KMG Articles and Reports
Chairman, Kotler Marketing Group, Washington, DC and Beijing
Presented at the World Marketing Summit, Dhaka, March, 2012
For the past two decades China has been the world leader in domestic infrastructure investment and construction. It has now become the global leader in infrastructure investment and construction. With towering Chinese capital reserves, bank and SOE resources, engineering, equipment, construction capability and strategic policies, global infrastructure investment and construction will be China next great economic driver to sustain GDP growth.
Rough estimates from the 2009 OECD Infrastructure Project suggests that annual investment requirements for telecommunications, road, rail, electricity transmission and distribution, and water taken together are likely to total around an average of 2.5% of world GDP. If electricity generation and other energy-related infrastructure investments in oil, gas and coal are included (as the IEA does in its Investment Outlook), the annual share rises to around 3.5%. Clearly, the figure would rise further if we include other infrastructures, e.g. sea ports, airports and storage facilities, telecommunications, etc. Since 2011 global annual GDP was $65 trillion, this amount to $2.275 trillion a year (at 3.5%) or $56.8 trillion over a 25 year period. The real physical need is probably closer to 5% of annual global GDP; and this excludes social infrastructure.
The highly respected 2009 Cohn & Steers Global Infrastructure Report projects a need for $40 trillion over the next 25 years for water, electricity, roads and rail and airports and seaports. Excluding other vital areas of physical infrastructure, the estimate corroborates the OECD forecast. Both of these projections do not account for cost increases or variable global GDP growth rates and revenue streams. Nor do they consider any reserve costs for unanticipated innovative systems that are bound to emerge over a 25 year time period.
To highlight the magnitude of investment need, KPMG estimates that the U.S. has to spend roughly $40 billion a year just to upgrade its roads. President Obama’s 2013 budget proposes $50 billion for all infrastructure expenditure. The estimates of different sources are all over the place, but they are all staggering.
When you consider that the U.S. purports to spend 2.5% of its GDP on physical infrastructure; Europe 5% and China 9%, you notice several things. The U.S. cannot even update its current infrastructure. It is rated as 26th in infrastructure quality by the Society of Civil Engineer’s 2009 Global Report. Europe at 5% is committed to infrastructure maintenance and marginal growth, but is hardly likely to accomplished this target in view of its long term fiscal crisis and sovereign recessions. China at 9% of its GDP is racing ahead.
However essential physical infrastructure is for competitive economic growth for Developed, BRIC and Developing economies, traditional capital sources cannot meet this need. Typically capital customers were government budgets and user fees; sovereign debt; commercial and investment banks; public funds, like the World Bank; private investment and PE funds; and commercial privatization. In today’s post- fiscal crisis world of intense global competition for infrastructure, these sources have largely dried up. The new frontiers of investment are Sovereign funds, specialized private global infrastructure funds, larger scale Public/Private partnerships and extensive Privatization.
As Berthold Brecht in his opera Mahaggony declaims, “There is no Money in this Town”! The gravity of this issue is illustrated by the paltry sum of available global infrastructure private funds. Goldman Sachs is among the largest of such funds. In its current 2011 report, GS Merchant bank announced it has raised $10 billion for investments in infrastructure and infrastructure related assets and companies.
Pension funds are enormous, but it should be noted that the second largest pension fund in Europe spends only 1% of its holding on infrastructure. Pension funds are reluctant to invest because of political instability, regulatory interference, cost overruns, extended periods of cost recovery (usually 20-30 years), and disruptive technology that can upset forecasts. Postal service investment has been wrecked by the Internet. Maritime ports are clobbered by trade fluctuations and competitive ports and trade routes. Rail investment is constantly at war with highways development and truck transit alternatives. Thirty years is a long time for cost recovery and a fair return on investment.
