HENNES & MAURITZ AB. H&M s Strategy and Entry into the Chinese Market

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1 HENNES & MAURITZ AB H&M s Strategy and Entry into the Chinese Market Exam: 48 Hour Individual Home Assignment Lena-Sophia Boerries Bsc. International Business Number of Pages: 10 Number of Characters:

2 1.1 Introduction This paper aims to give an overview of the H&M Group as a whole, assess its core competencies, as well as evaluate the different aspects of H&M s expansion to China. First, a brief introduction to the H&M firm will be given before going into an evaluation of its mode of operations within the Chinese market, thus concluding whether this mode is the most effective for the expansion strategy. This shall be accomplished by utilizing Dunning s eclectic paradigm. The eclectic paradigm will be focused on the retail store, not production, aspect in the Chinese market, and will evaluate as well as determine which type of foreign activity engagement H&M should partake in based the ownership- and locational-advantages. Finally, H&M s organizational architecture will be discussed and subsequently analyzed in order to determine whether this firm structure is the best fit. 1.2 Company Overview & Mode of Operations Hennes & Mauritz AB, otherwise known as the H&M Group, is a multinational clothing retailer company that was founded in 1947 by Erling Persson in Västerås, Sweden and has since then been a family-run business, with its current CEO Karl-Johan Persson being the grandson of the founder. H&M is a publicly traded company and is listed on the Nasdaq Stockholm, where its headquarters are located, with the majority of the shares being owned by the Persson founding family (H&M Group, 2016). The H&M Group has a total of 4,133 stores, and not only includes its namesake brand H&M, but also incorporates six other brands under its umbrella; these brands include COS, Weekday, Monki, Cheap Monday, &Other Stories, and Arket. The H&M Group s primary and largest label, H&M was present in 64 countries as of 2016, with 35 of these countries having an online shop (Loesche, 2017). The H&M label sells clothing for men, women, and children at an affordable price point, which corresponds with the company s mission statement of providing fashion and quality at the best price in a sustainable way (H&M Group, 2017). The business of fast-fashion itself is contingent upon providing the customer with an ever-changing assortment of stock, in which the retailer offers a trendy new look that can be worn for the moment (Loeb, 2015) and discarded quickly thereafter due to its relatively low price point. 1

3 As of August 2017, The H&M Group has opened 490 stores in China as well as an online shop, making it their second biggest market, only to be surpassed by the 511 stores in the United States (H&M, 2017). The H&M group first entered the Chinese market in 2007 by opening their H&M label flagship store in Hong Kong, which was closely followed by another store opening in Shanghai in that same year. H&M s strategy for expansion is largely location-based and focused on establishing a strong customer following. Both flagship stores were opened with the optimal location in mind, namely the first flagships were placed in major shopping areas that had large amounts of foottraffic and many tourists. H&M chose to rent their store spaces via lease agreements rather than buying real estate in order to allow for flexibility in the ever-changing business environment of retail, as evident by the steep increase in rent prices which forced H&M out of its Hong Kong flagship five years after its opening (Chen, 2012). Staying consistent with their expansion strategy H&M engaged in foreign direct investment by establishing their whollyowned subsidiaries in China, and set up its Chinese headquarters in Hong Kong. The main objective for expanding into the Chinese market was to increase the company s global growth by 10-15% annually, and this goal is best supported by the opportunities the Chinese market brings, with over a billion potential customers, this market is comparable to H&M s main market, Europe, which accounts for the majority of the company s sales (Hellstrom, 2007). 2.0 The eclectic paradigm theory: the OLI Framework The OLI framework, also known as the eclectic paradigm, establishes a framework that determines the extent of foreign activities, as well postulates that multinationals are driven by three sets of advantages (ownership, location, internalization) which determine whether or not a company will be encouraged or discouraged to engage in foreign direct investment (FDI), thus internationalizing and becoming a multinational enterprise. (Dunning, 1979). 2

