intellectual property protection.18 Upon joining the WTO, China began the relaxation of trade barriers. According to the Office of the U.S. Trade Representative, “China’s elimination of tariffs on the products covered by the Information TechnologyAgreement (ITA) – semiconductors and semiconductor manufacturing equipment, computers and computer parts, software, telecommunications equipment and computer-based analytical instruments – began upon accession and is to be completed by 2005.” China maintained various tariff and nontariff barriers such as preferences for domestic producers in government procurement but these practices came under increased scrutiny.19

Lenovo continued to compete effectively with global firms entering the Chinese PC market. Lenovo’s sales growth coincided with declining sales of well-known international competitors, see Table 2 below. In 1994, Lenovo had only 6% of the Chinese market, with AST, Compaq, IBM and DEC having a combined market share of 66%. In 1997, IBM, HP, and Compaq had a combined share of 21% of the Chinese market and that share fell below 10% in 2000, while during that same period the Chinese market grew at the rate of 25% per year, reaching nine million units. Lenovo’s market share rose to over 25% in the year 2000 and surpassed 30% by 2002.20 Overall, Liu felt fortunate that “Legend Group was operating in an era of continuous progress, and participating in an industry characterized by innovation and transformation.”21

18. See White House Fact Sheet, id. However, according to U.S. complaint before the W.T.O., China’s 17 percent value added tax on semiconductor sales in China created competitive advantages for Chinese companies because the Chinese government gave rebates to Chinese semiconductor producers of up to 14 percent for an effective tax rate of 3 percent. The case was resolved in July 2004 with China agreeing to stop providing tax refunds to domestic producers. See Office of the US Trade Representative, U.S. and China Resolve WTO Dispute Regarding China’s Tax on Semiconductors, July 8, 2004.

19. “China has traditionally restricted imports through high tariffs and taxes, quotas and other non- tariff measures, and restrictions on trading rights. As part of its first year in the WTO, China significantly reduced tariff rates on many products and the number of goods subject to import quotas, expanded trading rights for Chinese enterprises, and increased the transparency of its licensing procedures. However, during China’s second year of WTO membership, while China continued to reduce tariff rates on schedule and made other implementation progress, bureaucratic inertia and a desire to protect sensitive industries contributed to a significant loss of the momentum created in the first year of China’s WTO membership.” See Office of the U.S. Trade Representative, Foreign Trade Barriers, March 30, 2004. www.ustr.gov/assets/ Document_Library/Reports_Publications/2004/2004_National_Trade_Estimate/ 2004_NTE_Report/asset_upload_fild231_4191.pdf

20. See Powell, id.

Journal of Strategic Management Education 2(1) 61

Table 2: Selected Market Shares of Personal Computer Suppliers in China. Market shares are only approximate to indicate market rank

Sources of data: a. Yadong Luo, 2000, Multinational Corporations in China: Benefiting from Structural Transformation, Copenhagen, Copenhagen Business School Press. b. Approximate market shares based on news reports, company data, and Morgan Stanley Dean Witter, Asia/Pacific Investment Research, Legend Holdings Leader of the Chinese PC Revolution, December 7, 1998, p. 15, which uses data of PC AsiaDat Bulletin. c. Approximate market shares based on news reports, company data, and Deutsche Bank, Legend Holdings Limited, February 6, 2002, Figure 18, p. 15, which uses IDC data. d. Approximate market shares based on news reports, company data, and CEINet Market Research, Beijing CEINet Corporation, September 30, 2003, which uses data from Huicong International Information.

Lenovo was reorganized into six business units in 1995: (1) Legend Computer Systems, which engaged in the research and development, manufacture and distribution of Legend-brand personal computers (PCs), (2) Legend Technology, which distributed foreign-brand computer-related products, (3) Legend Advanced Systems, which provided systems integration solutions in China, (4) Legend Quantum Design International Corp (QDI), which manufactured and distributed motherboards, (5) Legend Techwise Circuits, which manufactured and distributed printed circuit boards, and (6) Legend Expert Systems, which provided system integration services in Hong Kong.

Lenovo’s managers decided to spin off its contract manufacturing unit as a 50/50 joint venture in 2003. Lenovo had engaged in contract manufacturing of

21. Chairman’s Message, Annual Report, Legend Group Ltd. www.legend-holdings.com, 2002.

Market Shares of PC Companies in 1994a

Market Shares of PC Companies in 1998b

Market Shares of PC Companies in 2001c

Market Shares of Notebook Computer Companies in 1H 2003d

AST 25%

Compaq 16%

IBM 8%

DEC 7%

Great Wall 6%

Lenovo 6%

Acer 4%

Langchao 3%

Changjiang 2%

Other imports 4%

Other producers 19%

Lenovo 14%

IBM 7%

Compaq/Digital 6%

HP 6%

Tontru 3.5%

Founder 3.5%

Great Wall 2.5%

Acer 2%

Toshiba 1.5%

NEC 1%

Other producers 53%

Lenovo 28%

Founder 10%

Qinghua Tongfang 6%

Dell 5%

IBM 4%

TCL 3%

Acer 3%

Great Wall 3%

Hisense 2.5%

HP 2.5%

Other producers 33%

Lenovo 20%

IBM 18%

Toshiba 12%

Dell 11%

Founder 9%

Compaq (HP) 8%

Tsinghua Unisplendour 5%

ASUSTek 4%

Acer 4%

Tongfang 4%

Other producers 5%

62 Lenovo: The Leading Chinese Computer Company Enters Global Competition

QDI-brand motherboards. Lenovo had merged its QDI motherboard manufacturing facility with its Lenovo Computer company after the motherboard business encountered losses due to intense competition in its export market. QDI had R&D centers located in Beijing, Shenzhen, Hong Kong and Silicon Valley. QDI’s motherboard brand was ranked fifth in the world and in the top three in Europe.22 The spin off would help Lenovo’s management to concentrate on the company’s core businesses.

Lenovo also spun off Digital China Holdings Ltd. in 2001 and the company was listed on the Hong Kong stock exchange. Digital China included three units of Lenovo: Legend Technology, Legend Advanced Systems, and Legend Network. Digital China was ranked as the largest IT products distributor and services company in China, see www.digitalchina.com.hk. The spin off eliminated any potential conflict of interest for Digital China, which could then sell various domestic and foreign brands on an equal footing. Lenovo no longer distributed foreign brands but concentrated on its own branded PCs. Lenovo’s managers could concentrate on the company’s own product manufacturing and distribution business.