Over the past decades Privatization has mitigated the deficiency of public finance, notably in telecommunications, gas and electric power, and roads. Privatization will continue to grow in the years to come; but it requires a dependable legal and regulatory structure, standards protocol for interoperability, politically reliable user fee rate setting regimes, and numerous subsidizes to make it viable for listed companies to finance, build, operate and maintain reliable and durable systems. It is an important contributor to infrastructure maintenance and growth in the U.S. and Europe, notably the UK. BRIC countries are getting there with 20%-30% of their infrastructure already in the private sector. Developing countries lag behind because they lack planning and management capability, as well as the legal, regulatory, administrative and political conditions that can protect long term foreign investment. There is also a resistance in developing countries to privatization because it withdraws a powerful instrument of political control and public employment from political leaders.
Public/Private Partnerships (PPPs), such as listed utilities, have developed over the past three decades to meet infrastructure needs. These are complex arrangements that meld public budget and debt resources with private or foreign public investment partners to build, operate and maintain infrastructure though a variety of business models. One model is equity investment; another is build, operate and transfer (BOT), which gives private companies concessions to build and operate public installations for a term to recoup capital costs and profit targets; and then revert the concession back to public ownership and whatever successive arrangements of operation and capitalization public authorities wish to make.
These are very long term projects and their performance has been mixed. The Millau Bridge in France was totally financed to the tune of 320 million Euros by the private company Eiffage on a 78 year concession for toll increases not to exceed the rate of inflation. The Confederation Bridge in Canada, linking Prince Edward Island to New Brunswick has a 35 year concession for private tolls. These projects are by and large successful, with exceptions like the bankruptcy of Sydney Australia’s Cross City Tunnel which overestimated the volume and value of truck freight to the port.
The newest sources of global infrastructure investment are the Sovereign reserve funds of BRIC and Middle East, primarily China. These funds have different investment strategies and business models and have taken an aggressive position in turning from sovereign debt purchase to investments and acquisitions of tangible infrastructure and company assets.
Sovereign finds, Public/Private partnerships and intensified Privatization are the key to future infrastructure in the competitive environment of wide and deep search for scarce capital. The old public finance paradigm of selling infrastructure to ample capital sources must be replaced by a new paradigm of competitive marketing to scarce capital sources. Marketers can help countries to shape infrastructure projects that can compete for capital on the basis of what capital customers specifically want, not the wish list of country desires.
China has built more infrastructures in the past two decades than any other country. It has more highway miles than the U.S.; the largest telecom network in the world; the three Gorges Dam; 14,000 miles of operating high-speed rail and work in progress for a total of 43,000 by 2015; the largest seaports in the world; airports galore and more planned; the greatest number of electric power plants in the world, along with 36 planned nuclear plants.
China has the engineering and related equipment, construction know-how, technology and human resources to build and manage many sectors of infrastructure anywhere in the world; not to mention its $4.3 trillion Sovereign fund and additional trillions held by State banks and State-owned enterprises. China is exporting infrastructure financing and construction abroad. Global infrastructure investment and construction is a new major driver of China’s economy.
Addressing European appeals for debt purchase, Lou Jinwei, Chairman of China Investment Corporation, China’s sovereign wealth fund, declared that “it is difficult for long-term investors, including his company, to buy European debt, and investment opportunities are more likely in infrastructure and industrial projects” (China Daily, February 15, 2012). Primer Wen Jiabao has reiterated this same message in numerous meetings with European leaders.
China has supported the West with national debt purchase for two decades, and continues to do so, to a lessening degree. Now, China wants to make real money by building tangible, revenue producing physical assets that advance their foreign manufacture, trade penetration and geo-strategic interests. Global infrastructure investment, construction and management are the new drivers of Chinese economy.
China’s infrastructure in Africa grew from less than $1 billion annually to $6 billion in 2007. Its cumulative investment by 2009 reached $24 billion, which was 10% of their total outbound FDI. This amount has grown since then, and it is concentrated in power, roads and rail, dams and water systems, airports, sea ports, mining infrastructure, telecommunications and special economic zone (SEZs).
