How to grow your business in China
The emerging superpower could well be the land of plenty for your business
Ask anyone who has been to one of China’s big economic centres – Shanghai for example – and they will tell you that they are bustling, energetic places that overwhelm the senses with a tangible aura of progress.
That was the impression Chris Parr, partner at KSB Law, got when a previous employer handed him the job of establishing a regional base in China. The company, chemicals group Solutia, required him to visit the country on a quarterly basis between 1997 and 2001.
“Shanghai was going crazy,” he remembers. “I was travelling there every three or four months and it was changing dramatically: getting bigger and bigger and more polished, more crowded and yet more hungry every time I went back.”
Parr’s analysis chimes with the experience of Tony Caldeira of cushion manufacturers Caldeira, which last autumn established a partnership with a manufacturing business based in China’s textile homeland, Hangzhou, two hours’ drive from Shanghai.
Caldeira’s one of a plucky group of pioneering entrepreneurs to have plunged headfirst into the land of the dragon. He developed a theory that the innate Chinese culture of trade and invention was suppressed during the Maoist days to such an extent that when the shackles came off, the latent tradition erupted in a flurry of enterprise.
“I was immediately grabbed by the work ethic of the Chinese people. There’s no 35-hour week in China, more like 35-hour days,” he says. “Imagine a spring that has been coiled for 50 years suddenly being released. There’s so much entrepreneurial energy here. Most people do not realise the impact this will have on the world economy.”
And it’s not just energy that the Chinese have to offer. Caldeira estimates that on average staff cost a tenth of their UK equivalents and are prepared to work hard for their money. Employees have a thirst for overtime and are happy doing ‘menial’ jobs, he says.
But the benefits do not end there: the workforce is upskilling at light speed. Parr admits that he underestimated his business partners and was stunned by their sophistication, which he believes surpasses Western standards.
“We imagine ourselves to be superior because we have an average degree from a passable university. Many people I dealt with in China not only got exceptional grades, but had also gone to Europe or the US and aced MBAs,” he says.
Other plus points include China’s missing national insurance contributions and the fact that from a day-to-day perspective, at least, employment red tape is less burdensome than in most Western countries.
Caldeira says staff turnover is relatively high in the populous commercial regions, but with millions of people spilling into cities from the countryside every year, there is a plentiful supply of labour in most areas.
And while the Cultural Revolution stunted an entire generation of learning, younger blue and white-collar workers are more than making up for it by striving to attain ever-higher standards.
Add to this China’s vast stock of natural resources – which drive down the cost of raw materials – and the fact that demand for consumer goods is rocketing; and you have the ideal components for business, whether you’re an exporter, importer or outsourcer.
Great leap forward
With its geographical enormity, enthusiastic work ethic and pockets of already advanced industries, China now consistently ranks among the top 10 fastest growing economies in the world.
With 1.3bn people and gross domestic product growth approaching 10% last year, it adds up to a lot of potential; potential that is already being realised by entrepreneurs like you who have dared to peer beyond its borders.
Yet China is not uniform. It is a vast, variable land mass with regional dialects, currencies and multifarious methods of doing business. It has huge sprawling cities, shantytowns, seemingly endless rural wastelands; astronomical wealth juxtaposed with terrible poverty.
As a modern commercial entity China was off the world’s radar until 1978. Even now the country’s questionable political, legal and human rights record continues to dissuade many from venturing in.
Those contemplating business there must consider that principles deemed fundamental in the United Kingdom – the right to own property, for example – are new concepts in China and can undermine legal agreements as well as business relationships.
Happily, it’s not only the Chinese workforce who is eager to get involved with Western companies – the authorities are also falling over themselves to encourage interest (and money) from organisations overseas.
The tax system is so biased towards foreign companies that since joining the World Trade Organisation (WTO) in 2001, China has come under mounting pressure to level the playing field for domestic enterprises.
For example, a Chinese software developer must pay standard corporate taxes at a rate of 30%, but a global market leader such as Microsoft, for example, pays just half that figure because it is pouring foreign money into the local economy.
David Sayers, tax partner at Mazars LLP, says pressure against this obvious distortion will begin to tell in coming years. By around 2008, he claims, the tax system for foreign and domestic businesses will begin to merge.
It will bring about the creation of a hybrid tax system: still juicy for Western companies, but less so than today. “I would say the incentives on offer are currently the best in the world,” says Sayers. “These will wear away gradually, but not until they have done their job and tempted enough people into the country.”
The various enticements are defined by where you choose to locate your business and which industry it operates in. Particularly favourable are the tax breaks for manufacturing businesses, especially exporters, based in coastal regions (see right).
This lop-sided tax regime has created a flood of interested businesses prepared to throw money at the Chinese economy. According to figures from the Organisation of Economic Cooperation and Development (OECD), China attracted $53bn (£28bn) of foreign direct investment (FDI) from industrialised countries in 2003 – well ahead of its developing rivals India with $4bn and Russia with $1bn. Even the US fell short, attracting just $40bn during the year.
According to HSBC bank, contractual FDI – money that has been promised but not yet invested – spiralled nearly 50% in the first quarter of 2004 compared with the same period 12 months before.
“Incentives like halving corporate tax for the first three years make it an incredibly attractive inward investment regime,” adds Sayers. “India is less attractive because businesses have a hard time with compliance.”
While the current tax system is positively magnetic, the environment for start-ups is less so. You can’t do it ‘off the shelf’ because of the bureaucracy surrounding the process, but then you wouldn’t want to rush this sort of venture. Set aside a couple of months to deal with the legals.
So far so good, but what about the downsides? Paradoxically, in many cases the negative aspects of doing business in China are intrinsically linked to the advantages. Caldeira says the raft of incentives on offer has brought about the demise of some naïve entrepreneurs.
