Invest in a Copycat?

I drive here in China. I love cars too. Always have. I read all of the magazines I can get here or load up when in the states. I am always intrigued when I see a model that is completely new to me. I want to know more about it, where it came from. You would think that cars being the high value, high visibility consumer item that they are would not be something that was easily copied. Amazingly, you would be wrong. There are a number of cases of Chinese copy cars that have been publicized and some auto makers have tried suing or at least making a media outcry. The copy that sticks in my mind at the moment is the Honda CRV. Although they have just released a new model that does look different, for at least 3 or 4 years, you would often see two versions of the Honda on the road. One was a Honda of course, and one looked almost exactly like it (Chinese copy), just slightly longer with poor fit and finish.

I always chuckle inwardly at the brazenness of this tactic. Now, the company that makes this CRV like machine does charge much less than Honda for their CRV. Consequently, there are a lot of them around and it could be called a success. Sometimes it is not a direct copy of a product that you see, rather a more subtle visual cue. There is a particular Chinese made car that I like the looks of. I think the reason I like it is because it has the iconic twin kidney grills of BMW on the front end. The first time I saw this car, I had to do a double take because I was not aware of a new BMW model coming out. Poor BMW. There are two other makers here who have designed their logos to be oh so very close to that of BMW. These companies are not making high end luxury cars, rather plebian transport for the masses that would never ever be confused with a Bimmer. Still, that circular white and blue logo does catch the eye.

When you pick up a copy of virtually any business journal today or turn on the TV, it will gush over the enormous sums of foreign investment coming into China. Private equity is a newer source of funds and there is a move towards investing in smaller independent Chinese firms. Some equity firms follow a strategy of investing that looks for particular value in the target company.

Copying is a real business strategy. When a new consumer item comes out in the US, if it is successful, there are soon other choices quickly available. When a new type of car, (think of the new crossovers) comes out, it is usually followed by others. The problem with the copying approach is that it cannot be the only approach. There has to be something else.

If copying a product is the main value a firm can offer though, could it, should it ever be invested in? There is a large part of the economy in China that is driven by products that have been copied. Molecule by molecule, measurement by measurement, brand identity by brand identity. My own company faces this challenge to an extreme in the chemical industry. (We estimate over 30 competitors making a product essentially the same as ours.) Copies can still win a big market share though. Of those 30 competitors of ours, there is one with over 50% market share. But is it sustainable and would I want to invest in a company like that? No, I would not. It may actually be sustainable, but the returns will be low, margins difficult to maintain and selling will always be on price. Chinese companies whether consumer or industrial B2B are fierce competitors with foreign firms and even more so with themselves. There is already a local price war for cars built in China. (Imported automobiles face high tariffs and are typically luxury brands.) There are too many car makers making similar products with little value that will not be here in 5 years time. Some will not be able to offer real value such that consumers want their offering on something other than price.

If I was to recommend a Chinese company for foreign investment, what would it do? What would it make? If the goal is sustainable return, then the answer would be investing like you do anywhere, you try and capitalize on value. That value might be in processing, it might in the product and it might be in the service. It might only be in the brand itself. Could there be a reasonable investment opportunity in a firm that competed in a highly competitive market? Yes, there could. But don’t get caught up in the overall market numbers or the notion of “1 billion customers.” Look at the value in the equation. Find real value and you will likely find an investment opportunity.

That question itself answers a lot about our view of a company. Would I invest in it? It is the same approach used anywhere; the challenge here is just many more companies to sort through.

Is copying a positive long term strategy? Should you invest in a company that focus’ primarily on that? No and no. There are exceptions, but these exceptions rely upon the company in question at least having some idea of producing value now or in the future. It relies on them attempting to move up the value chain. It relies on them understanding that copying forces competition on price and competition on price is the hardest model to follow and be successful.

Is a car that looks sort of like a BMW valuable? Not really. But, I might buy it if the quality and the price are a good mix. Does a logo that looks like Starbuck’s get me into the store? Maybe once, but past that it better have a service and product very similar or I am never going back.

Copying is just not a long term business strategy. At some point value has to be added. If it isn’t a long term business strategy then it is certainly not an investment strategy.

With that, let me offer a final note regarding value and perspective. Recognizing value is difficult because we all will have a slightly different view of what the value is. A restaurant could have value because of the food, the ambience and the service and for each of us the reason why we like the place could be different. Understanding value from and investment perspective requires being able to look at it from the actual consumer’s eyes. Even then, there will be different definitions of why something has value. There will be consistencies though, certain things that keep floating to the top. The Chinese consumer and industrial market is often maligned for its very low demand of value and quality. While it may be true, it is also changing and there is a slow momentum (think of a freight train just starting) of demanding better service, better quality, better design, better value. While it may mean that a majority of service and product providers are focused on volume sales and low prices, there is a small portion of companies that realize survival lies in providing something else. It is these firms that will need and can return on investment.

Jack Derington