The company manufactured PCs in three facilities, Beijing, Shanghai and Guangdong Province. Production capacity was expected to reach over 5 million units per year. Lenovo had a turnover of HK$ 20.2 billion in fiscal 2002-03, an increase of 5% over the previous year. Profits rose by 21% to HK$1 billion. Although Lenovo had shown a profit, the domestic market for home PCs was shifting toward laptops rather than desktops. Laptops were not only more costly to manufacture but faced intense competition from branded products offered by Dell, HP, and IBM.23

3. Lenovo’s Domestic Strategy

The success of Lenovo and other domestic computer companies in China went against the expectations of many market analysts. According to Business Week, “It wasn’t supposed to happen this way. A few years ago, most analysts were convinced that the global powers would gobble up the Chinese market, with locals like Lenovo stuck in second-tier status – at best.”24 Reduced trade barriers had created opportunities for global companies, but the outcome of market competition in China was not easily predictable – both global companies and domestic companies had potential competitive advantages. The company benefited from its pricing and distribution strategies.

22. Wang Chuandong, “Legend Initiates Strategic Merger,” China Daily, May 10, 1999, North American ed., p. 5.

23. Bruce Einhorn and Dexter Roberts, “A New Twist in Legend’s Tale,” Business Week, June 23, 2003, pg. 50.

24. Bruce Einhorn, “Foreign Rivals vs. the Chinese: If You Can’t Beat ‘Em … ,” Business Week, February 15, 1999, p. 78.

Journal of Strategic Management Education 2(1) 63

3.1. Pricing and Costs

Lenovo offered customers a blend of affordable prices, technical efficacy, and patriotism. A consumer purchasing educational software produced by Lenovo explained why he chose it over competing foreign brands: “It’s cheap, it works and it’s Chinese.”25

The company priced computers above cheap clones made in China but still competitively low in comparison with international imports. Lenovo recognized that income levels in China would remain low for some time and that penetration of PCs in the household market was limited by income levels. Lenovo and the other top Chinese brands had substantially undercut imported PCs by around 20%. Some models undercut IBM and Compaq by 30% in the mid-1990s.26 However, projected prices for PCs were expected to decrease by 10 to 20%, putting pressure on the company to keep cutting costs and enhancing quality. Lenovo positioned itself as the high-quality domestic brand, and its pricing strategy was to stay above the prices of competing domestic brands and below the prices of global brands. Prices differences narrowed substantially by in the following years.

The Legend brand was well known to Chinese consumers. As Liu observed, “The reason we are number one in the China market is because of brand advantage.”27 Lenovo’s sales continued to exceed those of lower-priced domestic brands such as Founder Electronics, Great Wall and Tongfang. In competing with global brands, Lenovo had the advantage of an exclusive focus on the China market, with specialized applications for specific market segments such as state enterprises, banks and small businesses.

Many foreign companies such as IBM and HP had encountered difficulties in trying to break into the Chinese market, contrary to confident early predictions. International companies benefited from established global brands, economies of scale, substantial financial resources, access to technology, and relationships with hardware and software providers. However, the market share of imports in PCs had declined steadily. A personal computer represented two to three years’ salary for an average Chinese household, so the low cost and relative quality of Lenovo’s computers allowed the company to capture over 27% of the Chinese market by 2003.28

The international companies were aware of the difficulties in serving the market but the rapid growth of the Chinese economy proved attractive. China was the world’s fastest growing market for information and telecommunications technology, with a “compound annual growth rate of 27 percent, approximately 4.5 times greater than the U.S..”29 Much of the 200 percent annual growth in PC

25. Jordan, “Mastering the Market,” id. 26. Dexter Roberts, id. 27. Jordan, “Mastering the Market,” id. 28. Bradsher, id.

64 Lenovo: The Leading Chinese Computer Company Enters Global Competition

sales in China in the early 1990s however was concentrated in the low-end market segment.30 In computers, multinational companies operating in China missed out on some of the opportunities provided by this growth because of their focus on the high-price, high-quality end of the market and their orientation toward wealthier urban consumers.31

Chinese consumers were initially unfamiliar with computers or the Internet. See Table 3 below on Internet usage in China. International companies were accustomed to dealing with consumers in developed economies and so did not offer sufficient information and training to new computer buyers. In 1999, only one out of every 175 Chinese owned a computer.32 Lenovo provided sales assistance and tutorials on how to operate a computer and how to use the Internet. While international companies offered well-known international brands, Chinese companies such as Lenovo offered brands that were well-known and popular in the domestic market.

Table 3: Personal computers, Internet and telephone usage in China

Source of data: World Development Indicators Database, August 2003, World Bank

International businesses found it hard to distribute their computers in China because of ownership restrictions in wholesale and retail and limited experience operating distribution channels in China. Lenovo had already established its far- reaching domestic distribution network. Moreover, while Lenovo sold through traditional dealer and retail outlets, Dell planned to bring its direct-sales business model to the Chinese market place. Liu expected that the direct sales model would encounter difficulties in China because of the limited use of credit cards, inadequate independent delivery, and preference by Chinese consumers for face- to-face interaction with sales personnel. Company founder and CEO Michael Dell reacted to these doubts by noting “That’s even what they told us in the United States.”33

29. World Information Technology and Services Alliance, “Background Paper on the World Trade Organization’s Negotiations and Issues Regarding Information and Communications Technology (ICT),” December 2002.

30. Roger Roxin Chen, 2004, “Corporate Reputation: Pricing and Competing in Chinese Markets – Strategies for Multinationals,” Journal of Business Strategy, 25, pp. 45-50.

31. This phenomenon was not unique to computers but also occurred in household appliances and electronics generally, see Chen (2004), id.

32. Dexter Roberts, id.

1998 2001 Personal computers (per 1000 people)

8.9 19.0

Internet users 2.1 million 33.7 million Fixed lines and mobile telephones (per 1,000 people)

88.6 247.7

Journal of Strategic Management Education 2(1) 65

Foreign competitors had faced tariffs and the value-added tax when they shipped computer components to China for assembly and imported computers that they manufactured abroad.34 International firms also incurred transportation and transaction costs when they imported parts or finished products. These costs created advantages for domestic producers that initially allowed domestic producers to undercut the prices of international brands.

3.2. Distribution

Lenovo’s growth in China was anchored to its strong domestic distribution network. Lenovo sold through about 3,700 distributors and resellers.35 Given that Chinese consumers required substantial amounts of information about computers, Lenovo’s distribution system conferred a distinct competitive advantage.36 Customers relied on demonstrations and advice from retail sales personnel.

