ABSTRACT
It is, in theory, much easier for a foreign company to establish a business venture in China than it was 30 years ago, or even 15 years ago. China is a member of the World Trade Organization and, in theory, embraces free trade. Foreign businesses are welcomed for the capital investment and technology they bring and the jobs they create. China is the world’s second largest national economy, an important part of the global economy, and embraces the existing global trade order. So much for the theory. In practice, getting started in China is still
very difficult. The late Ian Rae, a businessman with more than 40 years’ experience of owning and managing businesses in Hong Kong and mainland China, argued that it is easier to lose money in China in the 21st century than it ever was in the 20th.1 In part, this is because of the apparent ease with which foreign companies can now attempt to establish themselves. With most of the big barriers to entry – like restrictions on investment in certain sectors and limits on earnings repatriation – gone, there is a tendency among the more naïve foreign investors (which in our experience is quite a large tranche) to assume that business in China is now just like business anywhere else. It is not. Nandani Lynton put it best in an article for McKinsey Quar-
terly: everything in China is political, and everything in China is personal.2 Government still, and will for the foreseeable future, have a say in what gets invested in China where, when and how – and ‘government’
in this context means not just Beijing, but provincial and local governments as well, all of which have their own – sometimes conflicting – agendas. And as we have stressed throughout this book, guanxi means everything. Without the right personal relationships, any venture will fail. Much of the discussion about establishing ventures in China has con-
centrated on the form the venture should take. Effectively, there are three choices: licensing/agencies, joint ventures (JVs) and wholly foreignowned enterprises (WFOEs). Pretty much since the first edition of this book in 2000, consultants and financial journalists have argued that the best way forward was the WFOE route, with licensing as an option if you wanted only a low-profile low-risk presence, and that the most risky and dangerous way forward was the JV. The death of the JV was widely predicted. Today, WFOEs do predominate, but JVs have proved surprisingly dur-
able. According to Boston Consulting Group (BCG), 21 per cent of new foreign investment in China in 2014 came in the form of JVs, and the total invested in JVs in China amounted to US$23 billion. A BCG survey found there were more than 6,500 JVs in China, and a further 80 per cent of multinationals are intended to expand their JV activity across Asia (including in China).3 A quick scan of recent joint ventures in China shows a wide range of activity and sectors, from large companies to small ones, from health care to fast-moving consumer goods. How do we account for this continuing interest in JVs? We’ll come
onto the advantages and disadvantages of JVs in more detail in a moment, but the main reason seems to be that some companies recognise that the quintessence of doing business in China is partnership, and internalising partnerships through a JV can be, perhaps paradoxically, less risky than relying on purely external relationships as a WFOE does. That said, there can be plenty of problems with JVs and there are many spectacular examples of JV implosion. Many companies will, quite correctly, choose either a WFOE or a licensing arrangement. It all depends on what is right for them and their businesses. This chapter compares vehicles for foreigners to do business in the
PRC from the point of view of strategic and operating efficiency and effectiveness. The technical details of company formation, governance and taxation are widely available from law firms; we are concerned here with practicalities, whether the venture will succeed and whether it will deliver the required return on investment. The chapter is structured to follow a path of increasing commitment:
the distinction between production and distribution agencies and licensing
joint ventures wholly foreign-owned enterprises identifying and negotiating with partners making the choice
While Western businesses and consultants think primarily in terms of structure, the key distinction from the Chinese perspective is whether the proposed venture will import and distribute foreign goods in China; whether it will produce goods in China for export (outsourcing or offshoring); or whether it will both make and sell goods inside the country. Importing ventures are very popular with Western companies, who
seek the opportunity to sell their goods to China’s billion-plus consumers. The Chinese authorities tend to assess each venture on its own merits, in terms of how it will benefit the economy and whether it will directly threaten local competitors. This does not mean that all such ventures are frowned upon – far from it. Western companies selling goods that are much needed, especially those with high-tech components, are likely to be welcomed. Those selling luxury goods that do not compete directly with low-cost local products should find no opposition, nor should those who will be competing only marginally with very well-established local brands. On the other hand, the Chinese do engage in some protection (unofficial now, of course) of industries that are already overstocked with firms, or where local growth needs to be encouraged. (However, this protectionism is not universal. Some Chinese officials may well take the view that a bit of foreign competition might liven up local businesses and make them raise their game. One should not count on this happening, but it does happen from time to time.) It is rare in these post-WTO days for a licence to be refused, but it
