Foreign companies in China

I was interviewed last night by a reporter writing a story on foreign companies doing business in China.  At one point, she asked me what I saw as the best business opportunities for foreign business in China.  And I referred her to this post, China’s Five Best Business Opportunities, in which I list out education, healthcare, food, clean-tech/green-tech, and software. In that post, I noted that I have been pushing these same five industries for years.

Now I am just not so sure.

Let’s look at each of them.

  1. Education.  Everyone knows China is big on education and everyone knows China is particularly big about its best and its brightest (well, its richest anyway) getting a foreign or a foreign-like education.  So even though some aspects of China’s education business are shut off to foreigners, this does remain a prime area for foreign business. More anecdotally, our education clients, spanning a massive range of businesses, are almost universally thriving by doing business in China or with China.
  2. Healthcare.  Everyone knows China is aging, getting wealthier, and seeking to improve its healthcare. All of this is almost a perfect storm for those in the healthcare field.  But healthcare is a big field and much of it is a minefield of regulation, corruption and/or other assorted difficulties. Though no doubt this is overall a great field, it certainly has its issues.
  3. Food.  Everyone knows China wants better and safer food and I am an unabashed optimist about the role of foreign food in China. Without exception, every one of our clients that has fought through the requirements to be able to get their food product (of all kinds) into China, be that on their own or through a distributer, is thriving in China.
  4. Clean-tech/green-tech.  Everyone knows China has nearly limitless pollution problems and everyone knows that the Chinese government is concerned about that.  But this is a tough field for foreigners because it is one in which government connections are too often critical.  We have clients that have succeeded spectacularly and we also have clients with top tier products and management who just cannot (and will not) buy a break in China.
  5. Software.  Everyone knows China (like everyone else) wants better software.  The biggest hurdle I see for software companies in China is pricing.  A number of our software clients have told me that Chinese consumers and businesses are “not accustomed” to paying high prices for software and their Chinese competitors are accustomed to selling software at rock bottom prices. On the other hand, our clients that sell highly specialized industrial/commercial software seem to be doing just fine.

I can tell you one business of which I would be wary of starting in China: Corporate sleuths on edge after China detains foreign consultants.

But what about China for foreign business overall?

To that I turn to a “ChinaFile Conversation” from just yesterday, entitled, Is Business in China Getting Riskier, Or Are Multinationals Taking More Risks? The conversation is between the following China luminaries:

Krober starts the discussion by essentially saying things are still quite good for foreign companies doing business in China or seeking to do business in China and the numbers bear this out:

But the headlines are deceiving. Data and company surveys both show that China continues to be a magnet for foreign firms. Greenfield foreign direct investment, according to the Ministry of Commerce, has held steady at US$105-115 billion a year since 2010, well above the pre-crisis level. Inflows in June exceeded $14 billion, the highest monthly total since 1997. Broader data from the central bank, which include reinvested earnings, show that foreign companies committed a quarter of a trillion dollars to China in 2012.

Member surveys by foreign chambers of commerce consistently reveal that despite their discontent, foreign companies in China are still quite profitable and generally want to increase their investments. A walk down any Chinese high street will quickly confirm these numbers: foreign brands occupy a far larger and more visible slice of the market in China than in most other Asian countries, including Japan, Korea and India. And big cities are filled with tens of thousands of young foreign entrepreneurs who find it easier to start a new business in China than in their home countries.

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On the whole, though, the evidence shows that foreign companies win quite a bit more than they lose.

Schlesinger says that despite recent headlines, China is still the place to be for foreign businesses and dalliances with countries like Myanmar will only reinforce that:

The current onslaught of bad news about China—much of it real, some of it the pendulum-swing of pundits piling on—certainly makes China business seem like risky business. A slowing economy, growing social pressures, looming crackdowns or public relations campaigns against foreign companies—none of these are good signs for companies hoping to swiftly reap the fruits of their labors.

Some executives are scurrying to look for the next best opportunity in Myanmar or the Philippines or Indonesia. But for those who stay, and for their boards, this may be a necessary reset in expectations that actually leads to healthier and more sustainable investments.

 Schlesinger goes on to say that the downturn in media perceptions of China creates opportunities for smart companies that go to China and do things right:
Now that China bears are having their day, smart companies will go back and ensure the basics are right. That’s hard, slow, unglamorous work. But it sure beats having your executives jailed, your reputation sullied or your cut-corners exposed.
Ma sees China getting tougher mostly because it is getting more “normal”
But the terrain for MNCs in China has surely gotten more complex—and at times contentious—but those are relative terms. And most of the changes in the operating environment owe to what Arthur described as China becoming a more “normal” country in which to do business. Normal, of course, being filtered through the detritus of “Chinese characteristics”—uneven regulatory enforcement, opaque decision-making, relationships, and so on. It is worth reiterating the point that China has transformed rapidly from a capital-starved country to a capital-abundant one, and it has learned the rules of the game at the WTO and can play by them effectively. In combination, these developments make for an attitudinal shift in how China may be approaching foreign MNCs—if they no longer really need the capital, then what do they need now?
Dickinson notes how the old days of foreign companies getting away with ignoring Chinese law is over and that succeeding in China today requires abiding by Chinese law:

It is true that over the past 15 years, China has adopted a formal legal system that at least on its surface resembles that of a developed country and is, in that sense, “normal.” The paradox is, this normality has led to greater risk for foreign companies rather than reduced risk. The environment in China in general has not become more risky. However, the risk of violating Chinese law has increased substantially.