Lenovo’s specialty shops further enhanced its market position with consumers. Lenovo established its own 1+1 Home PC Specialty Shops located in Beijing, Shanghai and Guangzhou, and also targeted small and medium sized cities, with over 1000 stores established by early 2003.37 Liu Chuanzhi noted that with a retail marketing channel, the company would be “in a better position to understand customers’ needs and to better fulfill the demands of home PC users.”38 These shops provided consumers with training seminars and also computer demonstrations that showcased Lenovo computers’ capabilities. The shops showcased the Lenovo PC’s ability to handle digital photography, and also showed how Lenovo’s PCs could be linked in a home network. The specialty shops also featured Lenovo products and innovations.

In a press release in August of 1998, Liu discussed the reason for creating specialty shops, “These specialty shops will provide more thorough support in the area of application to computer users in China. Through this direct marketing channel, we will also be in a better position to understand customers’ needs and to fulfill the demands of home PC users. They will also help to enhance the popularity of home PC products and users’ knowledge in their applications.”

Yet Lenovo’s distribution system had to adjust its operations in response to competition. Dell’s centers only needed to keep six days of inventory due to their direct sales process. According to Ms. Ma Xuezheng, CFO and senior vice

33. Bickers, id. 34. Charles Bickers, “Sharing the Pie,” Far Eastern Economic Review, 162, June 17, 1999, pp.

54-56, Copyright Dow Jones & Company Inc. 35. Legend Annual Report, 2000-2001, p. 19. 36. Lily Wu, head of Salomon Smith-Barney’s regional technology research, notes that

distribution is Legend’s main advantage, see Tony Jordan, “Mastering the Market,” Asian Business, Copyright Far East Trade Press Ltd., February, 1999.

37. Corporate News, 2002/2003 Annual Results, www.legendgrp.com and company information. 38. Company Press release, August 9, 1999, www.legend-holdings.com

66 Lenovo: The Leading Chinese Computer Company Enters Global Competition

president, the twenty day stock of inventory that Lenovo kept in September 2002 was one third less than it was in 2001. Also, because Lenovo expected to see a great increase in demand for made-to-order computers, the company changed three of their six production lines to accommodate the shift in demand.39

Lenovo had plans to continue expansion of its distribution network, even within China itself. Instead of focusing all of their resources on Beijing, Shanghai, and Guangzhou, Lenovo’s assistant president and head of corporate marketing Alice Li stated that the company’s “sales team will shift a bit to the second- and third-tier cities.” 40

Another important facet of the Lenovo company’s success was its service network. In 2003 , the company had established nearly 600 Legend brand service stores and planned more openings. Owners of Lenovo computers could come to these stores and have their computers repaired. Yang believed that Lenovo’s service network provided a competitive advantage in serving Chinese consumers, stating that “Some foreign companies don’t provide service by themselves; they hand this over to the others. But we think the service should be provided by ourselves.”41 The service stores also retailed cell phones and other Lenovo products.

3.3. Product Diversification

Yang Yuanqing set a goal of product diversification for the company. Lenovo entered into markets for handheld computers and mobile phones and had also started providing IT services. Yang believed that these markets would grow quickly in China and that computer makers such as Lenovo were the natural suppliers, “In China a lot of customers haven’t known what exactly they want or what they need in terms of information technology and software. The PC manufacturers can help them.”42

The company issued a four-part mission statement. Lenovo would try to make the home a more digitized place for consumers through its offering of IT products and services. The company would make shareholders’ long-term benefits a top priority. Lenovo would provide its employees with an exciting environment leading to personal growth both inside and outside of the workplace. The company would help to bring its community into the modern age.

The company established four business areas: corporate IT, consumer IT, handheld devices, and IT services. The corporate IT division engaged in the research and development, manufacture and distribution of Lenovo’s commercial PCs, Notebook PCs, servers, and peripherals. The consumer IT division revolved

39. Powell, id. 40. Karen Cohn, “Extending Legendary Success,” Electronic Business, May 15, 2003, pg. 52. 41. Powell, id. 42. Powell, id.

Journal of Strategic Management Education 2(1) 67

around the company’s consumer PC and digital products. The handheld devices division manufactured various palm devices and mobile handsets. The IT services division provided services in such areas as system security, system operation, IT consulting, and applications in the finance, telecom, manufacturing, and government sectors. These four business areas corresponded to the company’s main target markets.

According to Yang, Lenovo Group planned “to accelerate business development, with server, notebook, mobile handset and digital products as the major growth drivers. We will also continue to pursue our transformation strategy, strengthening our ability to provide quality professional services and speed up the pace of our technological innovation.”43 Lenovo’s system integration business specialized in financial and banking systems as well as government agencies such as the Ministry of Posts and Telecommunications. Lenovo was poised to provide services for the eventual computerization of Chinese companies and government agencies; however, market growth in this area was off to a slow start.

4. International Entry into China’s Computer Market

Chinese public policy and economic conditions provide an essential context for the strategic decisions of Lenovo’s managers. Starting with the opening of the Chinese economy to trade in the late seventies and continuing to the turn of the new century, China’s economy experienced a rapid rate of growth of its Gross Domestic Product (GDP). China officially opened its economy to Foreign Direct Investment (FDI) in 1979, with additional liberalization of regulations occurring in 1986 and progressively from 1990 onwards.44 As can be seen from Table 4 below, FDI inflows grow substantially after 1991. FDI inflows substantially exceed FDI outflows, with FDI inflows equaling thirty times outflows in 2003. US FDI into China equaled $1,540 million in 2003.45 China government policy makers reduced economic controls allowing the development of competitive markets in many sectors while seeking the reform of the many large and inefficient state owned enterprises (SOEs). Although partly owned by the government, Lenovo was subject to the forces of competition from domestic and international companies operating in China.

43. “Legend Announces 2002/03 Annual Results,” Press release, Legend Group, http:// www.legendgrp.com/

44. Yadong Luo, 2000, How to Enter China: Choices and Lessons, Ann Arbor; University of Michigan Press, p. 13.

45. Bureau of Economic Analysis, www.bea.gov

68 Lenovo: The Leading Chinese Computer Company Enters Global Competition

Table 4: Indicators of Foreign Direct Investment (FDI) to and from China

Source: United Nations Conference on Trade and Development (UNCTAD), Foreign Direct Investment Database, www.unctad.org

The cost advantages of domestic producers in China’s computer market had eroded substantially in the 1990s. Looking ahead, these advantages would be further reduced with the elimination of tariffs and other trade barriers under the WTO and related agreements. Moreover, transportation and transaction costs associated with imports would be eliminated because the international companies had entered into manufacturing joint ventures or established manufacturing facilities in China. By manufacturing in China, international companies further benefited from lower production costs, particularly lower costs of labor. Lenovo and other domestic Chinese producers could not count on cost advantages in competing with international companies.

