doing business in the new china

The following is a guest post from Bob Rice of Trans-Pacific Management Partners LLC.  Bob recently returned to Seattle after spending nearly thirty years working in Asia (mostly China and Japan) for various global industrial firms in metals, automotive and energy.  Bob speaks and reads both Mandarin and Japanese.  I asked Bob to do a guest post looking at doing business in the new China from the perspective of someone who has been involved with its industrial side for so long, and the following is exactly that.

 

China:  Beyond Coming Crises

Observers of China tend to cleave into two groups, the China Bulls and the China Bears.  Writ large, the China Bull’s theme tends toward “China Rules the World” while the China Bears, waving their version of Little Red Books, seem to suggest that “China Will Crash Soon.”  Where’s the balanced view?

There is no doubt that China’s economic system has its problems, some of which are serious enough to propel certain sectors into crisis.  However, based on China’s leadership’s handling of the Asian financial crisis — growing through it at roughly 10% per annum, and the global economic crisis — growing roughly 8% per annum, would it not be reasonable to expect that China will have one or more indigenous crises, and that it will manage to limit the negative impact?  And would it not be prudent to anticipate where you might find opportunities to leverage the situation, pre- or post-crisis?

Consider, at a macro level, the trends in China today and make an attempt to put China into a global context relative to your business — and assume there will be, for instance, a banking sector crisis and a real estate crisis.  What will you do and how will you position your business?

A Richly Endowed Nation

China is fast moving up the technology ladder as other Asian nations have done, but at an unprecedented pace.  Though this appears to be Asian history repeating itself, it should be noted that China has significant differences relative to other nations which have followed this path.  China possesses a combination of advantages few nations enjoy.

Chinese culture and China the nation embody:

  • Strong work ethic;
  • Priority focus on education, particularly math, science, technology and engineering;
  • Huge talent pool of highly motivated, young, technically skilled people;
  • Effective, centrally directed “market” economy with key industrial sectors receiving priority funding and development, e.g. IT and telecoms, automotive, green technologies including energy, and aviation / aerospace;
  • Large continental nation with modernized telecoms and transportation infrastructure and a huge domestic economy which affords local firms easy access to ever growing markets of increasingly affluent customers.

Within the context of relatively easy access to Western markets and newest technologies, this supports a compelling case for significant continued — though slowing — expansion of the Chinese economy and rapid growth of its technology and industrial base.  And for those who insist that China’s growth cannot be sustained, one ought to consider the experience of Japan, Korea and Taiwan:  when these countries’ GDP gap with the US was at the same level of that between China and the US (in 2011) their economies grew at a CAGR of nearly 8% for 20 years!

Just as in the case with its neighbors, rising costs in China will not stunt strengthening of China’s manufacturing capability, but rather will precipitate investment in automation by the Chinese just as it has in the West.  Ever-rising labor, logistics and other factors impacting landed cost will not eliminate well managed Chinese competitors; it will stimulate their sensible and rational investment in overseas markets one bottom-line-driven step at a time.

In the automotive industry, China has obtained considerable amounts of component manufacturing and vehicle assembly technologies over the past 20 years.  However, China still is not considered world-class when it comes to designing a new vehicle from scratch.  A broad range and depth of engineering and design capabilities is required to integrate fuel economy, safety and emissions regulations and create a completely new vehicle that is also aesthetically appealing to a broad range of cultures.

But China now has the industrial and technical infrastructure, sufficient numbers of skilled executives, engineers, designers and technicians, and the financial clout to gain this capability and quickly integrate it into its booming domestic auto industry via acquisition of a global auto producer, e.g., attempts made by Chinese auto companies to buy assets of European auto companies during the global financial crisis.  Not a great deal of success, but that was just Round One.

Chinese automotive powerhouses are on the launch pad of globalizing their businesses. They have the business acumen to engage knowledgeable Western expertise with respect to import/export, distribution and dealer networks, as well as in defining product functions and features needed in these markets.  SAIC’s nearly flawless launch, guided with top notch Western expertise, of its Roewe Brand in China, is evidence of their preparedness to do so successfully.

Though the world should not be surprised on the day China lands it astronauts on the moon, China’s capabilities in aviation and aerospace are similar to those in the auto sector. China has mastered some of the requisite manufacturing and assembly technologies but is still low on the design and development learning curve — despite its recent successes in space.