4 2.1 Ownership Advantages H&M s competitive advantages lie within its core competencies that differentiate them from other market competitors. The multinational s over seventy years of experience in the retail industry as well as its sheer size of over 4,000 global retail locations, all of which are whollyowned subsidiaries, thus giving the company total control over each out of its stores and a major ownership advantage. Due to its aforementioned vast quantity of stores around the world, H&M must produce a vast amount of output, which in turn reduces the cost of production as the company is able to leverage its bargaining power within their supplier network, due its centralized buying unit in Stockholm, supplying a large volume of over 4,000 stores. By doing so, H&M has a definitive ownership advantage, namely economies of scale. Inbound logistics, a primary activity, is a key ownership advantage for H&M as the fast-fashion business is inherently dependent on reducing the lead time between designing a product and having it in stores. While the clothes are designed in-house by a group of 150 designers, the production is outsourced to approximately 800 independent global suppliers, most of which are located in Europe and Asia, from which the 100 employee strong buying department in Stockholm buys from. To coordinate this key activity, H&M has a highly effective inbound logistics system that not only incorporates an efficient supply chain, but also has a follow-up system designed to track orders as well as promote a swift product turnover in their retail locations (H&M, 2014). Their finely honed system allows H&M to reduce their average product lead time to as little as six weeks, allowing them to replenish their stock regularly and respond quickly to new trends, which keeps customers coming back to the store. As a complementarity, their sales and marketing is another primary activity that raises H&M above the rest. H&M s collaboration with big name designers (e.g. Karl Lagerfeld, Versace, Balmain) raise brand visibility, coupled with their scrupulous trend analyses that help predict future customer demands, are both aspects of a primary activity which has made the Swedish fast-fashion retailer a market leader (Sherman, 2015). A key supporting activity of H&M s global value chain would be its technology development. In order to support their expansive retail operations, H&M developed its very own in-house IT- Platform that is identical in each retail location, which in turn allows H&M to manage their 3

5 inventory efficiently by maintaining an updated overview sales and stock (H&M 2014). Their administrative infrastructure is also vital supporting activity, as its Scandinavian based ownership could be viewed as a competitive advantage, where the informal management style is goal-oriented rather than preoccupied with taking orders, as well as being decentralized henceforth focusing on cooperation throughout the entire company (Karlsson). 2.2 Location Advantages In order to better understand the macro-factors that would affect H&M s external business environment in China and further assess H&M s competitive analysis, a PESTLE analysis will be conducted on the factors that are relevant to the retail aspect of H&M s expansion into the Chinese market. The PESTLE analysis, an external analysis tool, takes the political, economic, social, technological, legal, and environmental factors of a country into account in order gain a comprehensive and strategic understanding of the business environment in a host country. Political-Legal Factors In 2001, China shifted to a market- economy thanks to its Premier, Zhu Rongji (WTO, 2001), settling a deal to became part of global trade by entering into the World Trade Organization (WTO). As part of this shift in policy, China amended or eradicated over 3000 administrative regulations and laws, including tariffs, quotas, or other trade barriers (WTO, 2011). As a result of these political and legal changes, foreign investment has soared in China. Still, it is important to note that the Transitional Safeguard Mechanism (WTO, 2001), which is in effect for 12 years after accession, is no longer in effect as of Although it is unlikely that China might leave the WTO, due to China s success in garnering foreign investments which significantly boosted their GDP as a result of their 2001 entry, it is still a possibility that must be considered when entering the Chinese market. When H&M first entered the Chinese market in 2007, it was a time of little societal unrest and relative political stability, hence being a locational advantage. This political stability was due in part to the nature of the Chinese political system itself. Being one-party state that holds no public elections for parliament, the political power in China remains static and concentrated 4

6 within the government s key representatives, which allowed the country to shift towards a more market-based economy with relative ease and little opposition. However, China s political stability is still much lower than that of H&M s home country, Sweden. At 27 and 82 percentile ranks in political stability respectively, China lags far behind. Similarly, China ranked a low 46 on the rule of law whereas Sweden achieved a 100 percentile rank in the same category. Although these two rankings (World Bank, 2016) may not be detrimental or deterring from doing business in China, it is of paramount importance to keep these political and legal factors in mind while conducting business in host country, as politics and legalities have a higher likelihood of changing in the host country than compared to H&M s home country of Sweden, perhaps resulting in a shift in a more unfavorable business environment. Economic Factors At $ Trillion GDP, China is the world s second largest economy, only to be surpassed by the United States whose $ Trillion GDP places it in the top spot (World Bank, 2016). China s steady GDP growth from its 2001 WTO inception to H&M s 2007 market entry, rising from 8.3% to 14.2% respectively indicated a strong upwards trend for the country s economy, and made for a favorable factor when deciding to engage in foreign direct investment of a new market, especially one with a potential as large as China due to its sheer size of over 1 billion in population alone (World Bank, 2016). While the GDP of China is substantial, the GDP per capita or purchasing power parity, is relatively low in comparison. While the United States is in 20 th place on a global level with $54,700 GDP per capita, China is in 106 th place with $15,400 GDP per capita (CIA, 2016). To circumvent the potential disadvantage of a low purchasing power parity, H&M analyzed its four main consumer segments (poor, mass middle class, upper middle class, affluent) and chose to focus on the middle class due to its rapid growth, with McKinsey forecasting its ability to rise to 550 million people or make up 75% of urban households by 2022 (China Power, 2017). To target the increasing middle class, H&M initially chose to expand to first-tier cities (e.g. Shanghai) and second-tier cities (e.g. Hangzhou) and therefore capture their target audience. 5

