China Law Blog

Recent issue of the Chinese Business Review has an excellent article on what small and medium sized enterprises (SMEs) need to consider in determining whether to go into China.  The article is written by Steven Ganster of Technomic Asia and it is entitled: "Strategies for SMEs: Smaller companies going to China need to think ahead, plan carefully, and remember the Six Ds."  My firm has worked with Technomic Asia (mostly with its Executive Director, Kent Kedl, who is based in Shanghai) so the high quality of this article comes as no surprise.  Both Steve and Kent have a wealth of experience assisting foreign companies in determining whether and how to go into China.

The article starts out by discussing how a "steady stream" of small and medium sized enterprises (SMEs) have "poured" into China in the last few years in an effort to make their fortunes or to lower their costs.  These smaller companies are able to take advantage of and learn from the mistakes made by the larger firms that preceeded them.

Steve advocates small companies consider the following as part of their China program:

• Perform rigorous due diligence in partner selection The PRC government offered partner companies to hungry CEOs, who often formed joint ventures without proper due diligence. These partners generally had a deficit in capabilities, a surplus in nonperforming assets, and many off-the-book liabilities.
• Base plans on more than just a "snapshot" view of the market Many companies made investments based on a current—and often inaccurate—view of the China market. The pace of change is so rapid in China that their plans were obsolete before they were fully implemented.
• Assess the competition realistically Management often underestimated the breadth and intensity of competition. Factories appeared seemingly overnight, causing excess supply and price wars. As a result, even though management forecasts were generally reasonable on a volume basis, they fell short on a value basis by as much as 30 percent.
• Be prepared for tough times When China's economy overheated in the mid- to late 1990s, western companies started to pull back, leaving their local management with few resources to sustain their China operations. Few anticipated the staying power needed to weather the market storms. China no doubt will witness periods of turbulence as its economy continues to expand.

He then goes on to note that SMEs "face critical challenges that may differ, at least in intensity, from those facing a larger MNC" and he lists the following as some of the China challenges oftentimes peculiar to SMEs:

• Niche market.  Successful SMEs often "have carved out a space in the market based on patented technology or process expertise developed over many years." These SME's must be particularly careful to protect their IP rights in China. 
• Thin Management.  "SME management is typically thinner than that of a large, diversified company." The required "investment of senior personnel" into a company's China initiative "can result in a high opportunity cost to the company."
• Limited International Experience.  SMEs typically have "limited international experience and infrastructure, resulting in a steeper learning curve and a greater need to rely on third-party organizations, which can be expensive." This lack of experience coupled with "the relatively high costs of hiring outside experts" often leads SME management to turn to "unreliable and unqualified resources that present a friendly and convenient 'China face' (for instance, the uncle of an assembly line worker who has 'great connections' with a local vice mayor). 
• Greater proportional risk.  "The financial risks of an investment in China can have more calamitous consequences for an SME than for a larger firm that can better absorb a failure or an underperforming operation. On the other hand, if management waits too long to respond to the need to go to China, it may have already compromised the company's financial health, heightening risks and limiting strategic options." 

Despite SMEs' special challenges, Steve sees them as having some distinct advantages as well.  Most importantly, they are usually able to move faster than big companies, a trait that can be of great importance in ever-changing China.  Steve also notes how the family style management of many SMEs often fits well with local Chinese management, making it easier to work together in a partnership.

Steve then outlines the "five main motivations" SMEs have to go to China:

• Attractive new market China presents an attractive market opportunity to support the development of a market entry or expansion strategy. This opportunity must be thoroughly substantiated to identify market potential where the SME can make money.
• Customer pull It appears critical to further explore a foray into China to defend or expand key customer relationships. SMEs in this situation should use direct customer probes to develop a clear and specific understanding of what their customers need from them in terms of localization.
• Competitive threat There is evidence of a growing competitive threat from China, either from western competitors that have set up there or from local Chinese players that have begun to penetrate existing customer bases. SMEs facing this situation should carefully measure this threat and identify possible countermeasures.
• Cost savings The SME urgently needs to capture the benefits of lower operating costs in China. In this case, companies should evaluate the best structural option to achieve these benefits at the lowest risk. There are often better and less risky alternatives than setting up a manufacturing facility.
• Stakeholder push Stakeholders are pressing management to consider expansion into China and require a clear and substantiated evaluation of the benefits and risks of doing so. Though not a legitimate motivation in itself to invest in China, stakeholder pressure can be a reason to take a serious look.

The drivers to go to China will usually be a "mix" of the above factors and management must clearly understand their own driversand the urgency to address them, along with the consequences if they do not.  Though examining these motiviations "may seem straightforward, companies often perform only a cursory evaluation during this crucial phase of the planning process."  Without the insight that comes from examining the motivations for going to China, management cannot accurately weigh the "financial investment, IP exposure, opportunity cost, and other risk" of going to China.

Steve Ganster is the author of the book, "The China Ready Company," which focuses on assisting companies in helping companies determine whether they are ready to go to China.  Steve and Technomic Asia have helped countless SMEs make sound decisions on their China policy and I urge SMEs considering China also consider a Technomic Asia China readiness assessment.