can be hedged in with terms and conditions: for example, so many local jobs will need to be created, so much local sourcing will be involved, and so on. This is particularly the case for firms producing mass consumer products such as white goods. Cars are another area where the government attempts to restrict and control the number of producers, although there has been some relaxation of this in recent years; but, with air pollution rising to crisis levels and cars a major contributor to the problem, further restrictions are not beyond the bounds of possibility. Ventures that are set up to make goods for export are, of course,
highly popular. Exporting to Western markets has long been a key element of Chinese economic policy. It has provoked some resentment in
the West, as witness the infamous ‘Bra Wars’ of 2006, when the European Union tried to place import tariffs on Chinese-made clothing coming into Europe. This exporting has huge benefits for the Chinese, not just in terms of the dollars, pounds and euros that exports earn, but also for the skills and technology that get transferred into the country along with production. It has also had benefits for Western companies able to tap into a pool of low-cost skilled labour and significantly reduce their production costs. Since the 2008 downturn, there has been an ongoing argument as to whether the offshoring boom in China is coming to an end. Some argue that rising productivity in the West will lead to ‘reshoring’, repatriating manufacturing to ‘home’ countries; others say that low shipping costs mean offshoring is still profitable despite rising wages; others point to a shift in emphasis in China from goods offshoring to services offshoring – a direct attempt to compete with India – as proof that there is still life in offshoring. It all depends to a great extent on who you talk to and their own beliefs. There is much debate about this subject, but, as yet, little evidence. Wages in China are indeed rising, at least in the south and east, but those rising wages have been at least partly offset by productivity gains. As with everything else, whether you manage to offshore successfully in China will depend largely, if not wholly, on the capabilities of your partners and your relationship with them. Combined production and selling ventures suffer somewhat from the
disadvantages of the latter. It is not uncommon for the government to request that at least a portion of the new venture’s production is exported, leaving the company free to sell the rest domestically. This requirement is often levied on Chinese firms as well, and is a source of occasional complaint by Chinese businesspeople. Some of the most successful joint ventures of recent years have been structured along a two-way network, with a foreign firm allowed to use the domestic partner’s distribution network to sell into China, while the domestic firm gains access to the foreign networks. These kinds of ventures are increasingly common in the car industry, as China’s car-makers grow in sophistication and begin to seek export markets. China joining the WTO has promoted the delusion that, as in the
West, a company once established can distribute its goods in any way it chooses. Restrictions and opt-outs remain in some sectors, and legal and regulatory advice should be sought at a very early stage. But even where the route appears to be clear, obstacles can suddenly emerge if government – national, regional or local – does not feel the venture is in the best interests of the Chinese. And as we remarked earlier in the book, government remains a very powerful, influential and active player. That is
why the suggestion that Western businesses in China do not need a partner is a fallacy. Again, everything in China is political. Every business in China has a partner in the form of the government, whether it wishes it or not. Government approval and support can lay down a golden path and help businesses to succeed. Government disapproval and lack of support mean that the foreign firm has to do everything the hard way, if it can at all. To get an idea of how government will view a proposed venture,
perhaps the easiest thing to do is apply the test of the ‘Three Represents’. In 2002, then-President Jiang Zemin laid down his own philosophy of the ‘Three Represents’ (though some speculate that it will gradually fade into the background with changes of the guard): the Party and the government should work to represent (i) the advancement of Chinese social productivity, (ii) the development of Chinese culture and (iii) the fundamental interests of the Chinese people. Now apply that test to the proposed business. Will it make a contribution to the growth of the Chinese economy? Will it advance Chinese culture, or at least, not actually do it harm? Will it serve the needs of the people of China? Businesspeople in the West are not used to having to think so altruistically, but in China these considerations are a useful indicator of how government will view businesses. If the proposed venture ticks at least one of the three boxes, it is more likely to be smiled upon.
