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China Employment Law. Watching A Bit Of The Sausage Being Made.

Posted in Basics of China Business Law, Legal News

As the Chinese government starts taking its employment laws more seriously (at least with respect to foreign companies doing business in China), our China employment law work just keeps increasing, as does our blogging on it.  The below is an email from one of our China lawyers (who is doing China employment law about half time these days), with all possible identifiers removed or changed. We are sending a version of this email out a lot these days.

As noted in previous emails, employment law in China has been in a state of transition over the past few years. Though the relevant laws have not changed all that much, the implementation of those laws has changed quite a lot, and it  remains inconsistent throughout the country. Many of the granular issues, like overtime and working hours, are handled on a case-by-base basis by the relevant local labor bureau, which is why it’s so important that we contact them and explain the facts of each situation before moving forward.

 Over the past few days we have spoken several times with the [Big China City] labor bureau, and, in particular the _________ District office, which is the office that handles applications and approvals for your WFOE’s employees. We explained your WFOE’s general approach to them, and we got the following clarification from them regarding  _______ District’s current practice regarding alternative working hours systems:

1.  Mr. Zhang’s [not real name] job position and salary make him theoretically eligible for the flexible working hours system. Other sales representatives employed by your WFOE (even those in ______) might also be eligible.

2.  We spoke with the supervisor of the _________ District labor bureau about the particulars of Mr. Zhang’s employment, and he indicated that there was a good chance Mr. Zhang would be approved to work under the flexible hours system.

3.  Your WFOE would need to obtain permission from the _________ District labor bureau BEFORE implementing the flexible working hours system.

4.   To implement the flexible working hours system, your WFOE would have to submit the following:  

  • an application
  • copies of the WFOE’s business license and organization code certificate
  • a list of employees working under the flexible working hours system
  • a summary of the work and rest schedule for such employees.

 5.   The _______ labor bureau does not have a formal position on whether (or how) travel time would count as “working hours.” Their position is that the WFOE’s rules and regulations determine this issue, but the company must ensure that each employee’s workload is reasonable. The labor bureau declined to elaborate on the definition of “reasonable,” other than to say that “it is what a normal person could finish in a normal amount of time” and that “any application for the flexible working hours system would have to explain how each employee’s workload was reasonable.” This is pretty typical and we have quite a lot of experience with handling this.  

6.   Your WFOE can prepare and submit this application itself or you can authorize one of our China lawyers to do it on your behalf.

7.   Upon receiving an application, the labor bureau will render an initial decision within 5 business days. However, the Huangpu supervisor indicated that much of the time, the bureau will issue a decision on the spot.

8.   The labor bureau will subsequently issue a formal decision. Any approval for the flexible hours working system will indicate the term of the approval, which can be for up to two years.

At this point, I suggest that you think about your approach to travel time and working hours for sales representatives and then we should discuss that. Depending on what you decide, we may want to add a line or two to Article _____ of your Rules and Regulations. 

 

The China-US Shuttle. Tain’t No Big Thing.

Posted in China Business

Clients (and others) often ask our me how many lawyers we have in China and/or how many China lawyers we have in the United States. I always have problems with those questions for two reasons.  The first reason is that I myself have no firm definition of “China lawyer” and so what I usually say is something like how we have a core group of eight lawyers who spend most of their work hours on China matters, but we also have countless other lawyers in the firm who bring their specialities to bear on our China matters. For instance, we often cover China arbitrations with one of our China lawyers and one of our litigators. Customs matters often involve a China lawyer and a trade lawyer. IP might involve a China lawyer and an IP lawyer. You get it…

But not only does my definition of China lawyer make counting difficult, it is usually not so easy even answering how many lawyers we have in the US and in China because we are always shuttling back and forth. Not to mention that it is the rare week that we don’t have a lawyer in Los Angeles or in Chicago or in New York or somewhere else in the United States. Last week, my answer regarding lawyers in China was five. This week it’s three, as one of our lawyers just returned from three months in China and another from China is here for  a few more days. But soon my answer may well be eight lawyers in China. The point is that it always varies.