“There are probably more opportunities in China than in the rest of the world put together and foreign investors were rushing in, often blindfolded,” he says. “Many of the people here are only after a quick kill and a lot of investors have been stung. This is the ‘Wild East’ where a devious minority mix with honest, ethical business people.”
To some extent, corruption is still restricting business growth in China, and while the Chinese government has demonstrated its intention to freeze out the fraudsters, meeting that goal countrywide will take a serious commitment of time, energy and coordination.
Like many things in China, the legal system is cellular both in terms of its interpretation and enforcement. Outside the major cities legal codes are patchy at best, but regardless of where you are operating, the system tends to favour nationals over foreigners.
Ken Ackroyd, head of global services at Fortis Bank, says the rules are more regularly bent than broken, so that goods can be bought more cheaply or sold more profitably. He uses the example of the scrap metal industry, where the commodity is bought and sold according to a changeable world market price.
On one occasion the product was shipped by a Fortis client to a Chinese customer at an agreed price under a letter of credit, but during transit the world price slipped. When the product arrived, the buyer tried to renege on the deal in order to benefit from the new lower price.
Fortis pursued the case on behalf of its client and finally the dispute was put to the arbitration of the International Chamber of Commerce, where Fortis won payment from the purchaser’s bank. “It’s one of the risks involved when dealing with China as the interpretation of documents can differ from our interpretation,” Ackroyd underlines.
But things are changing quickly. Jean Jameson, director of Connect China, a business consultancy for trade and investment in China, says the environment is improving and is now little or no worse than parts of Europe.
She says the most common instances of bad practice are as simple as non-payment for goods received, but retailers have also reported receiving faulty or in other ways inadequate items from their Chinese suppliers.
She admits that once you’ve paid for goods or services in China there is very little hope of getting your money back. Thoroughly researching potential business partners will limit this risk in the first place.
Jameson says: “The Chinese legal system is not as comprehensive as the UK’s, nor as fully formed, because it was Communist until the 1970s. They are trying their best to improve it; these days the Chinese arbitration service is very good but enforcement is less so.”
Perception of risk
As Caldeira says, it is a minority that are out to exploit Western interest in the negative sense of the word. Nevertheless, it pays to check potential partners with a fine-tooth comb. Working in your favour, however, is a deep-seated code of honour among legitimate Chinese business people. They will often go out of their way to save face and to maintain their good reputation.
According to Sayers: “In the UK you can hand your tax return in a few days late, get a slap on the wrist and move on. In China, where prestige is very important among business people, the stigma is greater.”
Parr believes the perceived extra risk helped his team make better deals in China, simply because they were more thorough, took fewer risks and made sure all parties were clear about the path they were taking.
Because there was almost no proper legal redress if things went wrong, the team made sure they got it right first time. Extensive – though mostly informal – due diligence was a must as were other basic precautions such as releasing company information slowly and not giving away money on spec.
He adds that companies should be careful not to insult honest partners by insisting that contracts are made out according to British laws: “It’s a bit much to insist on British law when you are doing a deal on Chinese soil with Chinese partners,” he says. Singapore law – considered a happy medium – is often accepted.
China in you hands
Despite the odd horror story here and there, most companies that venture into China come up smiling. Jameson says even companies that make grievous mistakes have the opportunity to correct them and usually manage to come out on top.
She says she knows of no out-and-out failures, only mistakes made and lessons learned. For example, after visiting China on just one occasion, a Leeds-based IT company very quickly resolved to set up an office without taking the essential precaution of checking local corporate laws.
It registered the company in Shanghai, but wanted to locate the business outside the city. In China, however, the registered business and the tangible business must be one and the same, so you have to locate where you are registered – otherwise you cannot recruit and are in general very restricted. It was forced to wind up the company and re-register it outside Shanghai.
In a happy ending, however, the company has since grown to a turnover of more than £5m – proof that in some cases at least, you do get a second chance.
But if you want to get it right first time, you must research your market and any potential business partners thoroughly. Parr says it took Solutia two years to establish its joint venture with a Chinese company. He explains that a week-long meeting takes a month to prepare and a month to follow up. Any proposals take time to draw up and time for your potential partners to translate, mull over and get back to you.
It only takes a couple of repetitions of this before the process begins to stretch out. Solutia was lucky because it spun out of a larger company that already had a presence in China, so contacts were immediately available.
“We got interviews and meetings with them and a number of different manufacturers,” says Parr. “But broadly I just got on a plane and flew out to meet our man in Shanghai. While he was doing the commercial background I was structuring a joint venture on the hoof.”
Parr admits that a company ‘going out there cold’ might expect the process to stretch out even more. But he suggests that with all the support available through trade missions and support organisations, you should hit the ground running (see Forthcoming Trade Missions on page 41).
Two or three visits should be enough to get you used to the Chinese way of business. Ideally the first one should be through a specialist organisation such as Connect China or UK Trade and Investment. A translator – preferably a Chinese person who speaks English, is a must. It’s easier to translate legal documents this way and crucial to have someone (usually the same person) who can explain various customs and traditions to you.
Much is made of the culture and language gap between the Chinese and British, but it doesn’t take much to get around these. A translator will help you negotiate the first hurdle and a basic sense of universal etiquette will help you over the second.
“It’s just like meeting anyone for the first time,” says Parr. “You don’t make risqué jokes, or act in a way that would offend a host. Remember that the Chinese see the British as having odd quirks too.” The overriding message for entrepreneurs considering making the jump into China is ‘be cautious and do your research’. Get to know the country, or more specifically the region, and the people you plan to do business with.
As with all business ventures it pays to be prepared, and a softly-softly approach will limit the risks, perceived or otherwise, multiplying your chances of turning eastern promise into a great leap forward.