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A computer legend in the making

Tycoon Liu Chuanzhi, the chairman of Legend Holdings, explains how his company became China's--and Asia's--leading manufacturer of PCs.

When people in most parts of the world want to buy a personal computer, they usually think first of the well-known brands: Compaq, Dell Computer, and IBM, for example.

Not so in China. There the branded PC of choice is called Legend. Never heard of it? Perhaps not for long, if Liu Chuanzhi has his way. Since 1984, Liu, the chairman of Legend Holdings, has built his company into China's (and Asia's) No. 1 manufacturer of PCs, with more than $3 billion in revenue. Legend expects to double that figure in three years.

Although still controlled by the state, Legend is a public company, and its shares trade on the Hong Kong Stock Exchange. Liu is a forceful advocate for going public and a pioneer in China in the use of stock options. In the following interview, Liu discussed the challenge of shaping a successful market-based company in China and the prospects for Legend in the hypercompetitive technology sector.

The Quarterly: Please tell us about the origins of Legend and how you went about building the company.
Liu Chuanzhi: I came out of the Chinese Academy of Sciences, where I was doing work on magnetic storage. But I had to put my designs to the side because there was no way to turn them into products. In 1984, when the market reforms in China were starting to take effect, the country's leaders called for the conversion of research and development results into products that could be marketed. I was excited about doing this type of work, but most people didn't understand it. Chinese people put scientific work on a pedestal, while commercial activities were looked down upon.

More important, although our company was a state-owned enterprise, we structured it as a private company from the beginning. I had to raise capital from banks and outsiders. The initial investment of 200,000 renminbi was so small that it was barely enough to get started.

The government did give me a very good opportunity. When I discussed terms and conditions, I requested the authority to make decisions myself. I didn't want the government to decide who would work for me. In addition, I had financial decision-making power. I could determine the wages and bonuses of our employees, and I didn't have to do so according to what the government told me.

As time went by, I wanted Legend to make its own PCs because we were technology experts. But at the time, China was entirely a planned economy. The government wouldn't permit us to produce computers because in China you had to have a license. The government felt that China had many factories, so why should it give a PC license to a company such as ours? I therefore crafted a strategy to go to Hong Kong, which didn't require a license. We set up a company in Hong Kong, at first to do trading, and we later set up a factory. When China's Central Planning Department saw that we had the capability, it gave us a license. So we went back to China.

Our earliest and best teacher was Hewlett-Packard. It was as HP's distributor that we to organize sales channels and how to market. How much did you rely on Western technology? Are there Western companies you try to emulate or Western CEOs from whom you would like to learn?
When we started to work as a distributor for foreign companies, we discovered that management was something we had to learn. So we learned from foreign companies while gaining an understanding of China's computer market.

Our earliest and best teacher was Hewlett-Packard. It was as HP's distributor that we learned, rather thoroughly, how to organize sales channels and how to market. Later we did a lot of business for HP and helped it reach its leading position in China's computer market. We also studied the strategies of Intel and Microsoft. We constantly read foreign management journals.

Particularly good were the books by Andy Grove, Bill Gates, and, especially, some Taiwanese businessmen, like Stan Shih. But one key point is that I wanted to do things according to China's actual situation, not just blindly follow theory without considering reality.

As for the CEO I admire most, that would be Jack Welch. I studied at Crotonville--GE's management-training center--for two weeks. I hope to meet him the next time I take a trip to the United States.

Which brands do you distribute in China today?
Our biggest business is HP laser printers and ink-jet printers. The second is Toshiba notebook computers. The third is Cisco networking products. We also distribute IBM minicomputers and Microsoft applications software.

Do Legend-branded products compete with these?
While we distribute Toshiba notebooks, we also have our own branded notebook that has now become No. 1 in the Chinese market. Several years ago, the market for Toshiba notebooks was very small in China--only a few thousand units a year. Later, after we became the exclusive distributor for Toshiba, we developed it into the No. 1 brand in China. But in the past two years, after we came out with our own branded product, our brand has surpassed theirs. In China, it hasn't been long since the market-opening reforms, so people don't have a strong sense of the market, and business ethics are underdeveloped. In addition, for laser printers HP is No. 1, while we're No. 2. This has created competition. Plus, in networking products, we compete with similar products we represent from Taiwan. Cisco's products are higher-end, so we don't compete with them. To compete more effectively as a manufacturer and a distributor, we decided to separate the branded-products business from the third-party distribution business. Legend Computer will retain its current listing in Hong Kong and focus on branded products. Digital China will be spun off as a new listed company to focus on the distribution of third-party products.

What is the basis for Legend's success in China?
From a longer-term perspective, we focused on two areas, and in both cases we looked to U.S. companies as a model. One was to restructure as a publicly held company and sell shares. We believed that after we restructured, we could get onto the same track as publicly held foreign companies. This also enabled us to offer stock options to our employees, and I believe that it has had a very positive impact on their performance.

