As I mentioned previously, I expect to be writing a number of posts arising from issues that were discussed at the recent Doing Business in China seminar I co-moderated last week. At lunch, one of the attendees told me that they had been told by a higher up at a big U.S. retailer that they would not be going into China because they did not trust the government not to shut them down.
I pooh-poohed that, saying that the more likely reason was because this retailer knew that it would have no particular advantage in China and that it would be better off expanding elsewhere. I then thought for a moment and added that I was not aware of a single foreign company that had been shut down in China when it was operating legally. That evening I asked a number of the other speakers whether they were aware of an instance where the Chinese government had shut down a foreign company that had been operating legally in China and they too were not. The odds of getting shut down in China are minimal if you are operating legally there.
Yes, China is and has been for some time stepping up its shut-downs of companies that are not operating legally there, but I just am not aware of an instance where it has done so to a foreign company that is abiding by its laws.
Last week, I attended co-blogger Steve Dickinson’s lecture on China labor law. Steve’s lecture was part of a truly superb Doing Business in China seminar put on by Global Nav. The thrust of Steve’s speech was that labor laws in China have changed, they are being enforced against foreigners, and they are very different from U.S. labor laws. In a nutshell, the biggest differences are that written contracts with all employees are required in China and firing an employee generally must be for cause. Neither of these are true in the United States.
Judging from the audience questions (and this was an extremely sophisticated audience), many were surprised by this and many had trouble understanding the full import.
A few days later, Steve and I were talking about this with the Chinese lawyers we work with in Qingdao. In explaining to them some of the cases we have handled for American clients who got themselves into trouble by improperly laying off Chinese employees, it soon became apparent to Steve and me that the Chinese lawyers were not grasping why these American companies were making these mistakes. They would ask questions like, “how could these American companies really believe they could lay off 100 people without first securing their approval and that of the government as well?” When Steve and I told them about US labor laws, the Chinese lawyers found them so bizarre, they actually laughed.
We told them of how there is a saying in the U.S. that one can fire an employee for good reason, bad reason, or no reason at all, just so long as the reason for firing is not one prohibited by law (such as racial or gender discrimination). We talked about how one might fire an employee for wearing a green shirt. We told them of how most employees in the United States do not work under written contracts and how companies generally prefer not to use contracts. It took us at least a half an hour for us to give a basic explanation of employer-employee relations in the U.S. Even then, it was pretty clear that these exceedingly bright lawyers were still nonplussed.
It was a good exercise for Steve and me and it only reinforced why it is that Americans (the labor laws in Europe are not so wildly different from China) in China so often act on Chinese employment law matters based on completely false assumptions as to how things are really done there
For more on China’s Labor Contract Law, check out the following:
- A podcast with Steve over at the China Business Network.
- “China’s New Labor Law As Plague On All Employers’ Houses“
- “China’s New Labor Law And Why Vietnam Is No Big Thing“
- “The Impact Of China’s Labor Contract Law“
In this post and over the next few days, I will try to convey some of what went on at the recently concluded Doing Business in China seminar at which Steve (my co-blogger and fellow China lawyer) and I spoke in San Francisco.
Qiang Li, an attorney with Los Angeles based mega-firm O’Melveny & Myers, spoke on “Creative Strategies to Finance Your Real Estate Investment.” Mr. Li is a partner in O’Melveny’s Shanghai office.
He did a superb job explaining the complicated financing issues that arise when foreign investors spend more than $10 million to purchase or develop Chinese real property.
Mr. Li talked about how even though he is essentially a mergers and acquisitions (M&A) lawyer, because so many of the largest properties in China are ultimately held by offshore entities, the best way to handle the real estate transaction is usually for the purchaser to buy the company, not the property.
Mr. Li began by talking about the various efforts the Chinese government has made in the last couple years to try to slow down real estate appreciation in China. He then focused on Opinions for Regulation of Approval and Administration of Foreign Investment in the Real Estate Market, more commonly referred to as Circular 171.