International competitors complained that Chinese companies such as Lenovo benefited from government connections or guanxi. The Chinese government had assisted Lenovo not only through tariffs, financial support, and technology, but also through direct purchase of its products by government agencies. Lenovo’s CEO Yang thought that these criticisms were just not well founded, “It’s because the operations staff of those multinational players in China have no other excuse to report to their bosses overseas.”46 Although government purchases had played an initial role in Lenovo’s growth, the company had diversified its customer base substantially becoming primarily reliant on product sales to households and commercial customers and expanding its services to business.

Year 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

Investment

FDI inflows (millions of dollars)

1,956 2,314 3,393 4,366 27,515 37,521 45,257 40,319 46,878 53,505

FDI outflows (mil- lions of dollars)

629 645 780 913 4,400 2,000 2,563 1,775 6,884 1,800

Cross-border M&A sales (number of sales)

0 1 1 5 26 58 65 72 79 214

Cross-border M&A sales (millions of dol- lars)

0 0 0 125 561 403 1,856 2,395 2,325 3,820

Cross-border M&A purchases(number of purchases)

0 1 6 2 28 13 30 13 22 73

Cross-border M&A purchases (millions of dollars)

0 0 202 3 485 249 799 101 452 1,647

46. Bruce Einhorn, “Legend’s Home-Field Advantage,” Business Week Online, June 15, 2001.

Journal of Strategic Management Education 2(1) 69

International businesses also faced significant transaction costs associated with distribution due to their limited knowledge regarding consumer characteristics, local business practices and government regulations. With the opening of the Chinese market as a result of China’s WTO accession, these cost advantages also would be lowered. International businesses would be able to establish their own distribution networks or partner with Chinese distributors.

Dell, IBM, HP, and Toshiba cut prices and saw their sales surge.47 Domestic players such as Founder and Great Wall responded with their own price reductions. Price competition took its toll on Lenovo’s market share and profits.48 Lenovo faced the possibility of being stuck in the middle resulting from price wars with international players at the high end and competition from domestic brands at the low end.

4.1. Dell in China

Michael Dell founded Dell Computer Corporation in 1984 in his college dorm room in Austin, Texas with an initial investment of about $1,000 and a year later, the company was making its own line of computers. By 1987, Dell became an international company by opening a subsidiary in the United Kingdom and by 1990, the company opened up a manufacturing plant in Limerick, Ireland to provide computers to Europe, the Middle East, and Africa. In 2003, Dell had around 40,000 employees worldwide and was the largest PC maker in the world.

Dell’s success depended in large part on its versatile direct-sales model that allowed its consumers to order customized products for delivery. Michael Dell argued that the company could succeed internationally because “In a lot of these markets the computer companies think that their customer is the dealer. Our customer is the end user.”49 Dell’s well-known strategy was first to target corporate customers and then to expand into the consumer market. Dell was Lenovo’s primary international challenger in the Chinese market. In late May 1999, Liu met in Hong Kong with Michel Dell.

Because of the high rate of growth of the Chinese computer market, Dell felt that there was room for international competitors to obtain a share of the market. Moreover, Dell planned to address the higher-margin business market for desktop computers and servers, where the nature of purchasing decisions differed from that of households. Dell projected that China would be the company’s main revenue generator outside of the United States within five years. Asia-wide, Dell’s operations sales in the region grew by 48% in 1998, double the industry rate.50 Dell’s efforts were noticed. Lenovo’s Yang remarked, “We pay attention

47. Rebecca Buckman, “Hewlett Reports Jump in Deliveries of PCs to China, Wall Street Journal (Eastern Edition), December 4, 2003, p. B1.

48. Bloomberg, “Legend’s Q4 Net Falls as Rivals Erode Market Share, Taipei Times, May 29, 2003, p. 11.

49. Charles Bickers, “Sharing the Pie,” Far Eastern Economic Review, June 17, 1999, pp. 54-56.

70 Lenovo: The Leading Chinese Computer Company Enters Global Competition

to all our competitors, but especially Dell.”51 In contrast, John Legere, the head of Dell’s Asian operations said, “We don’t have to beat Legend to be successful in China.”52

Dell made several moves to overcome the potential competitive advantages that Lenovo and other domestic manufacturers had over international entrants. In November 1998, Dell opened a 135,000 square-foot assembly plant in Xiamen, Fujian province. Dell avoided import costs and lowered transportation costs and some of its manufacturing costs by making its computers in China. Dell’s direct sales method also allowed the company to reduce inventory costs relative to competitors in China.53

Dell’s direct sales approach allowed the company to bypass retail and wholesale intermediaries and to avoid establishing a costly distribution network. The direct sales method offered Chinese customers the ability to customize their computers. Dell introduced toll-free help lines to provide advice for customers.54 To address the Chinese consumer’s need to have hands-on access to products, Dell set up displays in shopping malls. Because of limited credit card usage in China, Dell allowed customers to pay with debit cards and provided Chinese banks with Dell bank accounts that customers could use to deposit their payment for a Dell computer. Dell continued to encounter the problem of limited Internet usage, so that in 1999 less than 3% of Dell’s sales in China were online.55

Since their opening of its plant in 1998, Dell’s market share in China grew steadily. By June of 2003, Dell had 10% of the PC market, and 20% of the high- end computer server sales.56 However, Dell sales were concentrated mostly in the niche of the Chinese market served by other foreign companies.

4.2. HP in China

In 2002, HP merged with Compaq Computer Corporation, which expanded HP’s global market reach to over 162 countries. The combined companies had more than 88,000 employees and revenues of around US $45 billion. Formerly, HP had directed its efforts in China to selling to the commercial market. But in 2003, the company shifted its marketing towards the consumer PC market.57 As Adrian Koch, senior vice-president at HP’s personal systems group in Asia-Pacific and

50. Bickers, id. 51. Powell, id. 52. Bickers, id. 53. Bruce Einhorn, “Foreign Rivals Vs. The Chinese: If You Can’t Beat ‘Em…” Business Week,

February 15, 1999, pp. 78. 54. Einhorn, id. 55. Bickers, id. 56. Rebecca Buckman, “Computer Giant In China Sets Sights on U.S.,” Wall Street Journal, June

19, 2003, pp. B1. 57. “HP Breaking into Home PC Market with Low Prices,” SinoCast China Business Daily News,

June 12, 2003, pg. 35.