The second idea was to build a solid management foundation. We look at management on two levels. On one level, there are the nuts and bolts--marketing and promotions, channel management, product marketing, ordering, and logistics management--and we built these into the company. Then there is a deeper level that deals with what we call culture but might also be described as motivation and ethics, and this is more problematic than developing the nuts-and-bolts areas of management.

Can you elaborate on the challenge associated with this aspect of management in China?
Americans already have a strong sense of the market, a strong sense of business ethics, and a strong spirit of loyalty. In China, it hasn't been long since the market-opening reforms, so people don't have a strong sense of the market, and business ethics are underdeveloped.

How do you motivate a leadership team in China?
State-owned enterprises have problems in this area because of compensation limits. When a key manager gets paid a low salary, he doesn't feel the need to bear responsibility, nor does he have the ability to take responsibility, because a lot of things are simply out of his control.

I think going public has had two major effects on Legend. The first is the
>ability to obtain capital; the other is dealing with shareholder pressure. We have tried to instill a different culture at Legend. We hope that the highest managers at Legend will come to work with a desire to serve the company. What I mean by "a desire to serve the company" is something more than a desire for advancement--more than economic compensation and a better position. This is normal, but for Legend it's not enough. A Legend manager must first think of Legend as a career. If Legend does well, he'll do well. In China, there are two days a week of rest. But at Legend, most employees take only one day off, so that they can study. This is of their own free will.

And one important way you have addressed the motivation issue is the use of stock options?
We started the options program in 1994. Actual distribution began around 1998, and we think it has had a huge effect. One of our company's missions is to integrate the needs of our employees with those of the company. To make them true masters, from a materialistic standpoint, options play an important role.

Ten percent of the employees in our listed companies have stock options. Our entire company has about 7.4 billion shares, and 740 million shares are set aside for employee stock options. All white-collar employees who have been in our company for more than two years get stock options. But when they reach upper management, they get a lot more.

Legend was one of China's first companies to be listed abroad. How would you assess its experience as a publicly held company?
I think going public has had two major effects on Legend. The first is the ability to obtain capital; the other is dealing with shareholder pressure. The purpose of going public is not entirely to get the money. Dealing with shareholder pressure is a way to improve because shareholders demand transparency and systematic management.

So from one perspective, I regard this pressure as a type of motivation. Our company demands a special degree of transparency--the good, the bad; the shareholders must know everything. Legend's most fundamental objective is to serve the long-term interests of the shareholders.

Another big opportunity comes from the fact that we understand the Chinese consumer better than foreign companies do. In contrast to the slowdown in the global PC market, the PC market in China continues to grow at a rapid pace. What are the biggest opportunities you have identified? On the macro level, the Chinese market is starting from a low base. For example, only 4 percent of households in midsize cities currently have PCs. In large cities, this number is between 10 percent and 20 percent. In comparison with the United States, there is a huge gap, so the market potential is very big.

Another big opportunity comes from the fact that we understand the Chinese consumer better than foreign companies do and are better able to segment the market. Although American companies are strong in technology, they do R&D with a view to global markets--they haven't spent as much time conducting R&D for the Chinese market.

Just think about different product applications. The nature of written Chinese creates differences in the way IT products are used. For example, Americans are accustomed to using keyboards for input. Keyboards are suited just for alphanumeric input, not for ideographs. So computers in China must develop either voice input or a better way to input by hand. In addition, there is the way companies use computers. Financial statements in China are different from those in the United States, so software has to be developed differently. You need to have a deep understanding of how this type of product would be used by a Chinese company. This could be considered a weakness of American companies relative to Chinese companies.

We also view services as an important strategic area. For example, there are 10 million small companies in China that buy computers primarily for accounting, inventory, purchasing, and payroll. Just buying a computer is not enough. A company of, say, 200 people needs to be networked. Plus, you need to make modifications to the software. We expect that this will be a profitable sector for us.

What challenges does Legend face in its effort to expand market share and profitability? The biggest challenge is that this industry changes so much. We can't be like US companies that are in a position of leading the trends; the main thing for us is to keep up with the trends. Many American companies have taken different directions, so how do we assess which of them will become mainstream?

The second challenge concerns our business in China. Our market share is getting bigger and bigger. We have over 30 percent of the PC market in China. As we move forward, we'll reach our limit, so someday--probably after 2005?we'll have to go overseas. The question is how we will do this: whether we will try to sell branded goods or take the OEM approach. When we analyzed the drivers of our past performance, we discovered that it was due to our having leveraged local competitive advantages, such as knowing how to make products that fit the needs of Chinese consumers. However, once we go overseas, these will no longer be advantages, so I will be very cautious.

Just look at the experience of the Taiwanese technology companies, almost none of which have built brands overseas. They haven't figured out how to compete with foreign brands overseas. I think we could take the path of Taiwanese companies that are original-design manufacturers, or we could cooperate with Taiwanese companies.

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