Pay Attention to China’s Sector Shift

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When China experienced double-digit economic growth, multinationals probably felt like there was plenty of market share to be had. The pie kept getting bigger. But now that China’s growth is slowing, the pie has more definite boundaries.

In an International Finance Discussion Paper, Dr. Jane Haltmaier, senior adviser to the Board of Governors of the Federal Reserve System, presents the following breakdown of Chinese GDP growth (notice the single-digit growth in three of the last four years):

<img alt="" src="http://g.fool.com/editorial/images/62562/42-chinese-gdp_large.png" />

Sector shifts occur when resources and production shift from one area of the economy to another. We’re talking about the primary, secondary, and tertiary sectors – sectors like agriculture, industry, and services. The green bars in the graph above represent sector shifts that caused Chinese GDP to grow.

China already shifted employment away from agriculture to industry. As Chinese farmers used more modern methods, fewer farmers were needed, so more workers began manufacturing goods. More manufactured goods means Chinese GDP grows.

Haltmaier argues that sector shifts will contribute less to Chinese GDP in coming years (smaller green bars). As China’s economy matures, Haltmaier proposes that employment from agriculture will shift more and more into services. Look at the growth of the tertiary sector in Haltmaier's chart below.

<img alt="" src="http://g.fool.com/editorial/images/62562/42-chinese-employment-shares_2_large.png" />

Here’s the key--the services sector is more productive than agriculture but less productive than industry. So when farmers leave their fields and move to services, we won’t see as large an increase in GDP as when farmers joined industry. That would partially explain why we’re seeing slowed productivity growth in China.

Empire building

Some companies are ready for the shift. Samsung Electronics is one of them. As China’s top smartphone producer, Samsung beat out the next competitor by more than four million phones in the first quarter! You might think that smartphones are secondary sector products, but the smartphone segment toes the line between a product and a service. Consumers can’t use smartphones without communication services. Software and app development are additional services which accompany the smartphone market. As China’s economy develops, consumers have more discretionary money for technological devices and services. Smartphones attract that extra pocket cash, and they’re cheaper than personal computers.

Unlike Samsung, BlackBerry (NASDAQ: BBRY) and Nokia (NYSE: NOK) need to get their acts together. Both companies are among the top five players in India’s smartphone market. India is about to become the third-largest smartphone market – just behind China. But both BlackBerry and Nokia lost their top five status in China’s smartphone market last year. This is the wrong time to lose market share. At this pivotal phase in China’s smartphone market development, where major consumer spending shifts will likely translate into billions of dollars, companies need to get entrenched now.

Competitors like Samsung and Huawei are winning with low-priced offerings. That’s where BlackBerry and Nokia need to focus – and fast – if they want to recover market share in China. The good news: Nokia and Blackberry have a second chance – according to a past article in the Wall Street Journal, Chinese consumers tend to try new phones more frequently than other types of consumers.

Claim those fields

Oil production falls into the secondary sector. China still has lots of demand for oil, but consumption growth is falling. Just this month, the EIA lowered its 2013 forecast of Chinese oil demand growth from 4.4% to 4.1%. BP (NYSE: BP) makes some very detailed forecasts for Chinese energy in 2030. For example, BP projects that industry will remain the largest consumer of energy but see the slowest growth of any sector over the next 17 years. That lines up with Dr. Haltmaier’s predictions about the secondary sector’s slowing growth.

BP also forecasts China’s energy production to rise 46% by 2030. This means that American oil companies have to get in there fast – they can’t afford to wait while Chinese oil players maximize production in the second-largest oil consuming nation.

Good thing Chevron (NYSE: CVX) isn’t waiting around. 2012 saw Chevron spend $558 million on exploration in Asia, in contrast to BP’s $128 million. In January, Chevron obtained rights to explore two Chinese offshore blocks for oil and gas. It already has majority interest in three other offshore exploration blocks, a strong proposition because exploration blocks hold prospects for future production. American oil companies need to follow Chevron’s lead and lock in Chinese acreage before the local oil companies begin snapping up land and over-producing.

Dividing the pie

If businesses want a slice of the China pie, they need to establish themselves quickly before low-cost producers grab up the market share. Samsung laid a strong foundation and Chevron is staking its claim in the South China sea. But other foreign multinationals don’t have much time.

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This article was written by Nathan Adamo and edited by Chris Marasco. Chris Marasco is Head Editor of ADifferentAngle. Neither has a position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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