Why go to China? Part I. This article appears in: http://www.chinnovate.com/why-go-to-china-part-i/

Why invest in China? many managers ask. The neat answer is: don’t, unless you’ve got a great business proposition, which stands out as more promising than, say, a project in Brazil or Turkey. The reason is that doing business there is an art that has to be learnt.
In a nutshell, the country’s transformation drives corporate policies. China is constructing what the communist party calls a “socialist market economy”, and at breakneck speed. In just over 30 years, China has gone from number 32 on the world exporters league to number one, and more than 400 million people have been lifted out of poverty. The party-state’s current ‘Go West’ strategy to develop the hinterland of the northern and western provinces only accentuates this trend.

Provision of public welfare is minimal, which makes achieving 10% per annum growth an imperative. Rapid development of infrastructure makes pan-national market access easier, and accelerates the pace of social change in rural and urban areas. Labour productivity gains of around 10 per cent per annum ensures China’s salience as No 1 world trader, while a managed exchange rate jacks up inflation at home, promotes Chinese hyper-competitiveness on world markets, and helps pile up vast foreign exchange reserves, nearly equivalent to the total of all rich country foreign exchange reserves.

China’s party-state dominates the market process. It owns the land, issues and revokes leases, controls where people live, regulates raw material exploration and pricing, influences the economic conditions that prevail in each location through targets for economic growth and productivity, sets and revokes taxes, runs the whole financial system as a policy tool, and draws up its own, sometimes skewed statistics. Procurement contracts go to insiders, and the party-state has a monopoly on the political system, runs the official trade union, makes appointments to corporate boards, appoints the judges, and is determined to maintain control over the media and the internet. Hence the question: why go to China in the first place?’

The prime reason is China’s growth potential. With per capita incomes still 14% of the US, China remains a low-income country, and therefore is in a good position to achieve a rapid catch-up. Going to China also enables companies to profit from China’s new role as a regional manufacturing hub for the production of consumer goods in the wider Asia Pacific region, with China being the central link between Asian trade partners and industrial countries’ markets. Meanwhile, double-digit growth and market transformation have made it a rapidly growing consumer product market.
China, however, should not be considered by investors as simply a cheap labour country. Admittedly, unit labour costs can be up to 30 times lower than those in Europe or the U.S., but total operational costs are more telling. They include: the time spent searching for an appropriate location; learning to deal with the party-state; hiring, training and retaining the right people; the need to regularly audit suppliers to ensure that system, process, quality and regulatory requirements are met; and the possible damage to the brand if poor quality products are shipped. In addition, public policy ensures that while China’s comparative advantage is abundant labour, labour shortages are widespread, especially in the coastal regions.

So, if we decide to go, what are the requirements for success?

In one word, implementation, implementation, implementation. Companies which have decided to do business in China have to become even more real learning organizations than they already are. Their personnel have built up firm-specific knowledge over time through the firm’s collective learning process, as projects are completed and new horizons and opportunities open up in light of the knowledge acquired. Now they are going to China—or anywhere ‘abroad’—they need to learn about and acquire knowledge about different cultures, languages, institutions and customs that affect firm-specific markets. Acquiring this knowledge again takes time and involves a process of trial-and-error, of learning by listening to other firms and managers and of diffusing that knowledge through the firm. This is all the more relevant for firms entering a country like China, which is undergoing its own massive learning process as it careers along to greater wealth.

Choosing the right location

China is far from homogenous, so choosing the right location is high on the list of priorities. Local administrations scout for inward investment, offering favourable leases, tax breaks, waivers on recognising the official trade union and privileged access to finance and support on patent protection. However, these offers must not, business people advise, run contrary to what the company is seeking to achieve. The politics of the CCP has created a heterogeneous set of distinct markets. Rules handed down from Beijing are implemented differently across the length and breadth of the country. What sells in a first-tier city such as Beijing or Shanghai may not sell in a second- or third-tier city such as Wenzhou or Dalian. Infrastructure and human capital varies considerably across the country. Thus, finding the best location takes time, due diligence, and careful planning.

Government relations.

Business people are unanimous in stressing the importance of government relations at all levels. Given the importance of personal relationships, the many tiers of party-state structures, and the intricate nature of centre-local relationships, firms must devote resources on a permanent basis to cultivate officials from Beijing’s ministries right down to municipality and township levels. Getting to know the right officials can be a challenge in itself. A multi-national company making a large investment might find the red carpet rolled out with alacrity, but SMEs making a relatively small investment might struggle to make contact with the people they need to meet.

A suitable business structure.

If you choose to enter the market, you have to choose which business structure is best. China’s growth has gone hand in hand with a rapid evolution in policy, so that a variety of routes to enter the Chinese market have evolved over time. Firms may opt :to open a representative office in Hong Kong; to license their technology; to enter a joint venture with a local partner; for a wholly foreign owned enterprise (WFOE); or to create a holding company.

In certain restricted sectors, you may have no option to a joint venture. Remember that on the plus side, a partner may bring local knowledge, the all-important guanxi, market access, resources, and perhaps unique competences. They will expect the foreign partner to bring managerial skills, financial assets, technical capabilities, and a willingness to share expertise. On the negative side, there may well be a mismatch in expectations and in delivery between the two sides. It is certainly easier to run a business without a partner, but investing in developing relationships is that more difficult.

This is Part I of the “Why Go To China?” Series. To be continued…

About Jonathan Story, Professor Emeritus, INSEAD

Jonathan Story is Emeritus Professor of International Political Economy at INSEAD. Prior to joining INSEAD in 1974, he worked in Brussels and Washington, where he obtained his PhD from Johns Hopkins School of Advanced International Studies. He has held the Marusi Chair of Global Business at Rensselaer Polytechnic Institute, and is currently Distinguished Visiting Professor at the Graduate Schoold of Business, Fordham University, New York. He is preparing a monograph on China’s impact on the world political economy, and another on a proposal for a contextual approach to business studies. He has a chapter forthcoming on the Euro crisis. His latest book is China UnCovered: What you need to know to do business in China, (FT/ Pearson’s, 2010) (www.chinauncovered.net) His previous books include “China: The Race to Market” (FT/Pearsons, 2003), The Frontiers of Fortune, (Pitman’s, 1999); and The Political Economy of Financial Integration in Europe : The Battle of the Systems,(MIT Press, 1998) on monetary union and financial markets in the EU, and co-authored with Ingo Walter of NYU. His books have been translated into French, Italian, German, Spanish, Chinese, Korean and Arabic. He is also a co-author in the Oxford Handbook on Business and Government(2010), and has contributed numerous chapters in books and articles in professional journals. He is a regular contributor to newspapers, and has been four times winner of the European Case Clearing House “Best Case of the Year” award. His latest cases detail hotel investments in Egypt and Argentina, as well as a women’s garment manufacturer in Sri Lanka and a Chinese auto parts producer. He teaches courses on international business and the global political economy. At the INSEAD campus, in Fontainebleau and Singapore, he has taught European and world politics, markets, and business in the MBA, and PhD programs. He has taught on INSEAD’s flagship Advanced Management Programme for the last three decades, as well as on other Executive Development and Company Specific courses. Jonathan Story works with governments, international organisations and multinational corporations. He is married with four children, and, now, thirteen grandchildren. Besides English, he is fluent in French, German, Spanish, Italian, reads Portuguese and is learning Russian. He has a bass voice, and gives concerts, including Afro-American spirituals, Russian folk, classical opera and oratorio.
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