We love rotating our lawyers between countries because it is good for our clients, good for the lawyers, and good for our firm. The funny thing is that hardly anyone ever notices. I was in China and Vietnam for a few weeks recently and nobody much even commented. Most communication these days is by cell phone or by email or by Skype or via our firm’s own internal communication tools (Yammer and Lync), and all of these things work relatively seamlessly around the world.

I thought about all of this when I read a Fortune Magazine article by Verne Harnish, entitled Five Reasons to Escape Overseas.  The article extols the following five benefits employees (and in turn their companies) realize by going overseas:

You Get Closer to the Action. Prevents you from slipping into an “isolated worldview” and from missing international opportunities.

You Eliminate Distractions. Takes you away from the day to day demands of the home office.

You Build New Relationships. Its a great way to meet new people. For us, it’s a great way to increase the depth of our firm relationships.

You Uncover Best Practices. Learn from what works elsewhere.

You Beat Burnout. Reinvigoration “from being surrounded by different influences.”

I tend to agree, but what do you think?

 

High-Level China IP Delegation to Discuss IP in China at Fordham Law School this Friday

Posted in Events

A high level China IP delegation will be at Fordham Law School this Friday evening to discuss China IP and China IP legislation. This will be a free event hosted by the Chinese Business Lawyers Association and the Fordham IP Institute. If you want to attend (and you absolutely should) you will need to RSVP at events@cblalaw.org, and specify that you are signing up for the roundtable.

The roundtable discussion is from 4 PM to 5:30 PM at Fordham Law School’s Costantino Room. The PRC delegation, which is studying US laws and implementation regarding IP will include two IP judges from the Supreme People’s Court of the PRC; two members of MOFCOM, including the Deputy Director of US Affairs; a representative from the Legislative Affairs Office of the State Council; the Chief Officer of Legal Affairs at the China Food and Drug Administration; the Chief Officer of the Enforcement Division of the National Copyright Administration of China; representatives from the State Intellectual Property Office and from the State Administration for Industry and Commerce; and so on.  Basically everyone you could possibly want from China.

Attendees will not only have the chance to pose questions at the talk, but may also submit suggested questions to the moderators (through the same email address) ahead of the talk.

There will be a dinner and networking event after the talk from 6 to 8 PM. You can reserve seats for the dinner and networking event, also at events@cblalaw.org. Attendees pay the cost of their own meal.

 

Sounds like a great event.  Any thoughts on what you would like to say or ask to the PRC delegation if you could make it there?  Nothing snarky in the comments, please – and when I say “nothing snarky,” I am, of course, actually inviting you to be as snarky as you like.

Social Insurance For China Expats. It Depends.

Posted in Basics of China Business Law, China Business

Our clients often ask us whether as China employers they must contribute to social insurance for their expat employees. The answer is that it depends on the employer’s location.

The Provisions on the Employment of Foreigners in China (《外国人在中国就业管理规定》), mandate that expat participation in social insurance programs must comply with applicable Chinese law. But before the Interim Measures for the Participation in Social Insurance of Foreigners Employed in China (《在中国境内就业的外国人参加社会保险暂行办法》) were passed in 2011, there were no national guidelines. As with many things in China, the lack of central government guidance meant that each locale dealt with this issue by coming up with its own rules and that is still the case.

Shanghai, for example, does not require employers pay social insurance for expats. Since 2009, the governing guideline for Shanghai has been the Shanghai Municipal Human Resources and Social Security Bureau’s Circular on Several Issues Regarding Participation in Social Insurance for Urban Workers by Foreign Workers in Shanghai, Workers with Foreign Permanent (Long-Term) Residency and Taiwan, Hong Kong, and Macao Residents (《关于在沪工作的外籍人员、获得境外永久(长期)居留权人员和台湾香港澳门居民参加城镇职工社会保险若干问题的通知》)(沪人社养发[2009]38号).  According to this Circular, an employer does not have to make social insurance payments for an expat and even where the employer and the expat have agreed on the employer’s contributing such benefits, the employer’s obligation is limited to pension, medical and work-related injury insurance, with maternity and unemployment insurance not covered.

