22 March 2014

Doing business in China

Doing business in China is very difficult, but not impossible.

Almost everyone would like to do business in China. After all, China is the world's second biggest merchandise importer and also recipient of foreign direct investment.

Recent history is however littered with examples of tortuously long negotiations that are never concluded, successful Western companies which fail and retreat from China, and complex deals where it is necessary to grease the palms of government and Communist Party officials. But there are nevertheless many successful cases where a long-term commitment and loyalty to Chinese business partners has paid off, according to discussions at a recent China Canada Business Council event.

So what are some of the tricks to doing business in China?

China is very heavily regulated. Just to open an office, you may need to obtain five different licenses. In fact, the term "red tape" is of Chinese origin. But the main challenges are not legal, they are cultural and linguistic. You need to understand what your Chinese counterpart is saying, and that's not easy. For example, yes does not necessarily mean that you have a deal, it can mean yes we understand.

Chinese have a much less rigid view of contracts. For Westerners contract is the culmination of the process of legal, business and financial due diligence, and should be strictly enforced. For Chinese and most Asians, a contract is more like a letter of intent, a stage in the business process. Rather than rushing into litigation, the Chinese would prefer to avoid acrimonious disputes and renegotiate if possible.

Many Chinese contracts are not enforcable until they have been approved by the local or central government. This notion is not totally foreign to most Western countries, where you cannot buy a bank or a nuclear power station without government approval. But in China, government approval is required for a much broader range of transactions -- and approval may be at the level of central or local government, depending on the size and nature of the deal.

When you enter a contract in China, you already have to be thinking of how you can get out, if you need to. Dispute planning is essential. International private arbitration is a much better bet than relying on the Chinese court system. Courst are slow, expensive and public, and outside the very big Chinese cities, judges are not very high quality. Indeed, China only has a couple of decades of judicial experience which means that many laws have not been tested in courts, and lawyers and judges are not very experienced. It is better if the contract is in the Chinese language, but many legal terms are very difficult to translate between English and Chinese, and you should have your own translater.

There are two broad categories of foreign investment in China -- wholly foreign-owned enterprise or equity joint ventures. The sectoral policies regulating foreign investment in China are complex. Foreign investment is: encouraged in some sectors; allowed in others; restricted in sectors like financial services. real estate, professional services and entertainment; and prohibited in military industries, electricity and education.

Once you have all that sorted out, it can take you 2-3 months to set up a business in China, with a multitude of steps like -- structuring the investment, choosing the site/location, contacting the local government for possible incentives, getting legal and accounting advice, preparing the application, finding premises, signing the lease, environmental assessment, government approval, license, registration for taxation/customs/foreign exchange, getting your bank account, recruiting labor and management, and then finally starting operations. And when you start operations, you may be faced with summer power shortages due to system overload, if you happen to be located in Jiangsu province.

Will you be able to repatriate your profits? Yes, but again you need government approval.

Human resource issues are also messy in China. If you set up a representative office, you must have at least an equal number of Chinese hires as the foreign representatives. They can be directly hired or hired through dispatch agencies. Locally employed foreigners must have a work permit. Contract termination is also complicated. Direct termination is possible if the empoyee breaches a law or internal company regulation, but that can be difficult to prove. Termination can be achieved through negotiation, but compensation will be necessary.

A bigger challenge is how to retain staff. Direct benefits are obviously key -- like compensation, training, career development and a long term incentive plan. Then there are other benefits like recreational activities and family benefits. Foreign investors can also gain by making an effort to understand Chinese culture.

The Chinese new year is a big challenge for employers -- migrant workers who return home to the inland provinces to be with their families often do not wish to return to the coastal factories. Some factories are relocating inland in search of cheaper costs, but senior management are less keen to move away from Shanghai or Gwangzhou to boring second and third tier cities.

While China has to be part of your business plan, you must go in with your eyes wide open. And while there are very many examples of good Chinese factories, there are also very many which are not good.

The seven deadly sins of Chinese factories are: (i) short-term focus -- low reinvestment, just surviving, the money is all for the boss, his fancy car, watch and girlfriend; (ii) no pride in workmanship; (iii) neglect of quality management; (iv) no respect for workers; (v) compartmentalization of activities; (vi) no analytical accounting -- they don't know their costs because they are always fiddling the books; and (vii) no interest in improving and adopting best practices.

The nine deadly mistakes made by foreign companies are: (i) poorly defined specifications; (ii) not knowing what China costs should be in advance; (iii) failure to conduct due diligence; (iv) being seduced by the "golden sample" which factories cannot reproduce consistently; (v) failure to know and work with the project manager; (vi) not linking payments to performance; (vii) being seduced by Chinese hospitality and not maintaining strict professional relationships; (viii) leaky contracts which don't specify sufficiently well what each side has to do, and don't have dispute settlement mechanisms; (ix) not registering intellectual property (IP).

For IP, China is a first to file country, and you must register your trade mark and patents. But there are other ways to protect your IP -- such as by having a strong state-owned enterprise as your partner who will defend the IP, constantly innovating to stay ahead of the copycats, and beating others on quality and service. You should not let IP paralyse you, as there is lots of business to be done.

All things considered, lots of patience and handholding is necessary with Chinese partners. It is important to instil fear in your Chinese partners. China is a country that is ruled by fear, and you must show them that you are on top of things -- while not making them lose too much face.

In conclusion, nothing is impossible when doing business in China, but ... everything is difficult!


John West
Executive Director
Asian Century Institute
Tags: china, foreign direct investment, China Canada Business Council, corruption, red tape.

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