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China is the world's largest fireworks producer and exporter, with annual exports of more than US$500 million. But a fireworks ban instituted across 280 Chinese cities in 1993 hit the domestic side of the industry hard. The ban was lifted starting in Beijing in 2005 under a phased-in approach, until fireworks eventually were permitted across the country, and the home market was revived. The fireworks market in China now is about RMB 20 billion (USD $3.2 billion) a year.

In 2006, the State Administration of Work Safety required operating licenses for fireworks producers and gave local governments authority over them, which makes a license an exclusive monopoly over the market in a particular area. Only a small number of licenses were available. Panda Fireworks, based in Liuyang, Hunan Province was originally founded in Guangzhou, Guangdong Province in 1989. In 23 years, the firm has grown from an exporter to a company involved in the complete value chain, including R&D, manufacturing, sales and even event catering. Ten years ago, after a series of international acquisitions, Panda shifted to a domestic focus and fought a prolonged battle to acquire majority shares of the Shanghai Stock Exchange-listed Liuyang Fireworks, completing the deal in 2007. Panda, the only listed fireworks company in China, participated in the 2008 Beijing Olympics, the 2009 60-year National Day Ceremony, and the 2010 Shanghai Expo and Guangzhou Asian Games. It had industry-leading revenue of RMB 210 million (US$33.4 million) in 2011.

Zhao Weiping, Panda's founder and controlling shareholder, spoke with China Knowledge@Wharton about the company's growth opportunities in a tightly controlled industry, the numerous twists in the Liuyang Fireworks acquisition and how Panda established its brand in a highly fragmented industry.

An edited transcript of the conversation follows.

ChinaKnowledge@Wharton: Ten years ago, Panda Fireworks' focus was the export market. Why did you shift to the domestic market? What challenges and opportunities did this present?

Zhao Weiping: As an exporter, we worked as a manufacturer for foreign brands. This model has resulted in heated, homogeneous competition among peers, [and is] easily impacted by external dynamics. Most importantly, this model doesn't benefit the growth of our own brand, which in my view is the soul of an enterprise, a base point for companies to create value, and the core competitiveness to develop further.

The lifting of restrictions in Beijing in 2005 created a very good external environment for us to make a strategic transformation. Therefore, we quickly adjusted our strategy and devoted resources to home markets. I chose Beijing as the first place to enter. After hard work for almost a year, we have finally obtained the Beijing license, which is a watershed to our company transforming from an exporter to a company with proprietary brands.

If [the government in] Beijing hadn't lifted the ban, the domestic market would not have developed, and Panda Fireworks would not have made the first step of our strategic transformation... Seeking talent was the most difficult part of the process. Most of our people knew only foreign trading. We needed new talent to develop the domestic market, and [recruiting that talent] was a bottleneck to fast growth. To address this issue, we re-adjusted our strategy. On the one hand, we slowed down the expansion of greenfield projects while fully digesting existing markets. On the other hand, we decided to explore new markets though acquiring companies [made up] of outstanding teams. For instance, we purchased a fireworks company in Hangzhou at the end of 2011 and acquired shares of Wuhan Fireworks Company, which both have excellent teams.

ChinaKnowledge@Wharton: Besides government restrictions on fireworks consumption, what special issues do you see in the industry?

Zhao: First, China's fireworks industry is highly fragmented. More than 6,000 manufacturers and around 5000 sales companies operate in the market, plus more than several thousand illegal entities, meaning they operate without a license. Second, it is very difficult to apply for a license because it requires permission from three levels of government -- county, city and province -- and it is extremely difficult for non-local companies to apply due to strong local protectionism. Third, it is a highly seasonal industry, with most consumption around the spring festival holiday, which creates special challenges for management.

These factors make it very difficult for a company to expand nationwide. We put a lot of effort into applying for licenses in Beijing, Jinan, Taiyuan and Yunnan by ourselves. And in Zhengzhou, Wuhan and Hangzhou, we got the license by buying local companies. Today, Panda Fireworks is the only company that [has a license outside its home province].

ChinaKnowledge@Wharton: Panda Fireworks had attempted to buy the state-owned Liuyang Fireworks in 2003, but later aborted the deal. You were preparing for a Hong Kong IPO in 2005 but then ended the process and restarted the acquisition of Liuyang Fireworks. What made you do this?

Zhao: The first attempt at acquisition didn't work out in 2003 for many reasons, and we started preparing for a Hong Kong IPO. We were in our last year of coach period [a period of preparing to go public] in 2005, and the Liuyang government came to us in May to ask us re-consider the acquisition. After carefully weighing the pros and cons, we chose to acquire Liuyang Fireworks instead of proceeding with the Hong Kong IPO for two reasons: First, we think consolidating Liuyang Fireworks will upgrade our market position, Second, we would have better resources as an "A-share" company on the mainland instead of listing in Hong Kong, as listing [in China] will help investors and consumers understand us better and improve our brand value.

ChinaKnowledge@Wharton: What lessons are there for private companies in China that hope to buy stated-owned companies?

