More on Western Operators and Chinese Developers Coming Together

One of the areas I want to push on here at AHCB is what defines the best fit between western senior care operators and their Chinese partners.  If done properly, the coupling off brings together the top-level strategy both sides are eager to commercialize (the massive aging boom in China) with the operational tactics necessary to build sustainable businesses.  Much of what we discuss as an industry continues to be the opportunity and the paucity of infrastructure that exist; certainly the former is important to keep front of mind, and the latter must be a topic for constant discussion.  However, what can be easily missed is how to most effectively couple off with a Chinese partner, how to conduct the appropriate due diligence, and when to go it alone.  Not easy questions, and ones that will require an honest exploration of the expectations both sides bring to the table.  Answering these also brings us back, as an industry, to one of the most common questions I get asked privately:  “why is it taking so long to get the industry rolling in China?”

Answers to this vary, and many times take us back to infrastructure matters that govern how quickly invested capital can be efficiently deployed.  This remains a market where financial capital is not the issue, rather human capital is.  But even focusing entirely on human resource issues obscures other factors that are increasingly becoming issues for this industry.  I have written about this previously here and here, but on the Chinese side, frustration can be heard based on their belief of the limited “skin in the game” put forward by western suitors.  Right or wrong is not the question – how the Chinese side of the partnership views things is the point.  Managed properly, this sort of feedback provides the opportunity to refine business models, or position the western side of the partnership more in line with what Chinese developers anticipate.  As they see it, capital exists for hard assets – land, buildings, equipment – but not for their western partner to finance the export of the service model.  Their anticipation (again – right or wrong) is that their western partners will provide the necessary capital to bring the operations on line in China.

This was very much the emphasis of a recent conversation I had with Wei Song, the CEO of VcanLand’s Senior Housing.  I was eager to ask him to expand on the best way for western operators to pair off, but Song wanted to take the conversation one step back first:  “from a logical standpoint one question needs to be answered [first] … why the western operators want to come to China?  Well, it seems to me right now they see there is an opportunity to make money, but they do not want to take any risk – that is a dilemma for a lot of US and Australian operators.”  (emphasis mine)  What Song said next is something that as a consultant I ask potential clients.  My version of the question follows: “is the $X million dollars you are going to spend in China best spent in China versus anywhere else domestically?”  That leads to a second question about whether the organization has the cultural DNA to support an overseas green-field investment.  Song echoed this:  “I personally don’t see an obvious reason for them to come to China – they are busy working on stuff back home – they are making good money!”  Now, Song would be the first to admit these western entrants are also potential competitors, so a cynic might suggest he is putting up a smoke screen; however, the point he is making is one worth considering even if you find yourself unconvinced of his pushback.

Going to China is a massive endeavor.  You cannot do it piece-meal.  Those western operators who do it successfully are going to localize in ways that may cause their ultimate business model in China to be completely discontinuous from what has worked for them in their domestic markets.  The exciting potential for disruptive innovation will be something your company must have the flexibility to embrace in order to find your niche in China.  If your organization has the elastic entrepreneurial culture to absorb this and roll with it, to provide great autonomy for your China business while focusing only on long-term returns through the deployment of very patient capital, then go for it.  And, for what it’s worth, before you go to China make sure that you couldn’t spend finite capital domestically – or even in another international market – and get better risk-adjusted returns.

It is worth letting Song’s comments about what he sees as the sort of return on capital the industry should anticipate stand on their own.  As you read this keep two thoughts in tension one with the other:  Song is a savvy competitor who wants to make the market seem hard, and he is also an experienced investor who knows what it is going to take to be successful in China – some lessons which by his own admission he learned the hard way through failure.  On the financial returns investors should anticipate, Song added, “If you look at VcanLand, we are taking a huge bet and it is not based on a very thorough financial analysis – you just can’t do it … senior living offers future growth for the next 30 to forty years … there is money to be made, even if not very fat margins compared to what Chinese developers experienced in the last 20 years … but, if you want to focus on what you can do now, most people admit you cannot make money in it now.  It is hard to justify the kind of investment you need for projects and the human capital to build a system – you cannot quantify those numbers.  I have no confidence in the assumptions we are making, unless we can prove it of course.  I do not know what to tell potential private equity partners – it is hard to justify our model for companies that need a 20% return on capital.”