In 2007, China financed 10 hydroelectric power projects in Africa with an investment of $3.3 billion. It financed $4 billion worth of investments in road and railway network in Nigeria, Gabon and Mauritania. In information and communication infrastructure China supplied $3 billion in equipment to national firms in Ethiopia, Sudan and Ghana.
The $3 billion Great Gabon Belinga iron ore mine construction commencing in 2009 is China’s largest mining operation in Africa. China is building a rail that links the Atlantic coast of Africa in Bengala, Angola with two ports on the Indian Ocean, in Tanzania and Mozambique. This is the first ever East-West rail link between Africa’s two bordering oceans. The most recent investment is a $1.5 billion refinery investment in Uganda. China has also constructed Special Economic Industrial Zones (SEZs) in Ethiopia, Nigeria, Egypt, Mauritius and Cape Verde to leverage their infrastructure investments.
The recent Sino-Angolan association is illustrative. When a petroleum-rich area called for investment and rebuilding, China advanced a $5 billion loan to be repaid in oil. They sent Chinese technicians, fixing a large part of the electrical system, and leading a part of the reconstruction. In the short term Angola benefits from Chinese-built roads, hospitals, schools, hotels, football stadiums, shopping centers and telecommunications projects. In turn, Angola mortgaged future oil production of a valuable, non-renewable resource. It may turn out to be a costly trade for Angola, but their needs for infrastructure is immediate and that is precisely what China provided when no one else is willing to do so. Angola has become China's leading energy supplier. Chinese corporations, financial institutions, and the government are involved in billions of dollars worth of large dams in Africa.
Turning to Southeast Asia, South and Central Asia, Premier Wen Jibao announced a new $10 billion Asian infrastructure Investment fund. China Communications Construction, a Chinese company, is investing $100 million in constructing Burma’s new capital city airport. China is building rail links to Laos, Cambodia and Thailand. It is also building a railway that links Afghanistan, Pakistan and Uzbekistan, which is part of China’s plan to connect to ports in Iran and Pakistan. The railway will be a 700 km long at an estimated cost of $5 billion. China has also agreed to take over operations at Gwadar port in (Baluchistan province) as soon as the terms of agreement with the Singapore Port Authority (SPA) expire.
In Bangladesh, China is negotiating for investment and construction of Sonadia Island deep sea port, new rail lines through Myanmar to Bangladesh; and a $200 million loan for 3g telecommunications.
In Sri Lanka A consortium consisting of China Merchants Holdings International Company and local conglomerate Aitken Spence was awarded the tender for the construction and operation of the Colombo South Harbor Expansion Project. This $500 million Chinese investment is the largest foreign direct investment project in the country. Official data shows that China was Sri Lanka’s biggest lender in 2010, with loans amounting to $821.4m. It also offered $7.5m worth of grants. China plans to pump $1.5 billion into Sri Lanka over three years to develop infrastructure including roads, bridges, water supply schemes, irrigation and power.
The Philippines has presented to Chinese and international contractors a $12.1-billion transport sector infrastructure development project under the administration’s Public-Private Partnership (PPP) program. China is likely to take the biggest chunk.
In Europe the China Development Bank financed Serbia to acquire a bridge over the Danube. China Overseas Engineering Group won the bid for an A2 highway in Poland at less than half of what the Polish government had budgeted. That project is currently halted because of underestimated costs. China is investing an estimated EUR 10 billion in the Croatian seaport of Rijeka, which will be the largest seaport in the Adriatic. It is investing and building the new Zagreb airport and financing the rail line connecting Kiev to its airport. China’s CIC has taken an 8.6% investment stake in UK Thames Water and a 40% stake in Portugal’s national grid. A Chinese power company has acquired Portugal’s leading power company for Euro 2.7 billion. Bernhard Hartmann, an expert in the power utility sector at A.T. Kearney sees “a big wave of Western interests trying to find someone in China to bankroll them”. (China Daily, 02-17-12).