Zhao: The acquisition was a difficult process. Both the time span and the level of complexity were a rare case in China's capital market. Due to historical reasons, state-owned companies are very complicated in terms of shareholder structure and corporate governance, and the capital market was also in a developing stage at that time [because] many regulations [governing] M&A were not mature yet. So we could only explore and test by ourselves. All these factors brought challenges to the acquisition, as well as other negative impacts -- including punishment on big shareholders and myself by the regulators. But I am still very happy that we could successfully close the deal, which laid the foundation for the rapid growth of our company, although outsiders [were rarely aware of] the challenges and hardships.

The other experience is that, for a private company to buy a state-owned enterprise, the concerns and targets of the two parties are not aligned. Government officials care more about the social impact you'll bring to the deal, including facilitating local economic growth, its impact on employment and addressing the historical issues in that target company, which sometimes are in conflict with business goals. Meanwhile, the private company is always in a weaker position when negotiating with the government. If you want to make the deal happen, you need to understand the costs brought by these conflicts. We were only able to [complete the deal] after we had solved many historical issues, and all these negative impacts are the unavoidable costs of the acquisition.

I think, for a private businessman who aims to acquire a state-owned company, he needs to be really determined because there will be more difficulties than he would expect. If you are not prepared for that and not determined enough, the acquisition will probably never happen.

ChinaKnowledge@Wharton: Panda Fireworks has had a hand in fireworks displays at big events such as the 2008 Beijing Olympics, the 2009 National Day Ceremony and the 2010 Shanghai Expo. What was the effect of these events on the company's growth?

Zhao: These events are of significant importance for Panda Firework. First, the performance business has expanded our reach in the firework value chain, and laid the foundation for restructuring our business model. Performance service has become a major revenue stream of us. From the 2008 Beijing Olympics to the 2009 National Day Ceremony, and to the most recent contract we signed -- with the Algerian government to display fireworks across its 48 provinces for its national ceremony on July 5 -- performance service has provided stable growth and become a bright spot of our business. We are now planning to set up culture companies in Beijing and Guangzhou that will focus on designing and implementing firework performances for big events.

Secondly, performance service has upgraded our technology level. While participating in the Beijing Olympics, Panda Firework and other research institutions jointly developed a "chip firework," which can control the exploding time and display height precisely. At the same time, it can also reduce emissions to make it more environmentally friendly and safer.

At the same time, our performance service division has prompted us to rethink and more deeply explore the artistic side of our business. The displays at those big events were a perfect match of fireworks and the arts, and have greatly influenced our design concept and opened up a new road for our products to be differentiated.

Most importantly, these events have greatly improved our value as a Chinese local brand. Our brand was born at the Beijing Olympics and it's an eternal glory. The event has helped us to stand out among heated competition ... and won us consumers.

ChinaKnowledge@Wharton: China has a long history of fireworks, but because of safety concerns the product is not widely accepted. How do you view the industry's value creation?

Zhao: Indeed, pollution and safety are the major challenges of the industry. Safety accidents were mostly caused by quality issues related with non-standard manufacturing processes. We are strengthening our investment in efforts to make our products more innovative and green. I believe, as technology improves and regulations are more widely enforced, these concerns will be addressed gradually.

The value of the industry should be based on its cultural elements. With 1,000 years of history in China, firework displays are an indispensable part of the New Year celebration here, as well as in Times Square in New York City, the Eiffel Tower in Paris, or in any corner around the world. It's not only a celebration, but also a unique art form.

Furthermore, fireworks are not only an impressive visual art, but also an expression of emotion and culture. At many occasions, including weddings, graduation ceremonies, cultural festivals and others, fireworks are a unique way of showing your emotions. I believe combining fireworks with culture and the arts will be the source of value creation for the industry in future.

ChinaKnowledge@Wharton: How do you interact with the industry dynamics?

Zhao: The national safety supervision bureau is planning to build up the fireworks industry association this year and as a leading player, we will help to facilitate the [creation of] a sound legal environment on licensing issues, intellectual property and other areas.

On the other hand, we will make use of our financing platform as a public firm to consolidate the industry. I personally think that the highly-fragmented market of today does not benefit the efficiency of the industry, and it's also a waste of resources. Consolidation will create better value for the whole industry.

We will also try to improve management standards and technology levels, and build a larger talent pool...

ChinaKnowledge@Wharton: How do you view talent strategy and motivate your people?

Zhao: I personally admire those talents trained by West Point [the US military academy]. They are prepared to take on any hardships and challenges to achieve a goal. Genghis Khan's words -- "Cross the uncrossed river, climb the unclimbed mountain" -- are my favorite. I would like to build up a core team with fully devoted hearts and determined minds.

On the other hand, a good motivation system is the key part of my talent strategy. On top of pay, it's important to provide a platform to create a sense of achievement and happiness in our people. We call it the "happiness index": It includes pay, a good work environment, food quality, training and, in the future, housing funds.

ChinaKnowledge@Wharton: What is Panda's growth strategy?

Zhao: Our future vision is to build a company that is trusted by consumers. That means we create value for consumers and the whole society, and in the process improve our team's happiness index and sense of achievement.

To achieve this vision, we will restructure our business model, and devote more resources in retail to get closer to consumers. We are planning to develop an offline sales network, as well as building an online shopping mall to compliment our offline business, and respond to consumer demands more quickly.