Journal of Strategic Management Education 2(1) 71

Japan, acknowledged, “We have never been as active in China’s consumer space as we have been in its commercial PC space.”58

The company planned to penetrate the consumer market in several ways. First, HP offered a variety of its Pavilion desktop PCs at prices ranging from models for middle-class consumers to high-end consumers.59 Second, HP offered PCs both through direct sales and retail distributors.60 According to Koch, “Our blended go-to-market model was built around the belief of providing customers more than one way to buy our products and receive technical support.”61 Third, HP introduced a range of digital imaging products tailored to Chinese consumers as well as a low-priced multifunction printer.

HP planned a roll out in six major cities, Beijing, Shanghai, Guangzhou, Chengdu, Shenzhen and Hangzhou. HP also planned to sell its PCs and printers through the two largest home appliance retailers in China: Dazhong and Gome. The company also entered into a program of direct investment and establishment of R&D facilities in China.62

4.3. IBM in China

IBM, founded in 1914, assisted the Peking Union Hospital in installing a business machine in 1934. After a hiatus due to civil war and political change, IBM returned to China and later opened offices in Beijing and Shanghai in the mid- 1980s.63 IBM established relationships with government agencies, supplying an IBM 38 mainframe to the State Planning Commission in the mid-1980s.64

IBM established its Greater China Group to oversee a variety of its businesses. IBM’s Greater China Group included mainland China, Hong Kong, and Taiwan. IBM Greater China employed 13,000 employees in 17 cities, and included 12 joint ventures (JVs) in manufacturing, IT services and software development.65 Among IBM’s JV partners were the China Great Wall Computer Group, the Ji Tong Company, Tsinghua University and Shenzhen University. IBM earned JV revenues in at least fifteen Chinese provinces. Also, IBM had

58. Bien Perez, “Buoyant HP steps up sales drive in Asia,” South China Morning Post, March 4, 2003.

59. “HP Breaking into Home PC Market with Low Prices,” SinoCast China Business Daily News, June 12, 2003, pg. 35.

60. Bien Perez, “Buoyant HP steps up sales drive in Asia,” South China Morning Post, March 4, 2003.

61. Perez, id. 62. Source: Li Weitao, “HP Back in Home PC Market,” China Business Weekly, June 10, 2003,

http://www1.chinadaily.com.cn 63. Yadong Luo, 2000, How to Enter China: Choices and Lessons, Ann Arbor, University of

Michigan Press. 64. Luo, 2000, id. 65. Bien Perez, “Career Path Traces the Rise of Big Blue,” South China Morning Post, March 25,

2003.

72 Lenovo: The Leading Chinese Computer Company Enters Global Competition

customer service centers in many Chinese cities including Beijing, Shenyang, Shanghai, Nanjing, Guangzhou, Shenzhen, Chengdu, Wuhan, and Xian. IBM operated regional support centers in Beijing, Shanghai, and Guangzhou. IBM invested substantial effort to establish its brand among Chinese consumers.66

IBM saw China as a potential source of technology. IBM made substantial donations of software and computer equipment to Chinese universities and it formed a partnership with the Chinese national education system.67 These investments would serve to stimulate demand for IBM’s products and services but would also attract potential employees and create opportunities for cooperative research. In 1995, IBM established the China Research Laboratory (CRL) in Shangdi in the Northwest of Beijing, one of IBM’s eight major research laboratories around the world. The CRL was IBM’s first research laboratory in a developing country.68

IBM planned a shift in its China marketing strategy to a focus on the rapidly- growing software sector. IBM had based most of its activities on hardware manufacturing but it was the leading software company in China with a market share of over 6 percent.69 The CEO and Chairman of IBM Greater China Group, Henry Chow said, “The rest of the world has grown to a point where software and services exceed 50%, 55%, even 60% of the market… But if you look at the China market, probably around 65% to 70% is hardware, although that percentage is coming down.” The move toward software sales echoed IBM’s global strategy, which included a worldwide shift toward software and services. Chow continued “I see that my role is to integrate IBM China into the global IBM, to leverage some of the competitive advantages of China.”70

5. Evolution of Lenovo’s International Strategy

The Chinese economy had passed that of Japan to become the world’s second largest market for computers. With China’s accession to the WTO, competition from both foreign and domestic computer makers would intensify further. Dell and IBM were the largest foreign firms in the Chinese market and they were seeking ways to expand their market shares. Lenovo would have to find ways to defend its home market and to address the challenges posed by international competitors. Lenovo’s managers reviewed the company’s goals, competitive strategy, and organizational structure.

There were two major alternatives, other than abandoning the PC market altogether or seeking to be acquired. Lenovo could stay the course that it had

66. Luo, 2000, pp. 200-210, id. 67. Luo, 2000, pp. 200-210, id. 68. www.research.ibm.com/beijing 69. “IBM Ranked No. 1 in Chinese Software Market,” AsiaPort Daily News, July 9, 2002, p. 5. 70. Andrew Batson, “Interview: IBM Focuses On Software, Services In China,” Dow Jones

International News, February 24, 2003.

Journal of Strategic Management Education 2(1) 73

followed since its founding by focusing on the Chinese market and defending its domestic market position against incursions from other Chinese manufacturers and international competitors. Alternatively, the company could expand internationally by developing its marketing and sales outside China, launching its brand in international markets, and seeking alliances with foreign partners. In 2000, Lenovo chose to expand internationally.

Intense competition with international companies for the home and business computer market lay ahead. The company’s domestic distribution system had provided a competitive advantage but faced challenges from direct sales over the telephone and over the Internet. The costs of R&D, distribution, and development of the company’s brand would potentially affect Lenovo’s profit margins in the years to come. The company’s pricing strategy of staying above domestic competitors and below international rivals was under pressure as the price of components continued to fall and as international firms built production facilities in China.

Lenovo did not sell the cheapest computers, but instead relied on having a brand that was well known domestically and represented high quality. The computers featured the latest Intel processors and up-to-date software from IBM and Microsoft. Ms. Ma stated that “We don’t want to establish Legend as a brand of cheaper, lower quality.”71 In its domestic market, Lenovo faced competitive pressures from lower-priced domestic brands and higher-priced global brands. Said Yang, “We’re not interested in waging a price war at the cost of profits.”72

In 2000, when Yang Yuanqing became CEO of Lenovo Group, he noted that “We are adapting ourselves to unfavorable conditions in the market. We have prepared ourselves for springtime.”73 He identified international expansion as a major goal for Lenovo. This required reaching beyond the company’s traditional computer markets into IT markets in other countries. Overall, Lenovo would attempt to become a leading international IT provider. The company’s managers faced the difficult task of building on Lenovo’s domestic success while providing a launching pad for international growth.