China is causing Geostrategic sweats in its bid to acquire .03 percent of Iceland for recreational development and a future potential Atlantic seaport. It has purchased Greek debt as a quid pro quo for a 35 year lease on Piraeus harbor and a deal to finance the purchase of Chinese ships. China has announced interest in pumping money in Britain’s railways as part of a major plan to invest in the crumbling infrastructure of developed countries, and has also expressed interest in financing a proposed high speed rail line from London to the north of England.
Turning to Latin America, China is leading the way in foreign infrastructure investment. In July 2010 China signed a $10 billion agreement with Argentina to refurbish the Belgrano Cargas freight rail line and an additional $2 billion agreement to upgrade the Ferrocarril Belgrano Norte y Sur. Two other initial agreements worth $1.5 billion each are related to a potential subway line in Cordoba and train line connecting the Buenos Aires Ezeiza airport.
In 2009, China signed an agreement to take a 40% stake in a Venezuelan rail project worth $7.5 billion. This project will connect oil producing regions to the Capital as part of China’s interest in maintaining a steady energy oil supply from a Venezuela. A consortium of three companies from China, (as well as companies from Japan and South Korea) are bidding on a high speed rail project in Brazil to connect Rio, Sao Paulo and Campinas. Beyond rail, Chinese companies are building three hydroelectric dams in Ecuador. In total, China is financing over half of the energy infrastructure projects in Ecuador right now.
China is today the largest and most willing infrastructure investor in many countries on every continent. They have a current problem of getting into certain countries, like the U.S., but they want in and it is only a matter of time that they will get in. The U.S. needs China more than China needs the U.S. CIC has already taken a 15% equity interest in AES, the largest U.S. power company and is discussing a 35% share in its wind power business.
A great part of the world is seeking infrastructure investment and construction from China. Conversely, China is driving global infrastructure as a new growth industry. There are other global capital customers, but not of China’s scale and scope. China invests more today in Africa today than the World Bank. ME Sovereign reserve funds are not investing in foreign infrastructure. They prefer fast returns and lack strategic interests.
The demand for Chinese infrastructure investment exceeds its capital supply or scope of strategic interest. China is steadily adding internal and external capital and industrial partners for extensive ventures; and always varying is scope of strategic interest as conditions change. We are not looking at an earlier infrastructure “selling” scenario, where public authorities sold numerous projects to bankers and bond underwriters, who had to place ample capital supply into limited infrastructure demand. We are instead looking at a marketing scenario, where project demand exceeds capital supply and countries have to market their numerous infrastructure project needs to the limited capital supply of scarce capital customers. The paradigm has shifted from “Selling” to capital markets to “Marketing” to capital customers.
How to Market Infrastructure Investment to China
I suggest ten things to consider.
With regard to infrastructure, the seller is the public authority seeking investment for its projects. The buyer is the capital customer who wants to invest and construct installations that meet its economic and strategic objectives. The Marketer’s role is to help infrastructure sellers thoroughly understand China’s economic and strategic investment goals and requirements; and help governments develop projects that have a competitive advantage for China’s distinctive needs and wants. Marketers also help Chinese government agencies and companies find investment and construction projects that generate the greatest competitive value for the perceived interests of China. The key thing is customer-focus, and that is what Marketing is about.
China Investment Corporation is a $400 billion dedicated source of out-bound capital for Infrastructure investment, but it is by no means the only source or first port of call for a seller. State-owned Companies in road, rail, seaport, airport, mining, power generation are the initial point of contact. These Companies want the contracts for engineering, construction and management of developments. Buyers have to identify the prime contractors for projects, build a relationship and make their case. If it fits the goals of the SOE, the SOE will carry the ball through the political process for approval and ultimately to CIC and Peoples Bank of China, which hold the currency reserves.