As mentioned above, in 2011, China’s Ministry of Human Resources and Social Security passed the Interim Measures for the Participation in Social Insurance of Foreigners Employed in China. Under these Measures, an employer must pay for all five types of social insurance (pension, medical, work-related injury, maternity and unemployment insurance) for an expat. Shanghai, however, has not adopted this national standard and it is not mandatory for Shanghai employers to contribute social insurance for their expat employees. Shanghai’s position is that until the Central Government issues detailed national measures, it will not change its current rules regarding social insurance for expats.

Other cities, such as Beijing and Shenzhen, do not “see eye to eye” with Shanghai regarding expat social insurance. In both Beijing and Shenzhen, employers are generally required to pay all five types of social insurance (pension, medical, work-related injury, maternity and unemployment insurance) for an expat. But Shenzhen further complicates things by treating expats as employees without a Shenzhen hukou for purposes of social insurance. The exact types of social insurance which must be paid for expats depends on the class of medical insurance an employer provides. An expat with “class one” or “class two” medical insurance must receive all five types of social insurance, while an expat with class three medical insurance gets four types of social insurance (pension, medical, work-related injury and unemployment insurance).

Bottom Line: The short answer then to what employers need to pay in social insurance for their expat employees is the lawyer’s favorite: “it depends.” The slightly longer answer is that we need to check with the relevant authorities for the specific locale because there simply is no one right answer.

Changing Your China Factory? Be Careful.

Posted in Basics of China Business Law, Legal News

Just read an article, Toy supplier sues maker in reshoring fight about an American toy maker’s lawsuit against its Chinese supplier. The article describes the lawsuit as being based largely on allegations that the Chinese supplier ceased providing the American company credit and delayed deliveries, all in an attempt to make it impossible for the American company to start making its toys in the United States.

Though I have no idea one way or the other whether the allegations in this particular lawsuit are true, I do know that bad things nearly always happen when Chinese manufacturers discover that their American product buyers will soon be ceasing to buy product from it. For this reason, we instruct our client to line up its new suppliers and have them ready to go, before even hinting that it might be ceasing production with its existing suppliers. We give this advice because over the years our China lawyers have repeatedly seen the following:

  • US company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. China manufacturer then keeps all of the US company’s tooling and molds, claiming to own them. The way to prevent this is to get an agreement from your Chinese manufacturer that you own the tooling and molds before your Chinese manufacturer has any inkling that you will be moving on. For more on the importance of mold agreements, check out How Not To Lose Your Molds In China and Want Your China-Based Molds? You’re Probably Too Late For That.
  • US company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. US company then learns that someone in China has registered the US company’s brand names as trademarks in China. US company is convinced that its China manufacturer is the one that did these registrations, but has no solid evidence to prove this. US company is now facing not being able to have its product — at least with its own brand name — manufactured in China.
  • US company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. A few weeks later, US company has its products ceased at the China border for violating someone’s trademark. The US company is (rightly) convinced that its China manufacturer is the one behind the product seizure, believing that the Chinese manufacturer registered the US company’s brand names as trademarks in China long ago and is just now using that trademark to seize product as revenge. China has laws forbidding its manufacturers from registering the trademarks of those for whom it manufactures, but because it is usually not possible to prove that your manufacturer in Shenzhen had a cousin in Xi’an do the registering, this sort of thing goes on unchecked. For how to prevent this from happening to you, check out the following:
  • US company tells its China manufacturer that it will no ceasing to use China manufacturer for its production. China manufacturer then says that it will not be shipping any more product because US manufacturer is late on payment and owes X hundreds of thousands of dollars. China manufacturer then reports US manufacturer to Sinosure and Sinosure then ceases to insure product sales to this US company, which can have the effect of convincing Chinese manufacturers not to sell to US company without getting 100% payment upfront. For more on Sinosure’s role regarding China exports, check out Be Sure Regarding China’s Sinosure.

Bottom Line: Plan ahead before you even talk about pulling your production from a China factory.

China Hiring. Background Checks Required.

Posted in China Business

Just read a post on the China Leadership Blog, entitled, Why China Hiring Background Checks: We now have 15 reasons. The post was on the writer’s hiring agency had narrowed down job candidates to 15 and none of the 15 passed the background check:

We were placing a GM for a Western family owned factory. They are small and troubled.  We found 15 thoroughly qualified candidates for the position. We had candidates tell us they worked at a company 5 years when they only worked 1. We had candidates tell us they were super valuable,  and the company does not want to let them go. We were able to find out that they were fired a year before  while still in probation.