Circular 171 restricts foreign investors (both corporate entities and individuals) from using offshore (non Chinese) companies to purchase and hold real estate in China. Circular 171 now requires foreign investors investing in Chinese real estate to set up onshore (Chinese) real estate investment companies, which may be wholly foreign owned (a WFOE) or a joint venture (JV). Circular 171 applies to all Chinese real estate other than to a residence purchased for personal use. We previously discussed this new Chinese entity requirement in our post, Foreign Ownership Of Real Estate In China/China’s New Forex Rules.
The registered capital of such an onshore foreign invested company (the WFOE or, less likely, the JV — collectively referred to as a Foreign Invested Enterprise, or FIE) must not be less than 50% of the total investment amount if the total investment amount exceeds US$10 million. Circular 171 also mandates that the FIE may not borrow funds unless its registered capital has been fully paid up, it has obtained the relevant land use right certificate, and its self-owned project development capital constitutes 35% or more of the total capital requirement of the construction project.
Mr. Li also touched briefly on ways investors can minimize the China real estate “cash trap” by, among other things, shareholder loans. My knowledge of international tax is so limited I am afraid to say anything more on this for fear of getting it wrong. The next day, Mr. Li spoke on “Exit Strategies — Getting Your Profits Out of China.” I actually had to miss part of that talk to deal with a minor client crisis (involving, believe it or not, getting money out of China), but will link back to that presentation once I receive a copy of Mr. Li’s Powerpoint on it.
More to come.
Assuming my Cingular Wireless (“2.5g”) internet connection is working today (hey, it has been working a bit more than half the time lately), I will be live blogging today and tomorrow from the two day Doing Business in China seminar (with a distinct real esate focus). Both I and c0-blogger/China lawyer Steve Dickinson will be speaking.
I never knew writing this blog would give me such incredible power.
A couple of days ago, I did a post, entitled, The Basics of Getting Your Business Into China By WFOE/WOFE. That post briefly mentioned setting up a WFOE (Wholly Foreign Owned Entity) in “lesser known cities that encourage specific types of business development.” Kevin Smith of the Weifang Radish blog picked up on that line and posted a comment on how he thought his former town, Weifang, is a good place for foreign business:
I really love how “setting up in new industrial zones that are eager for overseas investment or lesser-known cities that encourage specific types of business development” is mentioned. When I was living in Weifang I got to know a number of businessmen engaging in or setting up business in Weifang. All of them expressed to me how impressed they were by the price and quality of office space and other resources available in and around the city. Furthermore, some of them had lived in or been in China multiple times on business over the years, and so weren’t just wide-eyed newbies. If I were an entrepreneur looking towards China, I would probably set up a business in a lesser-known Chinese city.
So in my follow-up comment to Mr. Smith’s comment, I “ordered” him to provide more information on doing business in Weifang:
You have two choices. Either you will write a long post on your blog, explaining why you would set up your China business in Weifang or some other second tier city (is Weifang, second or third tier?), and exactly what sorts of business make sense for Weifang and why. Perhaps 3 pages, minimum, single spaced.
Or, you will allow me to grill you on all of this via telephone or e-mail.
I am leading a one hour session in early May at a big time doing business in China Seminar in SFO and the session I am leading is on second tier cities. Pick your poison, big guy.
He wisely chose not to allow me to grill him directly and wrote the blog post instead. It is entitled, “Why Do Business in Weifang,” and it is excellent.
The post starts out listing some points as to why it makes sense to locate a business in China’s smaller cities:
It is easier to get to know top government leaders in small cities. For example, in Weifang I met and chatted with the Mayor and Vice Mayor on more than one occasion, and I’m just a foreign teacher. I think this is a major benefit. How likely would it be for me or a person running a small to medium sized business to meet and chat with the city leadership in Beijing?
Smaller cities have cheaper real estate prices. I don’t know about business properties, but for residential you’d pay about 2k RMB/sq meter in Weifang out towards the edge of the city (only about 10 minutes from downtown by car) and nearly 10k RMB/sq meter in Haidian in Beijing if you were looking to buy.