As in the automotive industry, China does not yet have the breadth and depth of engineering and design capability to create new and globally salable commercial aircraft.  But, the infrastructure and skills needed to achieve this goal are growing at a fast clip.  And China, today, has the financial resources to get its hands on this technology, and could, sellers willing, buy an interest in Boeing, Airbus, or Bombardier, thereby moving one step closer to owning the technical tools to grow design and development capability in China.  One wonders, about implications, for instance, of Embraer’s existing JV in Harbin expanding into a broad global, strategic alliance?  Can Rolls Royce, Pratt & Whitney, Snecma and GE say “No” to selling advanced engine technologies to China?  Put another way, is there not a structure that will yield significant strategic and profitable advantage for aerospace firms and China to collaborate?

China’s growth and development of this sector likely will diverge from the path followed by Japan, which though it continues efforts to create its own commercial aircraft designs, has ceased trying to build its indigenous military fighter.  Japan largely has been confined to the role of highly competent supporting partner to the largely Western commercial aviation industry.  China, with its great domestic demand for commercial and military aircraft, will push hard to build its domestic aircraft industry and likely will force global makers into a much broader collaboration than the model foreign firms employed with the Japanese.

Progressing Through Changing Times

Those who argue that China’s current competitive advantages will eventually be eroded by logistics, increasing fuel costs, IPR risks, and challenges posed by the differences between Western and Chinese business culture miss three important points:  1)  the domestic Chinese market is large and growing.  Companies that go there and take the time to build a profitable business while managing risks have an opportunity to grow local and profitable operations in China.  They can also better understand how to leverage Western capabilities and profitably marry those with Chinese strengths and take advantage of all opportunities to rationalize design, product development, manufacturing, and sales and marketing.  US Fortune 500 companies have established nearly 1,500 R&D centers in China.  2)  Just as has been experienced in the West and in Japan, Korea and Taiwan, declining competitive capability drives rational business decisions to cut costs, maintain margins, get closer to customers and optimize supply chains among other things.  Chinese companies will do just as the rest of the world has done and will have available to it the benefit of learning from past successes and mistakes.  3) China can leapfrog some types of infrastructure investments, most notably land line communication systems, and continue to build its infrastructure based on the latest and most efficient technologies without the burden of costs of legacy systems.  Might there exist benefit in all this for your company?

Establishment of a low-cost manufacturing footprint in China was a viable strategy.  Now though, China presents a different set of opportunities which encompass not only the domestic China market and Asian regional sales, but also global opportunities and threats.  Failure to evaluate this potential and develop strategies to deal with them is imprudent on the part of Western companies.

China’s 21st Century Tang Dynasty:  A Font Of Innovation?   

Chinese companies and their China-based competitors from Korea, Taiwan, Japan, Singapore, and elsewhere are increasingly capable and nimble.  Ted Greenwald of Technology Review suggests that entrepreneurs in China may eventually challenge those in the United States as innovation leaders.

The pace is faster here [in China].  Companies iterate, build things, and grow faster than their US counterparts.  So it’s possible that new ideas will arise in China and be ready for the world before any US company is even doing that thing.  It’s an exciting opportunity. 

I’ve seen startup clusters all over the world,” says Steve Blank, an entrepreneur and business school professor who recently returned from a visit to China. “But Beijing blew me way. They’ve built an ecosystem on a scale that puts Boston or Seattle to shame. Beijing compressed 30 years of startup learning into five years.

Beijing’s Great Leap Forward.

Western societies benefit from an open business and social environment that encourages innovation.  Enthusiasm for “new and revolutionary” exists at all levels of society — and this enthusiasm extends a welcome to global participants, including Asians.  A cursory review of ethnicity of membership of the various R&D groups publishing new findings and technologies reveals many Chinese scientists, scholars and engineers — of all disciplines — heading up or participating in the leading teams at the forefront of new technology development.

We’ve been surrounded in university and graduate schools by Chinese students and post docs for some time now, and they’ve taken their work back to universities and research facilities there…  [They have] successfully established themselves as world class scientists and engineers.  It will be interesting to see how they influence global politics and trade…”

M. Morales, PhD. Neuroscience & Biology, Seattle, WA July 2013

The next 30 years certainly will be interesting times.  How will China impact your global business?  How can you take advantage of this?

 

Let me start out by saying that I realize how ridiculous the term “New China” is.  First off, what does it mean?  I don’t know.  Second, if it means anything, it means that China today is not like it was yesterday, which has of course always been true, not just of China, but of everywhere. Despite its lack of meaning, I love the phrase because it does, in its own sort of crazy way, nicely convey that change is a constant in China.  Now of course change is a constant everywhere, but this just seems “more” true in China. I also love the phrase “really pregnant.”