As the last of the group of 15 refused to come clean and give us an accurate resume, we shook our heads in dismay. We are excellent at interviews and interview 90 minutes as our goal is to know. Despite that, we were unable to uncover these issues before the background check.

We had one guy tell us he was the overall manager for a big project, and he could describe in great detail all he had done. Our China hiring background check uncovered that he was a common worker under a manager who led that project.

I suspect many are surprised by the above, but I can tell you that if I told this to the China lawyers at my firm, not a single one of them would be surprised. In fact, their reaction would be along the lines, of “so.” We see this sort of thing ALL the time, with employees of our clients and with the Chinese companies with which they do business. Just the other day, an American company called to see about getting out of a long-term exclusive product distribution agreement it had signed with a Chinese company that claimed experience with selling a particular product, but had actually been in an entirely different business.

Bottom Line: Trust but verify. Conduct your due diligence.

Selling Into China. Because There Is Lots Of Money To Be Made.

Posted in Basics of China Business Law, China Business, Legal News
For years now, we have been screaming writing about how it is eminently possible to sell product and services to China without having a legal entity in China and with no personnel in China. And we get heat just about every time we do.

The heat comes from China consultants who fear the demise (0r at least a decline) in their business if foreign companies cease creating full-scale and expensive presences in China. These consultants insist that it is either legal impossible or just not feasible from a business perspective to sell into China from overseas.

Our response to these naysayers is always the same: we have plenty of clients minting money from China without a Chinese entity or a single company person on the ground in China. We then qualify it by saying that the appropriateness of such a strategy really does depend on the individual company’s product or service and various other legal and factual situations. In other words, selling into China from outside China can range from being a great solution to a terrible idea.

I thought of all this today after reading a fascinating New York Times Dealbook article by David Gellis, entitled, Alibaba Is Bringing Luxury, Fast, to China’s Middle Class. To grossly summarize the article, foreign companies are making money selling high end luxury goods (even food) into China through TMall.

Yes they are.

From the legal side, we as China lawyers deal with the following issues (among others):

  • China compliance issues. Is the Chinese entity facing any sort of sanctions? Is the Chinese entity one that is likely to cause our client corruption problems.
  • Product compliance issues. Is the product our client wants to sell into China legal in China? What sort of packaging/labeling is required? What about customs and duty issues?
  • The contracts between the foreign company and the Chinese company, be it a sales agreement, a distribution agreement, a consignment agreement, or whatever.
  • The intellectual property issues. Just because you do not have a company in China does not mean that you cannot and, more importantly, should not be doing everything you can to protect your IP in China, especially your trademarks.
  • Figuring out the best way for our client to get paid so as to minimize taxes.

For more on selling into China without being in China, check out the following:

China Law For Foreign Companies Doing Business In China. It’s Real.

Posted in Basics of China Business Law, Legal News

Pretty much since we started this blog, we have written posts that essentially set forth the following mantra:

  • China has laws.
  • China increasingly is enforcing those laws, against both domestic companies and foreign companies operating in China. Probably more against foreign companies operating in China than against domestic companies.
  • You are entitled to complain about the harsher enforcement of China’s laws against foreign companies as compared to as against domestic companies.
  • But you ignore China’s laws at your own peril.

Uber China lawyer Stan Abrams just came out with an excellent post that pretty much sets forth the above for the updated China world, which involves a stepped up crack-down on foreign companies. Stan’s post, entitled, Foreign firms ‘must follow Chinese law’ – Who Knew? quotes a Chinese government official who himself was quoted in a China Daily article, Foreign firms ‘must follow Chinese law’:

The government’s recent intensive antitrust investigations were conducted following Chinese laws and never purposefully targeted any enterprises, Lu Wei, minister of the Office of the CPC Central Leading Group for Cyberspace Affairs, told a panel during the World Economic Forum in Tianjin.

“China’s governance of the Internet follows the ‘bottom line’ approach, and all foreign Internet enterprises in China must follow the ‘bottom line’ of abiding by Chinese laws. There are two points. The first point is safeguarding the interests of China, which is very clear. The second point is safeguarding the interests of Chinese consumers, which is also very clear. Foreign investors, if they follow the two points, will be OK and welcome,” Lu said.