Too many foreign projects waste time by first going through diplomatic and political channels or going directly to CIC to gain interest. The real beneficiary is the prime SOE and its sub-contractors. It is there job to maneuver the political and financial process.
2. Investment objectives and goals
Foreign physical planners, engineers and politicians can draw up all sorts of infrastructure project proposals that do not fit China’s agenda. Government planning departments need marketers to keep them plan offerings that fit the China capital market, not their own glorious aspirations. How many politicians, planners and engineers and politicians have the foggiest notion of what China and its SOEs want; let alone who the Marketers are who can help fit projects to these wants? It is the challenge of foreign political leaders to make their planners and agencies aware of the need for Marketers to research, analyze, segment, target and brand their needs to China’s foreign infrastructure investment program. Infrastructure projects that do not fit what China wants are pie in the sky, in so far as China’s capital is concerned.
We are deluged with global engineering and innovation driven estimates of infrastructure need from every level of government, - $5 billion here, $20 billion there, even trillions, etc. The figures are so high they paralyze, rather than promote real investment activity. The new rule is to understand what capital customers, like China want to buy; not what foreign countries want to sell. The Marketers’ job is understand China objectives for return on investment; security; industrial fit; trade advancement and leverage; indigenous operating and management capability and efficiency; duration of capital recovery; geo-strategic advantage; and regulatory, legal, administrative and political support.
Every government has numerous physical infrastructure needs. Different capital buyers have specialized infrastructure interests, based on their industrial strengths and strategic goals. China, for example, looks for road, rail, power stations, airports and sea ports, bridges and mining infrastructure because of their mix of strengths in steel production, trade logistics, resource needs and other factors. They do not do as well as the French in nuclear power and water management, or the U.S. in terms of aviation. The Marketer helps country projects target the capital resources of different centers of infrastructure excellence and capital resource.
The next level of segmentation for foreign sellers is to distinguish big infrastructure projects from small ones. Big projects are more likely to attract Chinese interest where China is a welcomed investor on the basis of past and ongoing projects. For these countries, small projects can be layered into the negotiation for costly dams, rail and ports. For countries that have not previously welcomed Chinese investment, small projects may be of interest “as a foot-in-door” tactic. A large project, like California approach to China for investment in high speed, is hardly going to interest China. The political risks of a new departure of cooperation, however heartily hailed, are too great to engage. If California wants Chinese infrastructure capital, it should starts with toll roads.
A further level of foreign infrastructure investment from China is what is essential to replace or maintain and what is new and innovative for exceptional growth. Global investors, sovereign or private, prefer lower risk in-place infrastructure to new infrastructure. China would rather buy a share of the UK Thames water authority than build a new water system. The same with power plant expansions. Existing infrastructure has a payment system and management in place.
Governments have to make a seed capital stake in Public/Private Partnerships projects. The less robust the public investment, the higher the risk for private investors! Governments have to parse their money very carefully and invest enough to meet external investor risk standards. This means reserving enough money for those “conventional” projects that meet the risk standards of capital sellers, like China; not for “exciting” priorities beyond the pale of reasonable foreign investment. This is a tough lesson to learn for foreign sellers, because it is counterintuitive to the domestic political hype of grand schemes.
Infrastructure investment Marketers are international in a global economy; not nationalistic. They should try to work for countries that have a track record of attracting Chinese infrastructure capital, like SE Asia, South Asia (notably Bangladesh and Pakistan), Central Asia Republics, African countries and Latin American countries, UK, the Euro periphery and Eastern Europe. These regions welcome Chinese infrastructure investment. The trick is to multiply investments in these countries for synergistic economic value both to the seller and China capital customer.
