Family business' shift a Chinese parable

Plastic Christmas trees had been the Kao family's great moneymaker for years when Francis Kao told his father in 2001 that things could only go downhill from there.

Overlooking their 10,000-worker factory, Kao pointed nearby to the newly built campus of up-and-coming Huawei Technologies Co. as the symbol of the future.

"The high-tech industry is right by your side, but you're still sticking to the status quo," Kao recalls saying to his father, Michael. "How can the workers you employ stay cheap and the company continue to be successful now that service companies are hiring?"

The next year, in a complex and controversial deal the Carlyle Group bought in, and the Kaos reinvented themselves from low-end manufacturers to services-based innovators in the business of animation for TV and films. Across China, similar decisions are reshaping the world's second-largest economy, this year saving it from a hard landing as the old drivers of manufacturing, residential construction and exports falter.

The story of the Kao family and their bumpy ride, including troubled attempts to break into the U.S. entertainment market, offers insight into the challenges and potential for China. President Xi Jinping and his premier, Li Keqiang, are banking on a shift to services and domestic demand to realize the dream of prosperity -- recognizing that China today is too big to rely on exports and too expensive for low-end industries to drive growth.

Shanghai-born Michael Kao moved to Hong Kong when he was six years old and started his working life in the then-British colony as a tailor at 13. He learned how to make plastic Christmas trees in the city back when its low-end manufactured exports were still streaming off its wharves.

In his late 30s, Kao founded Boto Co., and after initial successes he opened a plant across the boarder, joining a wave of Hong Kong money that helped turn the sleepy fishing village of Shenzhen into one of China's most dynamic cities. It was here on a 1992 visit that Deng Xiaoping famously said it didn't matter if the cat was black or white, so long as it caught mice, giving a green light to entrepreneurs across the Communist-controlled nation.

Boto rode America's consumption boom through the 1990s, selling plastic trees to three main customers -- Wal-Mart Stores Inc., Target Corp. and Kmart Corp. With low labor costs, gross profit margins reached as high as 60 percent in those boom years, Francis Kao said. But the good times didn't last forever, and as the U.S. economy stalled when the dot-com bubble burst, business got tougher.

China saw its gross domestic product growth rates slip below 9 percent in 1998 through 2001, before a global pick-up was magnified in China by its entry into the World Trade Organization.

Francis Kao had already started diversifying the family fortune. He founded Imagi International Holdings Ltd. in the early years of the new century, producing a 26-episode animation series, Zentrix, that was sold to distributors in Hong Kong, Japan and Europe.

The new Wan Chai, Hong Kong-based firm soon expanded from employing eight people to about 160, as it made TV series such as Father of the Pride, an animated comedy about a family of performing lions in Las Vegas, for DreamWorks Animation SKG Inc.

As the new century opened, the Kaos found themselves deeper in the services game.

Then came another bump in the road. Father of the Pride aired on NBC in late 2004 to a mixed response from critics and tepid viewer numbers. There was no second season.

Imagi then spent three years producing its first independent film, Teenage Mutant Ninja Turtles. Premiering in 2007, it took in about $50 million in the U.S., half of Kao's estimate.

Fault lines in the global economy were beginning to open around the time of the film's release. In the U.S., the long boom through the 2000s was cracking as the cheap housing loans that helped fuel the spending started to blow up.

The company's next film, Astro Boy, was released as the world recession gripped in 2009. Its box office take disappointed investors, triggering a plunge in Imagi's shares after release. Kao stepped down as chairman before the movie even showed in theaters, partly due to his conflicts with management over the marketing budget for the movie, he said in an interview in Beijing.

"I knew the movie would be bad and decided to leave the moment I saw the poster," Kao said. "It was just Astro Boy flying in the sky. It didn't tell a story; it had no feeling."

Policymakers in China -- overseeing an economy hit hard by a plunge in demand for the nation's exports -- were facing tough times too. They responded with an infrastructure building spree, laying roads, airports and high-speed rail networks across the country, offering a prop to struggling heavy industries at the cost of creating a debt pile that now looms over the nation's growth prospects.

As the mainland economy revved up on the back of that stimulus, expanding 10.6 percent in 2010, Francis Kao established another Hong Kong-based animation company.

His Unicorn Studios would be different than Imagi. This time around, Francis was targeting a new audience -- the Chinese consumer -- publishing cartoon books and films with superheros of Chinese origin. The studio published a graphic novel of Blood and Steel based on a Hong Kong martial arts author's bestseller, and it is preparing to release an animated film next summer based on the adventures of the Monkey King, or Sun Wukong, the main character in the classical Chinese novel, Journey to the West.

"Now that China's market is finally mature, I can finally do what I have always wanted to do, which is to make films with characters based on our own culture and promote them to a global audience," he said. "It's vital to have a huge home base, because you need to rely on this market to cover costs and then sell products overseas to make more money."

China's movie-theater sales exceeded $6.2 billion by Dec. 3, surging 48 percent from the same period a year earlier to about 60 percent the size of the U.S. market. With about 13 screens opening each day servicing its 1.3 billion people, China is forecast to eclipse the U.S. as the world's biggest movie market as soon as 2017.

Meanwhile, labor costs in China have more than quadrupled since the 2002 decision by the Kaos. Services eclipsed manufacturing in 2012 to make up the largest chunk of China's economy and comprised 51.4 percent in the first three quarters of this year, from 42.3 percent back in 2002. The industry's outperformance has kept the nation's overall growth rate within reach of Premier Li's 2015 target of about 7 percent.

For Carlyle, the Boto purchase didn't fare well. It exited the business about 6 years after its investment after years of rising labor and raw materials costs.

"I have never regretted leaving the Christmas tree business," Francis Kao said. "I was so touched when I saw the credits rolling full of Chinese names when my films premiered in the U.S. I knew then that my children and grand children will remember me because of this. You don't get that from making Christmas trees."

Information for this article was contributed by Xiaoqing Pi and John Liu of Bloomberg News.

SundayMonday Business on 12/13/2015

Upcoming Events