Stan then analyzes the above quote. He starts out by noting that the part of the quote about “safeguarding the interests of China,” isn’t “empty fluff.” He then writes about why it is important it is for foreign companies to understand how their company’s goals align (or not) with Chinese government interests:

Although it’s not always stated up front, and not in every law that pertains to company behavior, most folks know that if corporate interests are in sync with government priorities, that’s a huge benefit.

Example: Company A sells a clean coal technology to power plants. China is trying to fight pollution. Result – Company A, all else being equal, will do pretty well in China, at least in the short term. In contrast, Company B sells luxury watches that most people can’t afford, but the watch has been a preferred way of gifting government officials. But China is fighting corruption. Result – the watch company’s sales are going to tank, at least in the short term.

Stan’s views very much correspond with our own, as expressed in the post, China’s 12th Five-Year Plan. Go With It, Not Against It:

[I]f you want to know where China is going over the next five years, read the plan, as China has and will continue to hew closely to it.  If your China business plan coincides with China’s Five-Year Plan, your likelihood of success will be considerably greater than if it does not…..To put it another way, “the trend is your friend.’

Stan then talks about how with all the recent investigations and fines being levied against foreign companies, foreign companies “feel like they are being singled out, while Beijing is saying: 1) most of our targets are domestic firms; and 2) but you broke the law” and then highlights why all of this really really matters to foreign companies doing business in China:

Bottom line here is that in the minds of regulators, these foreign firms have run afoul of local law and must face the consequences. As they are going to avoid commenting on specific cases, their only response is to say “Hey, follow the law and do what’s good for the country, and everything will be fine.” And if you don’t . . . well, bad things can happen.

So when a government official here says that foreign companies must safeguard the interests of China, you best pay attention. That is not the usual blah blah blah, but a very clear statement of reality.

He is absolutely right, of course. China is going after foreign companies and whether or not it is also going after domestic companies is of far less relevance to foreign companies, especially those that have experienced problems. And it is not just the foreign companies that are making the news. In the last few months alone, we have received phone calls or emails from foreign SMEs operating in China and reporting the following:

  • A very small company in a relatively small city had four of its five American employees — all of whom had been granted work visas by Beijing — denied their residency permits because the business was not making “enough money” to support so many expats. This was the local governments way of saying that we do not think you are reporting enough income and paying enough taxes and if you are not going to economically support us, we are not going to support you.
  • A mid-sized company in a mid-sized city told that if it did not pay at least double the amount of taxes next year, its use of foreign employees would be re-examined. The local taxing authorities believed that this company was not reporting all of its income and was penalizing them for this.
  • Two American companies operating as Rep Offices told to shut down their China operations and go home because they were exceeding the bounds of what Rep Offices are supposed to do in China. One American company operating as a Rep Office told that by next year it would need to be a WFOE or it too would be gone.
  • Multiple cases of companies being told that they need to stop buying so much of their raw material from outside China (i.e. Hong Kong) when that raw material is easily available within China. We find this particularly interesting because the Hong Kong companies from which the raw material is purchased are actually mainland Chinese companies that have illegally set up operations in Hong Kong so as to avoid paying mainland China taxes. We see this as part of China’s renewed effort to stop its own citizens and domestic companies from pushing money out of Mainland China. See Getting Money Out Of China. That’s Illegal.

We are absolutely convinced that Chinese government officials have been instructed to crack down on rule breakers, but because our law firm does not represent any Chinese domestic companies in their China legal matters, we have no idea whether this widespread crackdown is being also happening to Chinese domestic companies as well. But again, for foreign companies more interested in being able to operate in China than in geopolitical issues, the impact on domestic companies is usually going to be of only peripheral (if any) importance.

The bottom line is what Stan says: “‘follow the law and do what’s good for the country [China], and everything will be fine.’ And if you don’t . . . well, bad things can happen.”

China Non-Competes. Oh, Oh, The Price You’ll Pay

Posted in Legal News

A Non-Compete Agreement is a contract where one party agrees not to compete with the other. These agreements reduce the likelihood of someone using information you provide them to compete against you. Non-compete agreements are fairly common between Western companies and their more important employees and it is common for those Western companies to want similar such agreements with their China-based employees.