Smaller cities have lower wages. Teacher at Weifang University made between 1k and 4k RMB a month [roughly $125 to $500 USD]. No one made over 4k (officially anyway), not even the president of the university. I know this because I’ve seen the payroll. I’m not sure how much teachers at Beihang [in Beijing] make, but there sure are a lot of nice new cars on this campus, so I’m pretty sure that the answer is more than in Weifang, where the few teachers who had cars were the ones married to businessmen.
- Smaller cities typically have less pollution and less traffic and thus are easier to get around in.
The post then goes on to describe Weifang as follows:
- It is a third tier city.
- Grade A office space for cheap prices.
- Infrastructure is just as good as in larger cities – reliable electricity, Internet, telephone, cellular, roads, rail, even an airport (small but nice, not some scary relic of the Cold War) with daily flights to Beijing and Shanghai.
- Located smack in the middle of the Shandong peninsula making it a major hub between the larger cities of Qingdao, Jinan and Yantai. Because of its location, it is a good place to set up headquarters if a company has branches or often does business in each of those cities.
- Good hotels and conference space. Weifang has one five star hotel and at least seven four star hotels. Also, because most of the year these hotels are underused, good prices can be had.
- Just under two hours from Qingdao International Airport, which has flights to Seoul, Busan, Tokyo, Osaka, Fukuoka, Nagoya and Hong Kong in addition to around thirty domestic locations.
Mr. Smith then lists the following as possible business opportunities in Weifang:
- Outsourcing manufacturing for diesel – Weichai is a large SOE that manufactures diesel engines for China Rail.
- Outsourcing manufacturing for toilets – Milim is a large company that manufactures toilets for Gerber.
- Outsourcing manufacturing for pharmaceuticals – Yaxing Chemical is a large company that manufactures pharmaceuticals for Bayer.
- Trade in textiles – according to an African-Australian friend of mine in this business in Weifang, there are lots of textiles factories in and around the city.
- I have met American and South African entrepreneurs of medium-sized businesses who were outsourcing the manufacture of children’s furniture in Weifang and looking to outsource the manufacture of pipes used for plumbing and were strongly considering setting up a Joint Venture in Weifang with a local company there.
Excellent post and Since my law firm’s China attorneys are always working with American companies in trying to figure out where to locate in China and so any information like this is always helpful .My own thoughts:
- Weifang has a population of 8.5 million. I have never been to Weifang, but I have spent considerable time in Qingdao and in Yantai (two of my favorite cities in China), both nearby and in the same province (Shandong). Co-blogger Steve Dickinson has spent even more considerable time in Zibo, also in Shandong, and he has told me much about it. This does not for a moment mean “I know” Weifang, but it does allow me to put it in some context.
- I like and agree with Kevin’s point about it being easier to get to know the powers that be in smaller cities. Big companies get to know big city mayors, smaller companies rarely do. However, it is typically less important in the bigger cities for smaller companies to have dealings with the city’s higher ups.
- I am certain Kevin is right that business space and labor will be far cheaper in Weifang than in Beijing or Shanghai. I am also not surprised by Kevin’s touting the benefits of Weifang’s high end physical infrastructure and reduced pollution and traffic. I am not surprised because all of this holds true for Qingdao and for Yantai as well.
- But, unless your company has someone fluent in Mandarin with substantial business experience in China, I can see Weifang being very difficult. Weifang just will not have the experienced, bi-lingual China consultants, China accountants, and China lawyers of Beijing, Shenzhen, or Shanghai. Not really a reason to avoid it for OEM, but a very good reason to think long and hard about setting up an office there.
- Weifang is also not going to have the expat social life of Beijing or Shanghai either. Granted, there are many who do not care about this, but it has to be tougher to find a good American manager for Weifang than for Shanghai. I also think it would be tougher to find a good Chinese manager or engineer for Weifang than for, let’s say, Suzhou. Weifang also will not have the healthcare or the expat schools of a Beijing or a Shanghai.