Yang observed that “the Group's traditional personal computer business continued to record remarkable growth, and our corporate IT and consumer IT businesses continued to sustain significant rises in operating profit. Our advances in technology and value-added services have also helped us to achieve important breakthroughs in our newly developed businesses.”74 However, Yang’s strategy was ambitious: “We want to take ourselves to an international scale, to the scale of a world first-class enterprise.”75 As Yang formulated the company’s

71. Bradsher, id. 72. Daffyd Roderick, id. 73. Daffyd Roderick, “For Whom the Dell Tolls: Can Legend Computer Save China from the

World’s Biggest Boxmaker?” Time International, March 25, 2002, p. 44. 74. “Legend Announces 2002/03 Annual Results,” Press release, Legend Group, http://

www.legendgrp.com/ 75. Rebecca Buckman, Ben Dolvenin and Susan V. Lawrence, id.

74 Lenovo: The Leading Chinese Computer Company Enters Global Competition

international strategy, he planned to target markets carefully with particular products using a five-to-ten-year progressive roll out: “We won’t invest rashly abroad on a large scale.”76

International expansion would require creating a global brand. Yang said “Our goal is to become a famous international brand.”77 The company’s first step was to change its brand name in English from Legend to Lenovo. The company’s Chinese brand Lian Xiang, which means imagination, would remain the same. Yang later observed that “Having made reference to the successful experience of well-known international brands, we decided to choose a single branding structure, which would facilitate us to concentrate our resources on the accumulation of our brand value…We believe this would greatly enhance the brand image of Legend and pave the way for our brighter future.” The new name is a combination of the old brand name of Legend and the Latin word “novo” that represents innovation and renewal.78 The existing brand name of Legend would have posed a barrier to international expansion because other companies in many other countries were already using the name as a registered trademark. As Yang stated, “We had no choice.”79 The new brand name clearly signaled the decision to develop an international presence.

The company identified a number of strategies for achieving these goals. The company would continue to serve the IT market in China, while considering how to expand abroad. The company would seek to strengthen further Lenovo’s brand image with a series of new product introductions. Lenovo would devote R&D investment to creating high-margin IT products and Internet-related products and services. International expansion would entail developing international distribution channels and incurring substantial marketing and sales costs. The company would have much to learn about customers outside its home market.

Lenovo’s global expansion began with a move into Hong Kong, with plans to enter the U.S. in the next five to ten years and Europe after that.80 Yang cautioned “To go straight into the U.S. market – in this industry, the four major brands, HP, IBM, Dell, Gateway, they are all there, they cast their big shadows there, so this may not be your best market.”81 The company faced the challenge of devoting resources to international expansion while simultaneously competing with entry in its home market.

Arguably, Lenovo’s most powerful attributes in China were distribution and service networks. To expand successfully outside its domestic market, the company would need to address international distribution. One approach would

76. Buckman et al, id. 77. Powell, id. 78. Legend Group, April 2003 Press Release. 79. Bruce, Einhorn, “A New Twist in Legend’s Tale,” Business Week Online, June 23, 2003. 80. Bruce, Einhorn, “A New Twist in Legend’s Tale,” Business Week Online, June 23, 2003. See

also Powell, id. 81. Rebecca Buckman, Ben Dolvenin and Susan V. Lawrence, “Legend Goes for the Big League,”

Far Eastern Economic Review, June 19, 2003.

Journal of Strategic Management Education 2(1) 75

be to acquire foreign companies with distribution capabilities while another would be to rely on wholesalers and retailers for distribution. Lenovo’s CFO Ms. Ma noted these possibilities, “Acquisition is one of the possibilities and hopefully we can go through other people’s distribution channels, or partnerships.”82 Another option would be to emulate the direct sales approach that Dell employed so effectively. The company would need to compare the costs and benefits of alternative distribution channels.

In order to stay competitive with the technology of foreign competitors, Lenovo planned to increase its spending of revenue on research and development from 1.8% to somewhere in the range of 3 to 5%.83 Lenovo viewed its ability to tailor IT products to the needs of Chinese consumers as one of its core competencies.84 The company was a fast follower in applying product innovation incorporating technological innovations. Lenovo also explored contracts and partnerships with innovative international computer companies to access particular necessary technologies.

Product development was essential for Lenovo to apply its new Lenovo brand and address the needs of consumers and businesses outside China. Half of the company’s home-PC sales in China during 2002 were due to their “dual mode” PCs.85 These PCs were multifunctional in that they allowed users to skip the desktop screen and instead go directly to a screen display for an audio player or a movie player. Such products could prove attractive to consumers in many other countries.

Expansion abroad would also require marketing expenditures to promote the Lenovo brand. Lenovo’s managers would need to weigh the investment costs of developing the brand against the potential returns. The company would need to invest in identifying target countries and learning about customers and competitors outside its traditional domestic market. Lenovo’s managers would have to evaluate whether their products were suited to customer needs in developing and developed economies, and whether the company should focus on specific geographic regions.

Substantial expansion of sales abroad would have the advantage of lowering unit production costs if the company could take advantage of economies of scale particularly in manufacturing. Moreover, production in China would result in labor cost savings that could provide advantages in international markets. However, the company would have to balance these cost economies against the high cost of transportation. Cost economies would also need to be balanced against the potential advantages of locating product design and manufacturing close to customers.

82. Bradsher, id. 83. Bradsher, id. 84. Company information provided for this case study. 85. Buckman, id.

76 Lenovo: The Leading Chinese Computer Company Enters Global Competition

These cost tradeoffs existed even within the Chinese market. In July 2003, Lenovo opened a US $ 7.23 million computer manufacturing plant in Pudong, with the capacity to assemble 1.5 million desktop units and 360,000 laptops. The plant added to the company’s manufacturing facilities in facilities in Beijing and Huiyang, Guangdong Province. According to Yang, “The plant’s setup marks a complete supply chain for Lenovo in Shanghai, including research and development, manufacturing and a marketing network.” The plant could serve both the domestic Chinese market and the export market since it was located in the Jinqiao Export Processing Zone. Although, the costs of land and labor in Shanghai were the highest in China, the advantage of the plant’s location was proximity to larger markets since Lenovo obtained about a quarter of its sales in east China. Yang observed that the plant “will bring us big profits from economies of scale.” In evaluating relative costs of manufacturing in Shanghai, where the costs of renting industrial space (1.1 yuan per square meter per day) are multiples of lower-cost alternatives, Yang noted that “The priority of our strategy is to produce close to our market. We believe the lower transportation costs for product delivery will offset the increase in other sectors.”86