In China non-compete (竞业限制) agreements between an employer and an employee are generally limited to senior management, senior technicians and other personnel who have a confidentiality obligation. China allows for non-compete agreements that prohibit high level employees from working for another company that competes with the employer.

China limits these non-compete provisions to two years or less after termination of the labor contract and it also requires that the employer pay economic compensation to the employee to maintain the non-compete requirement. There are a number of things to which an employer with a non-compete agreement should pay attention, but in this post I only focus on non-compete compensation. The most important thing employers must know about non-compete compensation in China is that the employer is required to pay this compensation after the employee leaves the company and a failure to do so means the employee ceases to be bound by his or her agreement not to compete.

Pursuant to the Judicial Interpretation IV of the Supreme People’s Court on Several Issues Concerning the Application of Law in Hearing Labor Dispute Cases (“Judicial Interpretation IV”), if there is an agreement between an employer and an employee regarding post-employment compensation for a non-compete provision, their agreement prevails. If the agreement is silent on the amount of post-employment compensation for the non-compete provision, the employer must pay the employee compensation at 30% of the employee’s average monthly salary in the 12 months before termination, or the local minimum wage, whichever is higher.

Before Judicial Interpretation IV, there was no statutory guidance (other than Labor Contract Law which does not say much) on the standard of non-compete compensation and locales dealt with this issue by coming up with their own rules. For example, Shanghai used to hold that if there was no agreement on the amount of post-employment compensation, the employer had to pay the employee 20% to 50% of the employee’s last monthly salary. In Jiangsu, the rule was different: the annual non-compete compensation had to be at least one third of the annual salary the employee received from the employer over the 12 months before leaving employment. Though Judicial Interpretation IV is supposed to supersede all the local rules, it is nonetheless advisable to check with the relevant authorities to figure out exactly what their standard is as we are still finding local differences.

A literal reading of Judicial Interpretation IV would mean that even if the amount of compensation agreed to in a non-compete agreement between an employer and an employee is less than the local minimum wage, it is nevertheless valid and enforceable, because the 30% rule applies only when the non-compete agreement does not specify the compensation. But ex-employees could also argue that any amount less than the minimum wage is unfair and against public policy and thus should not be enforced. Some municipalities faced with this argument, including Shanghai have upheld the “freedom to contract” and ruled against the poorly paid ex-employee.

The key is to draft your non-compete provisions (in Chinese, of course) in a clear and easy-to-understand manner so that your employee cannot claim confusion and so that the specified non-compete compensation will not trigger a default compensation rate. I will cover more on non-compete agreements in our future posts.

 

 

 

Does a “Prudent” Market Entry Strategy for Healthcare Services in China Exist?

Posted in China Business

The below is part II of guest posting by Ben Shobert and Damjan DeNoble, partners at Rubicon Strategy Group, LLC, a strategy advisory firm for healthcare companies going into China and Southeast Asia and the co-authors of HealthIntelAsia.com, a website dedicated to Asia and China healthcare business strategy. Ben also has a regular column on Forbes, where he writes about life science issues in Southeast Asia.

Our last post introduced how regulations around foreign investment in China’s hospitals are changing, with the most recent announcement of seven WFOE pilots as evidence of these changes. Experienced China watchers easily recognize what is happening:  China has acknowledged that it has a problem which only foreign expertise and capital can fix.

Consequently, it is reforming its Foreign Direct Investment (FDI) Catalog, and associated sector-specific regulations, to accommodate more foreign involvement. This process is hardly unique to hospitals. Every other previously closed sector of the Chinese economy that is now open to FDI has gone through a similar process. Though it helps to be able to compare today’s opening of the hospital sector to efforts in other industries that have opened to foreigners, doing so is misguided in some important ways that impact go-to-market strategies for western hospital operators and investors.

First, while in form WFOEs are now possible for China’s hospital sector, it remains unclear whether as a foreigner you should really try to go it alone. If, as a western hospital provider, you want to take the WFOE path, you need to be very sure you can get the land you need, located in proximity to where your market exists, and that the requisite medical institution licenses you will need are obtainable without a Chinese partner.  One need look no further than German hospital operator Artemed, and their July 2014 announcement about their work in the seemingly progressive Shanghai Waigaoqiao Free Trade Zone, to see that even here a foreign operator found they needed a domestic Chinese partner.  Simply because a WFOE status within a particular sector has been given the green light by China’s central government doesn’t mean as a foreigner you still aren’t going to need a domestic Chinese JV partner.