- Kevin did a great job outlining possible business opportunities in Weifang. It sounds like Weifang is doing just fine economically and I wonder about it as a location for foreign retail, like fast food, hotels and clothing. How much foreign retail is already there? Shandong is a big food production region. How connected is Weifang to that? Are foreign companies coming in for food?
As always, the comment lines are open, and I urge anyone with views on other second and third tier Chinese cities to pipe up.
Just received an e-mail from one of our most loyal and best read readers, who is involved with a software business in China. The e-mail said only “Interesting discussion and affirms a lot of points being stressed in your blog” and then linked over to a podcast at ITconversations [link no longer exists] described as follows:
Dr. Moira Gunn speaks with a panel of experts on a new kind of outsourcing. Not software or call centers to India, but about American biotech to China. China Attorney Devon Cuyler, Bridge Pharmaceuticals CEO Dr. Glenn Rice, US-China Entrepreneur Winnie Wan and China Venture Capitalist Marietta Wu talk about what parts of the biotech industry are being outsourced.
It all sounds really interesting, but I am heading out of town in a few hours to speak at a doing business in China seminar and I do not have the hour or so required to listen to this, so I am posting it here as a recommended read/listen.
I spent much of last weekend on an airplane going through stacks of documents I had been meaning to read for month. While doing so, I came across a big US government Commercial Services print-out I had picked up at a doing business in China seminar many moons ago. Darned but there was some good stuff in there and I was planning to post on it in due course.
Due course became today after I read how Diddy, a well-known entertainment mogul, record producer, and actor, (f/k/a and a/k/a Sean John Combs, Puff Daddy, and P.Diddy), is paying a big price for having violated the first rule on the list of what the US Commercial Services sees as the “Major Causes of Business Problems in China” [link no longer exists]:
- Inadequate vetting and due diligence of Chinese partners, distributors and suppliers.
- Giving away too much in joint ventures.
- Absence of contract clauses guaranteeing licensing compliance spot checks.
- Lack of appreciation of what differentiates a commission from a kickback in the Chinese context.
- Failing to register your IP (patents, trademarks and copyrights) “in a timely fashion.”
- Failing to keep a detailed eye on the always changing legal and regulatory environment in China.
- Failing to retain a qualified China lawyer to help navigate the ins and outs of China law
Interesting how many of these (really all of them) relate to the law.
I like this list and I think it appropriate to list a failure to conduct due diligence at the top. This failure is particularly common among SMEs (Small and Medium Enterprises). Far too often I see companies entering into transactions worth hundreds of thousands to millions of dollars, knowing shockingly little of the Chinese companies with whom they are dealing. Is it not worth the $2,500 to $10,000 to know with whom you are dealing?
Diddy’s China problems are instructive. Diddy heads up clothing company, Sean John, which is now facing a public relations nightmare after it was discovered that the “faux” fur on its coats from China is actually real fur. This discovery has precipitated a recall of the coats and will no doubt lead to a considerable loss of money and prestige for the company.
These problems almost certainly would never have occurred if the company had conducted sufficient due diligence on the company from whom it was purchasing its coats and/or conducted quality control monitoring of the product.
If you are doing business in China, read the list so as to avoid your own “faux pas.“
China Law Blog’s own China Lawyer, Steve Dickinson, was the third featured speaker at the recently completed Doing Business in China seminar in Chicago. Steve’s talk was entitled, “China: The New Paradigm for Market Entry” and focused on the idea that China today is not the China of ten years ago.
Steve discussed the following five paradigms:
- Company Formation. Going into China as a wholly foreign owned entity (WFOE) is almost always preferable to going in as part of a joint venture (JV).
- Management. Foreign companies doing business in China should use international best practices. This means responsible, ethical leadership and, above all else, this means following both China law and US law (for example, the FCPA).
- Sound Business Practices. Steve told of a client who set up his business in a particular city in China only because that was where the son of a purported Chinese general with whom the company was connected lived. Steve emphasized that businesses going into China must make their China decisions based on their “own business economics, internationally accepted business practices, and the law.” Steve described Guanxi as overrated and no substitute for good business.