Whenever my law firm starts getting an increasing number of phone calls/emails from companies that have ordered product from their Chinese suppliers and then had those suppliers shut down without ever providing the product, I write a post like this one, detailing what foreign companies doing business in China or with China should be focusing on to protect themselves.  Those phone calls and emails started increasing a few months ago and though they are not necessarily an iron-clad indicator of the direction of China’s economy, they are a good indicator of what is happening to Chinese manufacturers and to what is happening to foreign companies doing business in China.

Rather than reinvent the wheel, I am going to reprise an email I received and responded to years ago as a classic example of the sort of phone calls and emails we are getting these days as well. Here goes:

Hi. I am an avid reader of China Law Blog. I run a small _________ company in Shanghai and have come upon my own situation in which I would like to ask for a legal opinion. It’s not a very big issue and maybe not even worth pursuing it but since we are a very small company with limited funds it’s still of relevance for us.

A part of our business is renting out _________ machines to customers such as restaurants. One of these restaurants has just gone out of business. Since several months of rent are due to the landlord, the landlord has locked the shop down with all equipment (our _______ machine, the restaurant’s employees’ personal things, etc.) all still inside. The landlord is saying that they will release everything inside the restaurant only after discussing with the restaurant operators, all significant employees of which have now left town.

I am not exactly sure what will happen, the situation is vague as many things are here, but we would like to get our machine back (wholesale cost of about 20k RMB).

My questions now are if the landlord has the right to keep our property (e.g., the machine) and if not, if there is anything worthwhile that we can do about it?

Thank you.

Here is my response:

Without reviewing your contract with this restaurant, I have no way of knowing what you can and should do. If you have a really good contract (preferably in Chinese) that makes clear that the ______ machines belong to you unless and until they are fully paid-for, then you should show that to the landlord and odds are good he will let you walk off with your machines. If you don’t have such a contract, I wish you good luck because at that point it is not likely to be very clear who owns what.

We have lately been getting a ton of these sorts of requests and I am going to do a blog post on it, stripping your email of any identifiers.

This is China’s new reality, brought about by more businesses failing and by foreign companies that are doing business in China having become much more intwined in China’s economy.  About a year ago, I wrote a piece for the Wall Street Journal discussing the impact China’s slowing economy is having on American businesses that do business with China and how they should respond to that.  The article is entitled, “China’s Slowdown and American Business” in the US Edition and “China’s Slowdown and You” in the Asian edition, and if you want to read the whole article, you should Google either title and “Dan Harris” and then click the leading link and the full article will appear.

In the article, I assert the following on doing business in the new China:

  • The Chinese government “is much more concerned with social harmony than with economic numbers” and that is why it is continuing to encourage wage growth even though higher wages make China’s factories less competitive.
  • China’s prioritization of its citizens’ contentment means that China is going to get tougher on foreigners, just as it (and nearly every other country) has always done when times are tough. Everything foreign businesses do will be under heightened scrutiny.
  • The authorities also are throwing new roadblocks in the way of foreigners seeking to form businesses in China. Such higher standards are not uniformly applied. Beijing and local governments are ever more eager to distinguish between “contributing” and “noncontributing” foreigners. Thus, it has never been easier for well-funded, nonpolluting foreign companies to secure approval to operate in China. Conversely, it has never been tougher for foreign companies that pollute, pay low wages, or have no plans to hire Chinese employees to get their foot in the door.
  • Chinese exporters, particularly those that compete with companies from lower-wage countries like Vietnam and Bangladesh, are suffering—in particular in very low-tech, very low-wage industries such as textiles, clothing, shoes and low-end electronics and toys. Foreign companies that do business with Chinese companies in these industries must be on their guard.
  • The key to weathering China’s slowdown will be for foreign companies to go back to basics: think afresh about what a company contributes to China’s economy and how that is likely to shape policy makers’ opinions; focus on scrupulous regulatory compliance; and renew focus on due diligence at a company-to-company level.

Though the above is happening, there is something very positive in China is happening as well: a greater number of China businesses are getting savvier, more sophisticated and more international.  China’s high end (in terms of sophistication and savvy, not necessarily the product they produce) companies are getting bigger and deeper at the very same time its low end companies are suffering. These high end companies are doing their utmost to do more than just churn out bad quality widgets; their goal is to provide a product or a service (or a product and a service) that can compete anywhere.  I first started talking about this trend about a year ago and since then I have mentioned it at just about all of my speaking engagements and I am finding that people are increasingly agreeing with me on this.  The point is not that the existence of such Chinese companies is new, rather that the number of them is proliferating at a rapid pace as more and more Chinese companies are realizing that “stepping up the pace” is the best way for them to survive. Co-blogger Steve Dickinson hit on this trend in his post The New Role Of Written Contracts For Product Purchases In China.

In other words, the importance of choosing your China partner — which was always critical — has become even more so.

What are you seeing out there?