Second, be very clear eyed about where profit resides in China’s healthcare economy.  In late 2013, we worked with CN Healthcare on a study of how much capital had been invested into China’s private hospital sector and why. The answer was telling: of the roughly $1.7 billion in capital that had been invested in China’s hospitals, almost all of it came from domestic Chinese players, and almost all was driven by pharmaceutical companies and distributors who viewed purchasing a Chinese hospital as a way to protect their profit margins in the wake of growing price pressures on pharmaceuticals sold via the hospital. For those reading this unfamiliar with China’s hospitals, keep in mind that historically one of the most important sources of revenue for Chinese hospitals has been the sale of pharmaceuticals. As China has developed more sophisticated reimbursement strategies such as those embodied in the Essential Drug List (EDL), hospitals have struggled to replace lost revenue from lower prices on pharmaceuticals with pricing models that emphasize services. This is hardly news; McKinsey China’s 2012 analysis of the Chinese healthcare consumer emphasized the challenges facing private healthcare operators given the resistance by Chinese consumers to pay for healthcare services. In other words, don’t assume the value of your services is going to be immediately clear to the Chinese consumer. In fact, the Chinese consumer is wary about private healthcare in general, and private hospitals in particular.

Third, be extremely cautious about the public-to-private option with Chinese hospitals.  Running in tandem with the gradual relaxation on foreign ownership of Chinese hospitals has been a set of policies from the Ministry of Health (MOH) that allows for formerly public hospitals to be privatized. In theory, foreigners now have at least three go-to-market options: greenfield (build an entirely new WFOE hospital from the ground up), public brownfield (buy and privatize a formerly public hospital), and private brownfield (buy a formerly Chinese privately run hospital and transfer ownership).  Let’s just say that if you are looking at a hospital in China that is for sale – whether public or private – it’s safe to assume there is a really good reason the hospital is for sale in the first place. You need to quickly get to the bottom of why the hospital is for sale, as well as the rights you have as a foreigner purchasing these assets (hint: hospital ownership and management laws are about as developed as company law was in China in 1985, which is to say, not very).

Fourth, have a bias towards a healthcare delivery model that is extremely easy to articulate to the Chinese consumer. What do I mean by that? Too many westerners bring ideas about what they want to do in China based on how healthcare is consumed and paid for in the west. China’s healthcare needs are so overwhelming, and the potential market is so large, that it can be easy to assume whatever capacity you build out will be successful.  If we look at the revenue growth and profitability of three publicly held healthcare operators in China – iKang, Concord Medical, and Chindex – we can see very different revenue and profitability trajectories. Specifically, iKang and Concord are growing at very high growth rates (iKang’s 2011 revenue was 68.23 million USD, by last year they had achieved $202.3 million USD in revenue; Concord’s 2011 revenue was $372.05 million USD, by last year Concord had grown to $980.63 million USD).  Chindex’s revenue growth and profitability has been sufficiently uneven that, as we pointed out yesterday, they are being taken private later this month. There are a couple of ways to interpret this, but one important narrative is that iKang and Concord have a very specific set of treatments and interventions they market to the Chinese middle class consumer versus Chindex’s United Family Hospitals that are more general and perceived by the consumer to be less specialized in the care they offer.

The last component that should reinforce anyone looking to make an investment in China’s hospitals is an awareness that healthcare in China is a political hot potato. While today FDI policies in the hospital sector are perceived as “friendly” to foreign capital and expertise, we need look no further back than last summer at the GSK scandal to recognize that China’s government faces a fundamental challenge to its legitimacy as a consequence to decades of under-investment in the country’s healthcare system, and that it will use tactics of public trial and blame to distract Chinese families from problems that are entirely of the government’s own making. Yes, be positive about what China is doing in the hospital sector but also never lose sight that foreign involvement in this part of the country faces some of the most unique political pressures of any sector that has opened to foreign investment in the last decade.