- Branding/Trademarking. Do not to wait until you are successful in China to establish your brand in China. Due to China’s first to file trademark laws, you must be first to trademark your brand in China and if you are not, someone else will get it. Steve told of our law firm receiving calls from companies seeking our help in prosecuting trademark cases in China even though they own no Chinese trademark because they never registered anything there. Steve also emphasized the need for foreign companies to create and trademark a Mandarin brand name because that is the name by which virtually all companies in China (including such biggies as Coca Cola and Dell Computer) are known.
- Intellectual Property. IP enforcement in China is improving and how if a foreign company is going to take advantage of this, it must register its intellectual property (i.e., its trademarks and patents) in China. Foreign companies also must protect their IP (including their copyrights which need not be registered, but which often should be) by prosecuting IP violators.
The overall theme of Steve’s talk was that China’s legal systems have advanced to the point where it now makes sense to conduct business in China pursuant to international best practices.
Yesterday, I did a post on Janet Carmosky’s speech at a recently completed Doing Business in China Seminar (The China Forum) in Chicago. I just returned home from Chicago to a slew of thoughtful comments on that post, that are simply too good to leave in the comments section. So here goes:
Loyal CLB reader Joseph Wang had this to say:
I actually found the points that Mr. Carmosky made somewhat insulting, which may pose a problem if you are trying to do business. The most important thing that you need to know about Chinese is that Chinese are people and vast generalizations about groups people aren’t usually accurate. I have no doubt that a lot of Chinese people (as do Americans) lie, cheat, and steal and have short term thinking, but I think it is absurd to make that a generalization.
Having said that there are sometimes a lot of advantages to *not* being part of a network. If you aren’t part of the local network you are considered more unbiased and untainted and this isn’t a small thing in some areas. Imperial China had a rule in which an official never served in his own home province, and curiously the Communist Party has the same sort of rule with provincial Party Secretaries and the People’s Liberation Army.
Also, someone from another province or village can be as much a foreigner as someone from outside of China. This can be used to your advantage. The classic example of this is banking reform where Beijing and Western banks have formed a very powerful alliance against local networks.
Also the line between a “Chinese” and “non-Chinese” network is very murky. For example, a lot of the strongest Chinese networks are school or workplace based, but this a lot of those networks have large numbers of non-Chinese or are mostly non-Chinese (such as people who went to Harvard or the people that worked at Goldman-Sachs).
Mr. Wang: I think you would be justified in being insulted if people believed these attributes applied to all Chinese. I certainly do not believe that and I very much doubt Ms. Carmosky does either.
Tim Lamb had this to say:
Not sure I agree with Ms. Carmosky either. Understanding a culture is more than looking at how it is expressed by those who practice it. To truly understand a culture you have to go past the behavior and look at what forms that behavior. It is similar to describing genotypes by only studying phenotypes.
For a better read into relationships and how they work I would recommend: “Gifts, Favors, and Banquets: The Art of Social Relationships in China”.
On another note, I would not discount the cultural aspects of conducting business in China or in the United States for that matter. Once you get past the legal contracts, the business models, forecasts and office policies, you have people actually conducting the work for you. The success of a company rides heavily on corporate culture and this cannot be forced by contract. I have watched too many companies fail or far more frustrating, never become as good as they could because of a corporate culture that did not encourage its people or worse discouraged its people.
Tim: Of course culture matters. There was a lot of talk about the difference in managing Chinese employees. That kind of discussion makes complete sense. If you will note, I said that “as a China lawyer, I think Ms. Carmosky’s views should not affect how you do business in China.” In other words, there are certain legal things that should be done no matter what.
Jonathan had this to say:
This is such a fantastic post that it can replace half the posts on this blog. OK, I’m exaggerating a bit, but still. Thanks.
Jonathan: Which half should I delete?
GE Anderson said this:
1. “Americans think the Chinese lie and steal.”
I’m hoping she followed that up with a little clarification.