7 Yet with the geographic center of middle class growth shifting towards inland China and therefore third- and fourth-tier cities (Barton, Chen, & Jin, 2013) this offers unique expansion opportunities. H&M has responded and expanded its retail stores to not only cater to these burgeoning areas but also respond to the increasingly competitive Chinese retail market. CEO Karl-John Persson has noted that H&M has tested second tier-cities and third-tier cities in China and found the concept is working well (Fickling & Lin, 2014). Social Despite its move from a planned economy to market economy by entering the WTO, the Chinese economy is still not completely motivated by market factors, but also by relations or guanxi. Guanxi and the importance of maintaining face and trust in relationships, such as when negotiating contracts with government officials, is crucial while doing business in China (Goh & Sullivan, 2011). In terms of demographics, the rise of the middle class is an important social factor, as well as its sub-unit generation G2 or those born after the mid-1980s, the latter of which will comprise 35% percent of urban consumer demand (Barton, Chen, & Jin, 2013). One can also use Hofstede s cultural dimensions theory (Hofstede, 2013) to gain insight into a society s culture and values. Of these six dimensions, the masculinity vs. femininity and individualistic vs. collectivistic indexes will be addressed. China is masculine society, which is characterized as being driven by achievement, competition, and material rewards for success. China s religious roots contain a mixture of Buddhism, Taoism, and Confucianism which lay the groundwork for a collectivistic society. China s highly collectivistic culture means people act in the interest of the group, rather than the individual. This translates into personal relationships taking precedence over the organization, thus often giving preferential treatment to those within a close group, as is described by the principle of guanxi. Technology While the technology factor traditionally encompasses R&D and technological innovation, and the how technologically developed a country is overall, the main factor of analysis will be internet usage and how this relates to e-commerce activities. As of 2017, China has 731 million internet users, which translates into over 53% of China s entire population being 6

8 active online (Millward, 2017); 95% (695 million) of the internet users are accessing it via mobile (Russell, 2017). Deloitte reported that Over 60 percent of consumers think Internet is the main way for them to learn products, prices and brands (Deloitte, 2016). In the context of H&M s Chinese market, it s online store and corresponding mobile shopping app are of critical importance in order to reach customers and grow sales. Environmental Regulations For nearly a decade since H&M s market entry, environmental regulations remained lax until the National People s Congress 2016 decision to promulgate the Environmental Protection Tax (EPT) Law, which will come into effect on January 1, The EPT Law targets all operators engaged in business activities, not individuals or non-business operations like government institutions, and specifies air, water, waste, and noise pollutants as taxable (Hu, 2017) While environmental restrictions were not stringent during H&M s 2007 market entry, the advent of the EPT Law means that H&M s retail locations could be adversely affected or restricted in some capacity in future. 2.3 Internalization Advantages As previously mentioned, H&M sought to proactively expand its global operations by 10-15% annually and satisfy shareholders by consequently engaging in market-seeking FDI, therefore expanding its global market by entering China in H&M s mode of entry in China was establishing wholly-owned subsidiaries, an approach the company uses for the majority of its foreign markets. The locational advantages of entering the Chinese market include its relative political stability due to its one-party system and low barriers to entry since it became a WTO member; should this not be the case in the near future, franchising might be an option to mitigate risk. The growth of China s middle class is a key economic factor; with an increasing number of the population in the middle class, which is H&M s target consumer, H&M s potential market expands, thus fulfilling their market-seeking FDI approach. While the social environment of China differs from H&M s home country of Sweden and could cause a rift between leadership styles, the advantages of a masculine society include the possibility of incentivizing employees to realize goals and further boost sales with the prospect of a 7