Frankly, I think it is a waste of time for Marketers to try to sell U.S. National projects to Chinese capital customers. There is too much Congressional resistance to Chinese tangible investment, despite recent sanguine Presidential rhetoric. The best U.S. sellers are certain State governments like Georgia, Texas, Iowa and several other States that have reached Companies reaching out to China. National level infrastructure is political dynamite. Slow progress is being made in the energy field. For example, Sinopec paid $2.5 billion to Devon Energy of Oklahoma of a 1/3 stake of 1.2 million acres of drilling property. Other investments have been with Chesapeake and other U.S. energy companies. The key s low profile and not controlling share. CC has 15% of the share of AES, The largest U.S. power company and is bidding for a 45% share in its wind power business.
Positioning is all about offering a superior value proposition to customers than competitive offerings. It is the Marketer’ job to document the unique and superior fit of his client country’s project to China’s capabilities and trade, financial and strategic interests, like the transcontinental African rail and the investment in Portugal’s largest power company which they got for very little money. The positioning question is always why the capital seller should invest in project X, rather than Project Y. Why is X superior to Y in revenue, political reliability, trade or geo-strategic advantage.
Chinese capital buyers want synergies in their investments. They prefer to work with countries that have a strategic plan for Chinese investment for multiple infrastructure inputs over a long term period. One infrastructure impacts another set of needs. Roads, rail and ports make mineral resource acquisitions feasible. All of these inputs leverage Chinese trade through Special Economic Zones that bring hundreds of Chinese companies to the infrastructure region.
Some countries, like the UK, are developing strategic plans for Chinese infrastructure investment. Cressida Hogg of 3i Infrastructure in the UK sees an emerging UK strategy for Chinese investment in a new model for investors to take on more of the construction risk instead of seeing infrastructure purely as a safe income yielding asset. The UK needs 200 billion pounds of investment in energy, water, transport and other projects by 2015. For the past two decades it has aggressively privatized infrastructure and “there is no political resistance in the UK to Chinese or other investors in major infrastructure assets, unlike the United States.” In turn, China has its own strategy. Bernhard Hartmann “believes that China is engaged is some form of strategy of the utilities and infrastructure sector worldwide” (China Daily 02-17-12).
The purpose of branding is to build customer trust in the seller. The UK has done a splendid job of marketing its country brand as an aggressive infrastructure privatizer, a friend of China and a stable government. France is a good friend of China; but a reluctant privatizer. African countries like Kenya, Ghana, and South Africa are relatively stable, compared to other African countries.
Country branding has its limits. Democratic regimes change leadership frequently by election; autocratic regimes have longer leadership cycles, but are prone eventually to rebellion. In both cases the cast of characters changes in the long duration of an infrastructure project. Brand trust requires continuous relationship building that can withstand these changes in political leadership.
Foreign State, provincial and municipal governments have more entrenched elites than National governments, which can better sustain public/private partnerships for the long duration of a project. They are also more aggressive and innovative because of intra-national regional and local competition.
Countries need well funded and organized campaigns to promote their infrastructure projects to China’s CIC and kits SOEs. It is not enough to impress China to have a President or Governor’s hailing a new day of bi-lateral cooperation. Foreign countries need road show events, business models and plans, documentation, financial incentives, public relations and events, favorable public opinion, political support, corporate business involvement, community support, media celebrity, social networking, personal relations and tireless staff work to demonstrate serious to China. China wants to see a big, well financed promotion campaign to get them on board.
Finally, countries and state governments need an aggressive infrastructure marketing organization in place to play the competitive game of capturing scarce infrastructure capital. Public bureaucrats, by and large, know nothing about Marketing, and are notoriously poor at Selling. Public infrastructure marketing organizations should be public/private consortia, so there is embedded business and political leadership, profit-centered incentives and driving energy to battle the way to China’s infrastructure capital market and win the battle against ever smarter competitive countries. Marketers should propose, design and staff these organizations.
In conclusion, infrastructure replacement and innovation is the biggest new industry in the world. It has traditionally been left to public authorities and bankers to handle. This can no longer to the case. Marketing must step in with its vital discipline and play a robust role in the value exchange between infrastructure project sellers and new capital and construction buyers, principally China.