China: Expanding Your Circle of Competence

One point that Buffett hammers home nicely is the idea of staying within your circle of competence.  This blog post is a great recap of both Munger and Buffett’s view on circle of competence.  However, if you read between the lines, Buffett and Munger are both learning machines.  Munger has said, “In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero. You’d be amazed at how much Warren reads – at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”

Reading is about deepening the knowledge we have within our circle of competence and also expanding it.  I believe the world is competitive space and refusing to learn is the surest way to lose in this competitive world.

I have attempted to avoid learning about China for quite some time, but I have a long list of books building up in my library. I started down that path over the weekend with a short intro called, The One Hour China Book.  It’s a quick read and made me want to take the next step.  I thought I could provide a quick recap of the book.

Urbanization: The shift towards cities is adding 18.5m people each year to China’s cities.  This is equivalent to adding the population of Netherlands to China’s cities each year.  The infrastructure growth needed to support this migration is driving huge parts of the economy.  Additionally the urbanization is changing consumer preference dramatically.  Brands, such as Nike and Apple, might not have flourished in a rural area, but in dense cities the social aspects of brand recognition increase the consumer awareness and change buying patterns.

Huge Manufacturing Scale: This point is mostly known from a U.S. perspective.  However, the manufacturing “shift” is still underway.  The shift from low-tech assembly to high tech manufacturing is continuing to have an impact on the future competitive nature of various industries.  A few decades ago, Nike might have been the main export (shoes), but now the majority of exports are classified as tech (think iPhones).  In fact, the recent Samsung battery recall occurred because of an error at a Samsung (Korean) subsidiary and Samsung quickly sought out a replacement for the recalled items from its secondary supplier, a Chinese manufacturer.

Rising Consumers: OCED predicts that by 2026, the Chinese middle class will represent 66% of all middle class globally, up from 18% in 2009.  This rising middle class has had multiple ripple affects upon the farming industry, among others.  China is now the largest consumer of pork and will soon overtake the U.S. as the largest consumer of chicken.  This is only the start of how the rapidly evolving “value for money” to experience and fashion consumer will take China.  It’s unclear how quickly or where these consumers will land (Chinese or foreign brands), but the shift is underway and the numbers are massive.

Money: I am going to reserve comment on this subject as I am currently reading another book called Red Capitalism, which discusses this topic in more detail.

Brainpower Behemoth: This is one area that I think Americans underestimate China.  In some ways, we overestimate our origins.  See this article (“We Were Pirates Too“) regarding the similarities with intellectual rights in the early U.S. with China currently.  China’s education system may still be trailing in engineering and science areas, but there is no reason to think that their progress will not continue.  This book is written by two Professors who openly point out the gaps and deficiencies, but argue that these gaps are closing rapidly.

The idea of creativity and innovation are bandied about as characteristics that the Chinese educational system does not foster.  However, the innovation currently happening in China is “cost innovation.”  This cost innovation has allowed China to compete directly with other multi-national companies in developing countries, such as Africa where cost structure is a priority.  However, research and development dollars are shifting and the true innovations will be the next stage.  For example, in 1993, China accounted fro 2.2% of the world’s R&D budget, however, by 2009, this figure had increased to 12.8%, second only to the U.S.

Chinese Internet: Here is a good data point on this issue: “The total number of Chinese users online is large (550m in China vs. 245m in the US), and this has mostly been a phenomenon of just the last few years.  Of the 500m Chinese currently online, about 300m of them (60%) have only moved online in the last three to four years.” (For reference, the current U.S. population is roughly 320m)

The aspect of the internet in China that most intrigued me was how some of it feels more “innovative” than what we currently have in the U.S.  WeChat, in particular, has embarked on a One App to Rule Them All strategy and so far has created a “Super App.”  This is, in some ways, what Facebook has laid out in its ten year plan.  However, Tencent, the corporate parent of WeChat, has already done it.  Some people are waiting for the “next iPhone” to come out of China when WeChat has already become “the next big thing.”  You can read more about WeChat in this article (“When One App Rules Them All“).  John and I plan to write more about Tencent, but suffice it to say my initial research makes me wonder why Tencent is not more valuable than Facebook.

This book is a quick read and provides some initial guidance on the outlines of where you might want to go for further research.

Some follow-up articles on the internet in China can be found here: (Money as a Message, Mindset for Thinking about Innovation and Competition in China and Live streaming in China). The author of these posts is Connie Chan and she is excellent.

Matt Brice is the portfolio manager of The Sova Group, LLC, an investment firm that manages separate accounts for clients. Matt can be reached at matt@thesovagroup.com.

 

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