The truth is that *people* lie and steal. Anywhere we go in the world, we encounter people without integrity who are driven by greed. The secret to success is figuring out who those people are and avoiding them.
“…Westerners who actually believe they are in a Chinese network are…operating under a potentially dangerous illusion…”
An illusion that some Chinese are only too happy to nurture. When someone calls you “lao pengyou or zhongguo tong,” proceed with caution.
I 100% concur.
Nina Ying Sun says, I say network you say network, let’s call the whole thing off:
Whether to get into the Chinese networks or not, it’s a strategic decision any westerner has to make. There are pros and cons associated with either way. But of course you can also stay in between. I think Janet Carmosky is doing a great job with her approach, while the other approach seems to serve Steve Dickinson well. BTW, Mandarin is not widely spoken in “exotic” provinces in China like Xinjiang.
Robert Grace (who organized the conference, which was absolutely excellent) had this to say:
I understand the comment that Mr. Wang has made, but I feel compelled to clarify an apparent misunderstanding. I organized the China Forum in question and I attended Ms. Carmosky’s presentation. Ms. Carmosky did not offer the sweeping generalization that Mr. Wang finds insulting as her own personal view. Rather, she simply was summarizing what she believes a number of Westerners (inaccurately) believe about Chinese ethics. She went on to point out other generalizations that Westerners often make that only serve to undermine their success in the Chinese market.
Robert is right, but maybe not. Ms. Carmosky did say that Westerners often say Chinese lie and steal, but in explaining why this is the case, she seemed to be agreeing. That was certainly the impression I got from her talk and that was the impression received by everyone with whom Steve or I spoke about the talk.
I think it only fair that Ms. Carmosky have a chance to express her views here on the issues arising from my doing a post on her speech. I am going to ask her to respond and also request that she provide a copy of her speech for posting. I also want to stress again that Ms. Carmosky has spent nearly the last twenty years immersed in China. Her Chinese is outstanding — as I mentioned previously, she is the only foreigner of whose Chinese language skills I have ever heard Steve Dickinson gush. She was married for nearly twenty years to a Chinese man and she has been involved in China business for a long long time.
My knowledge of Chinese history is perhaps 1/100 of Ms. Carmosky’s so I cannot help but view China today from a very different prism than her. I do not see China as unique. I see Chinese business behavior as exactly what I would expect from a country moving from communism (with a Cultural Revolution) to capitalism. What I see in China today is in so many ways similar to what I saw in Russia in the first ten or so years after the fall of communism there. I again refer to an article I wrote a long time ago on doing business in emerging countries. When I wrote this article, I was not thinking of China, but it fits in beautifully with this discussion of China today:
PRINCIPLE FOUR: Exercise Extreme Patience.
This principle stems from the maxim that everything takes twice as long as you think it will. If it takes twice as long in the West, triple that in emerging market countries. You’ll go in both as a businessperson and a teacher and in both roles, the learning curve of your partner will almost certainly take way more time to deal with than you think.
For example, many emerging market countries have a history where “bad business” meant “thinking long-term.” A year or two after the fall of Soviet communism, I was involved in a matter where an investor put $250,000 into a Russian joint venture. The business very quickly was making good money and all indicators pointed towards steadily increasing profitability. But, quite quickly, the Russian company stole the $250,000. Was it so irrational for the company owner to think so short term in a country where the government and tax systems had such a history of unpredictability?
Remember: It takes patience to encourage change of mindset. Extreme patience.
I think the duration of a country’s capitalist system, its economy, and its legal system greatly influence business behavior. I think American business behavior is based at least as much on the belief that a breach of contract will lead to an expensive and detrimental lawsuit as on our mindset. I am in the middle of renting all episodes of the HBO series, Deadwood. I defy anyone to watch that show and still claim America’s business morality is inherent in our culture, rather than something that has evolved over time, mostly for business, rather than moral reasons.
China is new to capitalism. China is learning how to conduct business according to international best practices. Some there have already learned and more will learn. I do not believe there is anything immutable in the “Chinese mindset” that should make me believe otherwise.