9 monetary reward or promotion. China s internet penetration is a further locational advantage, as H&M s entry into the Chinese market consists not only of physical stores, but also of an online store, thus allowing H&M to reach a wider audience of customers who may not be able to visit its retail locations in person. All factors being considered, I would argue that having full control of their Chinese operations via wholly-owned subsidiaries instead of engaging in a joint venture entry mode that could offer lower cost benefits (which arguably might not hold much weight due to H&M s economies of scale) yet pose the risk of opportunistic behavior of partners, was the best choice for H&M. H&M s extensive experience and know-how in the retail industry as well as their expertise in coordinating inbound logistics and advanced in-house IT framework is a key competitive advantage. Sharing their tacit knowledge or handing over responsibility to a local firm in a joint venture could disrupt the advanced and highly complex system that comprises their core competencies. In summation, due to H&M s ownership advantages and motivation to continue expanding globally, opening up shop in China was a natural progression in consideration of the country s locational advantages that outweigh the country s locational disadvantages, thus making foreign direct investment the ideal option. 3.0 Firm Organizational Structure The organizational architecture of the H&M Group is best described as having a global matrix structure (see Appendix A) and is pursuing an international strategy. In terms of the H&M Group s vertical differentiation, the decision-making power is mostly decentralized, wherein the CEO focuses on daily management and appoints members of the executive management team, which includes the CFO and 9 other members, who are in charge of group-wide functions that include: production, sustainability, expansion, communications, HR, business development & logistics, as well as the person responsible for the H&M brand and the person responsible for new business (H&M, 2016). The company s horizontal differentiation is divided into sub-units which consists of joint group functions that apply to each brand sub-unit. The brand sub-unit is divided into H&M and new business, which includes the H&M Group s other labels. The H&M brand is divided into three sub-units, design/buying and PR/Marketing which are both centralized, with the country sub-units being decentralized and acting mostly 8

10 autonomously in their group functions. In order to coordinate these sub-units within H&M s decentralized structure, and in order to transfer core competencies between the units, there is a need for both formal and informal integrating mechanisms that can help achieve coordination in the large MNE. Due to the large nature of the firm, formal integrating mechanisms, such as direct contact to mangers and teams, are divided into each country s individual unit. As a part of H&M s decentralized global strategy, country managers have responsibility over sales, profitability, and all departments in their country. This would allow local employees of the host nation to directly speak to a superior of relevance who is familiar with the current business environment. H&M also utilizes informal integrating mechanisms such as knowledge networks to coordinate activities. In the case of H&M s retail stores, this knowledge network would include H&M s own advanced IT system and infrastructure that allows data (e.g. sales, SKU stock) to be accessed and this give insight on both a national and global scale. H&M s decentralized matrix structure offers many benefits for conducting business on an international level. It allows top management to focus on key issues thus giving individual freedoms to the sub-unit hierarchies. It also provides more flexibility and therefore boosts local responsiveness, which allows the business to adapt more quickly to a changing environment. Better decisions are reached as the relevant country managers have the autonomy to implement change and have more knowledge of the host country due to their proximity and know-how. Another benefit would be increasing control by having selfcontained sub-units, wherein the local country managers are held responsible for their market s overall performance, ergo holding them accountable and reducing excuses. It would make little sense if H&M were to switch their global matrix structure to that of a worldwide product divisional structure, as H&M s product range is not diverse, due to their mass production of one type of product (clothing), the production activity of which is not even done in-house, but by external suppliers. Similarly, a worldwide area could be a somewhat suitable fit as it focuses on global sub-units that are largely autonomous, yet these five area sub-units are too simplified in comparison to H&M s presence in over 60 countries, thus 9

11 potentially not allowing for the possibility of local responsiveness. In terms of the Chinese market specifically, the only dimensions that H&M might consider changing would be incentivizing the lowest hierarchy group (sales floor retail) with monetary or promotion awards, due to their masculine society, to monitor customer reactions and feedback. This would help boost local responsiveness at the most basic level, and would emulate the approach the global market leader and H&M s main competitor, Inditex, has taken in order to reduce lead time, predict customer trends, and boost sales as a whole (Hansen, 2012). Overall, their current use of the matrix structure is the best fit for H&M s internationalization strategy, as it provides a good combination of central and local perspectives on leadership and entrepreneurship (H&M, 2014). 4.0 Conclusion A pioneer in the fast-fashion field, the H&M Group is the second largest global clothing retailer in the world (Fast Retailing, 2017). They expanded into China in 2007, entering onto the market via wholly-owned subsidiaries and have grown China to become their second largest market globally within ten years. Through their extensive managerial experience and excellence in managing inbound logistics, H&M was able to exploit the locational advantages that China had to offer. China s locational advantages included a growing middle class with increasing purchasing power and a political climate that promoted tariff-jumping, both factors were extremely favorable for engaging in FDI. Consequently, H&M continued its core globalization strategy by establishing itself as a wholly owned company in China. This allowed H&M flexibility in its expansion strategy so it could control what cities to expand to and the timing for each city s expansion. H&M s organizational matrix structure balances its O- advantages as well as allowing space for local responsiveness and future international growth. Based on its global expansion current activities, H&M s continued future as a market leader in the fast-fashion industry seems certain. 10