Another advantage of producing in Shanghai was the ability to cooperate with international partners. By manufacturing notebook computers in Shanghai, Lenovo planned to work with Taiwanese partners First International Computer, MiTAC, Compal, and Acer, who had advantages in R&D and chip design. Yang noted that “Legend will use the new assembly plant in Shanghai as a strong foothold from which to develop the market with Taiwan partners.”87

Competition in the Chinese market for notebook computers intensified. Lenovo and international companies such as Dell, IBM, Toshiba, and Sony maintained or increased their market shares. Matsushita began to produce notebook computers in its factory in Xiamen, Fujian Province. Domestic companies such as Great Wall, Langchao and Hisense left the notebook market.88

To strengthen its research and development and software capabilities, Lenovo partnered with many international companies including Intel, IBM, HP, Siemens, Toshiba and Microsoft. Lenovo’s partnerships, particularly with Intel and Microsoft, provided much-needed access to R&D as well as funds for marketing. In 2001, Lenovo entered into a US $200 million joint venture with AOL Time Warner that involved bundling AOL’s Internet services with Lenovo’s computers and use of Lenovo’s web sites. Lenovo’s Ms. Ma said that Lenovo wanted to have a strong partner when China joined the WTO.89

86. The information and quotations in this paragragh are drawn from “Legend Opens Factory in City,” Shanghai Foreign Investment Service Center, July 29, 2003, http://www.sfisc.com/news/ 0308a02.htm

87. “Legend Holdings Cooperates with Local Notebook Makers,” Computex Online, June 8, 2001, www.computex.com.tw/comp2001/news0608.asp

88. Li Weitao, “Matsushita to Tap Local PC Market,” March 4, 2003, Business Weekly, http:// www1.chinadaily.com

Journal of Strategic Management Education 2(1) 77

Lenovo launched its “Legend World” technology convention in 2002, the first Chinese IT company to host such an international convention. The conference was attended by the full range of international IT firms including Microsoft, Intel, Oracle, and Texas Instruments. The meeting was intended to give IT companies in China greater access to international technology while providing greater information about the Chinese market to international companies. Lenovo introduced its concept of “collaborating applications” that allowed different consumer, commercial and corporate IT products to work together, reflecting Yang’s vision of technological innovation and the company’s technology strategy in relation to developing global IT standards.90

Lenovo, through its Technologies Development Company, contracted with Microsoft, IBM, Oracle and Lotus to act as their software dealers.91 Lenovo signed a deal with Microsoft to develop set-top boxes that allow users to access the Internet and email through their television and telephone. The low-cost boxes would use Microsoft’s Venus operating system, a Chinese language version of its Windows software.92 Lenovo agreed to jointly develop software with Computer Associates. In cooperation with Toshiba, Lenovo established a marketing college with training sessions to be conducted in Beijing, Shanghai, Guangzhou and Chengdu to train technicians and sales personnel from Lenovo, Toshiba, and Intel.93

Lenovo entered into a number of manufacturing agreements. Lenovo contracted to manufacture HP’s Inkjet printer. Lenovo’s contractual alliance with Siemens involved production of Siemens computers in Lenovo’s Huiyang plant. Siemens was the leading PC seller in Germany and one of the top 10 worldwide. The companies planned long-term cooperation in production, research, development and marketing.94 Other global entrants found local partners: IBM partnered with Great Wall, HP partnered with the Stone Group and the Star Group, and Toshiba with Tontru.95

Lenovo in 2003 formed the Digital Home Working Group with 16 other companies (Fujitsu, Gateway, HP, Intel, IBM, Kenwood, Matsushita Electric/ Panasonic, Microsoft, NEC CustomTechnica, Nokia, Philips, Samsung, Sharp, Sony, STMicroelectronics, and Thomson). The working group would attempt to standardize formats for digital equipment to give their consumers interoperability between their devices, including for example Lenovo PCs and Nokia phones. The

89. Michelle Levander, “A Great Leap Forward? Legend’s innovative partnership with AOL may signal the direction of China’s Internet market,” Time International, June 25, 2001, pp. 28.

90. “Legend Launches the First Innovative Technology Convention: Legend World 2002,” Company press release, Beijing, December 3, 2002.

91. “Legend Technologies Selling Microsoft Products,” Asiainfo Daily China News, Copyright Asia Intelligence Wire from FT Information, April 14, 1999.

92. Bickers, id. 93. “Legend-Toshiba Marketing College Opened,” Asiainfo Daily China News, Dallas; Copyright

Asia Intelligence Wire from FT Information July 6, 1999. 94. China Daily, June 1, 1999. 95. Kenneth L. Kraemer and Jason Dedrick, id.

78 Lenovo: The Leading Chinese Computer Company Enters Global Competition

working group also sought to develop products that could share information allowing customers to have a networked household. Devices would share digital content such as music, photos, and video. In addition, the working group would share some types of marketing costs. The working group strengthened Lenovo’s lines of communication with international companies, improved Lenovo’s access to technology and enhanced Lenovo’s international brand recognition.

6. The IBM Acquisition

The IBM acquisition represented a rapid acceleration of Lenovo’s plans for international expansion. What were the strategic motivations for the acquisition? What were the potential complementarities between Lenovo and IBM’s computer business? What obstacles lay ahead for the company?

By divesting its PC business, which required high-volume and economies of scale, IBM could concentrate its efforts on R&D and the high-end corporate market. Also, according to a filing before the U.S. Securities and Exchange Commission, IBM’s personal computing division had made losses steadily for the three and a half years preceding the sale to Lenovo: $397 million in 2001, $171 million in 2002, $258 million in 2003, and $139 million in the first six months of 2004, on total sales of about $34 billion over the period.96 Although IBM gained from the sale and divestiture of an unprofitable business unit, what would be the benefits for Lenovo in acquiring the PC division?

Lenovo stood to gain scale from the acquisition, potentially adding IBM’s $10 million in annual sales to its total. IBM already manufactured its ThinkPad laptops outside the U.S., see Table 5 below. By consolidating some production of the combined company in China, particularly assembly, Lenovo might benefit from economies of scale in manufacturing. By consolidating purchasing of components with its own sourcing, Lenovo could reduce transaction costs of procurement. Through standardization of parts and price concessions from suppliers receiving a greater volume of orders, Lenovo could reduce procurement costs. Joint management of the supply chains for the combined company might improve productive efficiency and reduce logistics costs. To achieve these gains, Lenovo would need to effectively integrate its worldwide manufacturing and component sourcing activities.