Song would be the first to admit that VcanLand would not be investing in senior care unless they felt they could get good returns on their capital, but what he is framing are the expectations of the sort of return, and the time frame within which it will occur.  For a real estate developer like VcanLand, smaller returns over a longer period of time than what has been experienced in the last decade might be frightening; yet, rather than run from this reality, they have chosen to embrace it.  Song shared, “the majority of Chinese developers are still thinking about one thing for sure – the old good time is gone.  The next ten years the market is going to be concentrated in 50-100 players in the traditional residential area.  So, a lot of [residential] developers are venturing into retail, office, and hotel sectors, but when they are thinking about senior housing, it is not like other sectors.  A lot of people are studying it, and a lot are using it as an excuse to get cheaper land, but even that practice is not going to last very long.”

I found Song’s comments about the efforts of residential developers to leverage senior housing and continue extending the runway on what they know works (building even more residential developments) illuminating.  He pointedly added, “In 5 years this will be over.  The government is not dumb … They are not going to allow this game to continue.”  Later, Song added, “in 5 years a new opportunity may present itself – the Central Government may promote a special type of land for senior living.  Most likely certain government agencies will evaluate whether you are really doing senior living.  It will get formally added into any 5-year land planning process for a city.  This is the process by which cities already identify hospitals, schools and shopping centers.”

As Song sees it, the successful Chinese developers are going to be those who convert their mentality away from purely real estate companies to what he calls “a service company.”  Song shared, “companies like Vanke who are under tremendous quarterly pressure to perform are going to find it difficult to stick out the unknowns and the service issues inherent in this business model.  I hope there will be more players who convert into senior living – this sector needs good suppliers for the marketplace, but the reality is that for most this is a hard question to answer.”

I will end on this point, which goes back to a question asked in a recent blog post:  doesn’t the market entry strategy taken by western hotels shed light on what western senior care operators should do?  Song acknowledged there were lessons to be learned here, but he also cautioned not to take the comparisons too far:  “some people say ‘hey – look at the hotel management companies – how did they manage to do it?’ – If you look at the hotel sector, when people come in they bring value domestic players cannot bring – the customer.  Things like the global reservation system are really unique.  Most people who came over to spend money in China initially were expats.  This meant serving those guys becomes important – you don’t have to really adapt to the locals.  Then, the locals say, ‘hey – I can stay in the [western] 5-star as well.’  But senior housing is different – none of the people living in the senior housing are expats – they are all Chinese … the biggest value we [VcanLand] brings to the table is being able to build a local team in China.”

Listening to Song, and wrestling with his thoughts, I think the industry has two choices.  You can believe his analysis is designed to wall off the industry from outside competition.  Believing that seems to me a stretch given no one player is going to dominate this market, it is simply too big, and Song knows this.  Or, if you find that unsatisfactory, you absorb Song’s points and make sure they are internalized in your own go-to-market strategy in China.  What would that mean?  Four things.  First, Chinese developers perceive western operators are bringing too little capital to the game.  Long time China hands in consulting firms will tell you that this frustration aligns perfectly with Chinese industrial firms who dislike paying for intellectual property or other intangible service-oriented “goods.”  Tangible items – machines and factories – they get.  Knowledge, and management contracts?  Not so much.  This does not mean you cannot be successful selling management contracts (obviously we know several companies already have); what it does speak to is the nuance of doing it successfully, and the strategy of making it as tangible as possible when viewed through the eyes of a Chinese partner.  Second, put skin in the game!  If your path to commercialization in China required only the capital it would take to get on a plane and maybe some soft costs related to training and kicking a couple of tires with some lawyers, rethink that.  The more serious the Chinese suitor, the more they are going to want to understand your willingness to put your own capital at risk.  Third, make sure your Chinese partner has a similar view of how the Chinese real estate market is going to change, and why their transition into senior housing is necessary.  If they think this is just another housing play versus a long-term commitment that will generate smaller, if more consistent returns, then walk away.  Fourth, find a partner who can either already help you staff the operation or someone who is highly motivated to do this – someone who “gets” the human resource side of the business and is dedicated to doing what it will take to provide the necessary staff to make the model run.  Western operators are going to find success in China, but if Song is right, it will only be when solutions are tailored to what Chinese developers want and are wiling to pay for.  In the short term, western operators may need to keep in mind their first customer is the Chinese developer.  Only by meeting their Chinese partner where they live and acknowledging how the Chinese partner’s expectations are framed can western operators build successful platforms for the Chinese consumer.

By:  Benjamin Shobert, ,