12 References Barton D., Chen Y, and Jin A. (2013, June). Mapping China's middle class. Retrieved October 19, 2017, from BBC Asia-Pacific Beijing drivers ignore No Car Day. (2007, September 22). Retrieved October 19, 2017, from Cantwell, J., & Narula, R. (2004). A critical reflection and some conclusions on OLI. Routledge Studies in International Business and the World Economy: International Business and the Eclectic Paradigm,35, doi: / ch13 Chen, T. (2012, July 26). H&M Flagship Store to Close Amid Rent Rises. Retrieved October 18, 2017, from amid-rent-rises/ China Power. (2017, September 11). How well-off is China's middle class? Retrieved October 19, 2017, from CIA. (2016). COUNTRY COMPARISON: GDP - PER CAPITA (PPP). Retrieved October 19, 2017, from Deloitte. (2016). China E-Retail Market Report 2016(Rep.). Dunning, J. H. (1979). Toward an Eclectic Theory of International Production: Some Empirical Tests. The Eclectic Paradigm Journal of International Business Studies. 11 (1): Fickling, D., & Lin, L. (2014, April 03). H&M Adds Stores in Smaller Chinese Cities as Competition Rises. Retrieved October 19, 2017, from 11

13 Goh, A., & Sullivan, M. (2011, February 24). The Most Misunderstood Business Concept In China. Retrieved October 18, 2017, from Hansen, S. (2012, November 10). How Zara Grew Into the World s Largest Fashion Retailer. Retrieved October 19, 2017, from how-zara-grew-into-the-worlds-largest-fashion-retailer.html?pagewanted=all Hellstrom, J. (2007, April 11). H&M sees China growth, stable global margins. Retrieved October 18, 2017, from Hofstede, G. (2013). Cultures consequences: comparing values, behaviors, institutions, and organizations across nations. Thousand Oaks, Calif.: Sage. H&M Corporate Governance Report 2014 H&M Corporate Governance Report 2015 H&M Corporate Governance Report 2016 H&M. (2017). Fashion and quality at the best price in a sustainable way. Retrieved October 18, 2017, from H&M. (2017). Market overview. Retrieved October 18, 2017, from Hu, W. (2017, May 24). China's New Environmental Protection Tax Law. Retrieved October 19, 2017, from 12

14 Industry Ranking. (2017, August 31). Retrieved October 18, 2017, from Karlsson, A. Scandinavian Ownership a competitive advantage? Stockholm School of Economics (n.d.). Retrieved October 19, 2017, from Loeb, W. (2015, October 23). Who Are the Fast Fashion Leaders And Why Does It Matter? Retrieved October 18, 2017, from Loesche, D., & Richter, F. (2017, March 10). Infographic: Number of Markets in which the H&M Group is Present. Retrieved October 18, 2017, from Millward, S. (2016). China now has 731 million internet users, 95% access from their phones. Retrieved October 19, 2017, from Russell, J. (2017, January 23). Half of China s population now uses the internet on a mobile device. Retrieved October 19, 2017, from World Bank Group. (2016.). Worldwide Governance Indicators. Retrieved October 19, 2017, from 13

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16 Appendix A Matrix organisation of the H&M group BOARD OF DIRECTORS AUDITING COMMITTEE CEO CFO BRANDS JOINT GROUP FUNCTIONS** H&M ACCOUNTING Design/ Buying Country 1 Country 2 Country 3 etc. PR/ Marketing COMMUNICATIONS NEW BUSINESS* COS CONTROLLING Design/ Buying Country 1 Country 2 Country 3 etc. PR/ Marketing EXPANSION & OTHER STORIES Design/ Buying Design/ Buying Country 1 Country 2 Country 3 etc. MONKI Country 1 Country 2 Country 3 etc. WEEKDAY PR/ Marketing PR/ Marketing HR IT LEGAL BUSINESS DEVELOPMENT Design/ Buying Country 1 Country 2 Country 3 etc. PR/ Marketing LOGISTICS CHEAP MONDAY Design/ Buying Wholesale Country 1 PR/ Country 2 Marketing PRODUCTION Design/ Buying H&M HOME Country 1 Country 2 Country 3 etc. PR/ Marketing SECURITY SUSTAINABILITY * New Business has overall responsibility for producing, refining and supporting the group s newer brands. ** In alphabetical order. 15