96. New York Times, December 31, 2004, p. C4.

Journal of Strategic Management Education 2(1) 79

Table 5: The components for an I.B.M. ThinkPad X31 that sells for $2,349.

Source: Barbosa, New York Times, 2004, id.

The acquisition potentially offered marketing synergies. Lenovo increased its world market share from 2.3% to 8.3% as against Dell’s 18% and HP’s 16%, edging out Fujitsu, Toshiba, Acer, N.E.C., Gateway and Apple.97 Lenovo would gain access to U.S. and European markets for its products, such as multimedia PCs, by employing the knowledge of former IBM employees regarding consumer preferences, marketing techniques, and sales distribution channels. At the same time, Lenovo could apply its Chinese distribution network and knowledge of Chinese consumer preferences to market and sell IBM ThinkPads and ThinkCenter PCs. The company would need to coordinate its international sales and distribution efforts, integrating the IBM business with its Chinese business. Combining IBM’s Chinese business with Lenovo’s domestic distribution would likely prove straightforward. However, outside China, growing the business might present substantial difficulties, given IBM’s prior concentration on business customers and Lenovo’s combination of consumer and business sales.

Lenovo gained the use of IBM’s brand name. Lenovo would use the IBM brand name for IBM’s popular ThinkPad laptop PC and ThinkCenter desktop PC for up to five years. This would ease Lenovo’s entry into the international marketplace where IBM’s brand was well known. By associating Lenovo’s brand with that of IBM, the company would improve the recognition for its own brand. This would reduce the marketing costs required to launch a new brand. The challenge would be to hold on to customers who had purchased IBM’s ThinkPad

Input Location Manufacturers Approximate Cost Assembly Mexico IBM NA

Memory S. Korea 10 manufacturers 512 megabytes $60

Case and Keyboard Thailand NA $50 Wireless Card Malaysia Intel $15 - $20 Battery Asia NA $40 - $50 Display Screen S. Korea Samsung and

LG Philips 15-inch $200 17-inch $300

Graphics Controller Chip

Canada and Tai- wan

ATI and TSMC $30 - $100

Microprocessor US Intel Centrino Chip $275 - $500

Hard Drive Thailand NA $1.50 - $2.00 a gigabyte (typical drive 40 gigabytes)

97. Barbosa, December 4, 2004, id.

80 Lenovo: The Leading Chinese Computer Company Enters Global Competition

as a high-end laptop. Lenovo would have to weigh the effect on IBM’s former customers of changes in marketing, product design and types of components.

In addition of IBM’s products, Lenovo stood to benefit from IBM’s technological knowledge in two ways. First, Lenovo would obtain the technology owned by IBM’s PC division. This included the design of the ThinkPad laptop, which would prove useful given the shift toward mobile computing in PC markets. Second, Lenovo would gain from the technical knowledge of the employees of IBM’s computer division. In addition, Lenovo’s existing technological partnership with IBM would be potentially enhanced and lead to cooperative R&D and other joint ventures.

Stephen M. Ward Jr., the Senior V.P. and general manager of IBM’s Personal Systems Group, was named CEO of Lenovo as Yang Yuanqing relinquished the post of CEO and became Lenovo’s Chairman. The new company would retain IBM’s managers, placing them in top positions, and the company would be headquartered in the United States. Lenovo would benefit from the knowledge and experience of the managers and employees of IBM’s PC division. IBM had over 10,000 employees with about 2,500 in the US and the rest working abroad, about 4,200 of which were already working in China. These employees would join Lenovo’s 9,000 employees and would bring distinct and complementary technology skills. Also, IBM employees would bring experience in managing an international business and operating in developed economies. Training and international teamwork would be needed for Lenovo to transfer effectively the skills of IBM’s employees across the company.

The acquisition of IBM’s PC division also represented a partnership with the parent company. IBM had agreed to provide customer service, financing, and leasing. Also, IBM would have an 18.9% share of Lenovo. This meant that IBM would have an interest in the success of Lenovo and would be likely to partner with the company in other areas including R&D. Lenovo could partner with IBM in serving large businesses and government agencies in China. Both Lenovo and IBM already served large businesses and government agencies in China and there were clear benefits from partnering in those efforts. IBM had extensive experience in serving corporate and government customers and offered products and services for large-scale customers. Lenovo brought connections and knowledge of corporate and government customers China. In July 2003, Samuel J. Palmisano, IBM’s CEO approached a senior official in the Chinese government seeking approval for the potential sale of its PC unit to Lenovo. Such approval was desirable not simply because Lenovo was partly owned by the Chinese government. It also provided the basis of a partnership between IBM and the Chinese government that would potentially translate into corporate and government sales. Although there was no specific deal, Palmisano observed “It’s a much more subtle, more sophisticated approach. It is that if you become ingrained in their agenda and become truly local and help them advance, then your opportunities are enlarged.”98

Journal of Strategic Management Education 2(1) 81

7. Overview

Lenovo’s acquisition of IBM’s PC division set the stage for Lenovo’s entry into global competition. However, the challenges confronting its CEO Stephen M. Ward Jr. were just beginning. One difficulty would be integrating the organizations of the two companies. Lenovo had concentrated its efforts in China before the acquisition. Now, the company would be headquartered in the U.S. and the company would need to coordinate its international managers and employees. Another difficulty would be integrating the product lines of the two companies, the high-end IBM ThinkPad would complement the existing computer products offered by Lenovo as well as the company’s other electronics products. The merger offered significant complementarities in marketing, sales, manufacturing, and technology, but achieving those benefits would require substantial integration and coordination of the company’s activities across many countries.

By acquiring IBM’s PC division, Lenovo heightened its rivalry with Dell and HP. The company would need to address the cost efficiencies of Dell’s direct sales model and HP’s strong consumer retail sales in the U.S. and Europe. Computer prices continued to drop and other competitors were expanding their international activities. Fujitsu-Siemens, the leading computer company in Europe, offered both consumer and corporate IT products, drawing on the strengths of its two large parent companies. Japan’s Toshiba would continue to build on its strengths as a large diversified electronics company with expertise in mobile computing, design and manufacturing of components, and industrial electronics . Taiwan’s Acer had significant experience in global operations. Building on its position as the leading laptop computer seller, Acer planned to expand its sales in the U.S. and China. Although Lenovo had become the third largest PC company in the world, in many ways Lenovo’s entry into international competition was just beginning.

98. Steve Lohr, “I.B.M. Sought a China Partnership, Not Just a Sale,” New York Times, December 13, 2004, p. C1.

82 Lenovo: The Leading Chinese Computer Company Enters Global Competition