In the old days, foreign companies just ignored Chinese law and relied on connections and the rest to operate for maximum profit. These profits were high enough that the time and effort of working in the chaos of China was justified. Over the past 10 years, the system in China has changed dramatically. This is the Wild West to Chinese law and regulation no longer works for foreigners.

This puts foreign companies operating in China in a difficult situation. The fact is that Chinese companies routinely ignore Chinese law. So, foreign companies operating in China are faced with a major decision that carries big risk. They can follow the law and struggle or fail in the Chinese market or they can act like their Chinese competitors and violate the law in order to compete on a level field.

The risk is: as China becomes increasingly stressed by the declining growth of the economy, the government has shown that it will seek foreign scapegoats. Drugs are too expensive: it is the fault of the foreign drug companies. Food is not safe: if is the fault of the foreign fast food companies. Mobile phones are defective: it is the fault of the foreign phone manufacturers. The China Dream has not been realized: the foreigners are holding us back. As a result, taking action against foreign violators of Chinese law is an obvious way for the Chinese government to deflect attention away from the deeper problems in the Chinese economy and society.

Dickinson goes on to say that foreign companies doing business in China or seeking to do so must ask themselves whether they can both follow the laws and be profitable, or not.

China opportunities for foreign business, what do you think? Better now than ever? Worse?  The same?  Mixed, depending on the industry?  And what are the best opportunities anyway?

As long time readers of this blog know, one of our consistent themes has always been that foreign companies in China should not expect to be treated the same as Chinese domestic companies, no matter what the laws may say. The reality (not just in China) is that it is usually good politics to go after foreign companies and it is usually bad politics to go after domestic companies. The reality also is that when a large number of citizens have a particular problem, it is very good politics for the government to show that it is trying to solve it.

Right now, inflation is a big issue/problem for China’s citizens and last week China went after a foreign company to show that it is trying to solve it. And in an article, entitled, “Unilever gets mouth washed out for remark,” the China Daily wants to let the world (or at least China’s own citizens) know about it:

China has levied a fine on consumer products giant Unilever of 2 million yuan ($310,000) for talking to Chinese media about planned price hikes that sparked panic buying of shampoo and detergents in late March.

The National Development and Reform Commission (NDRC) imposed the fine after finding the Anglo-Dutch company “illegally disseminated news of price hikes and disturbed market order”, the top economic planning agency said in a statement on its website on Friday.

In late March, several cities in China suffered panic buying for household items. The NDRC said these were due to Unilever China spokesman and Vice-President Zeng Xiwen, who suggested in media reports that a price hike was in store for consumer products due to the soaring cost of raw materials.

I am not sure what law Unilever violated (and I am not about to spend the multiple hours necessary to figure it out, but I am guessing it relates to price-fixing:

Unilever’s shampoo, skincare and laundry detergent products account for 12 percent, 12.6 percent and 15.2 percent of domestic market share, so discussing a price rise in advance will likely lead to a price hike in the whole industry, the NDRC said.

Quite wisely, Unilever is taking the decision and the fine sitting down:

“We accept the decision of the NDRC and Shanghai Price Bureau. As a responsible company, we abide by laws and regulations in China and our global Code of Business Principles. Consumers are our top priority and we will continue to provide high quality products to the public,” Unilever said in a statement on Friday.

Then the China Daily implies (or flat out says?) that foreigners are to blame for China’s inflation:

“Being an influential company in China, Unilever should understand that any decision it makes will greatly impact the whole industry,” said Qi Xiaozhai, director of Shanghai Commercial Economic Research Center.

“Many multinational companies are taking advantage of China’s consumer markets because similar violations overseas will get more severe punishment,” said Qi.

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“Foreign companies get too many benefits compared to local companies, it’s time to make a change,” Pan Ping, a white-collar worker at a private company in Shanghai told China Daily.

Through the Unilever case, the Chinese government is trying to provide fair and transparent market conditions for both domestic and foreign companies, Pan added.

Back in 2007, I wrote of this same issue back in the context of China’s environmental laws, in a post entitled, “China Warns Foreign Companies On Pollution“:

China has always and will always (at least for the foreseeable future) enforce its laws more strictly against foreign companies than against domestic companies. I am constantly writing about this not to complain about it, but simply to point out the reality. Just because your Chinese domestic competitors are getting away with something does not in any way mean you will be allowed to do so.

Beijing is also now at the stage where it is pretty much neutral about all but the largest foreign companies remaining in China. I am not saying it is neutral about foreign direct investment (FDI) in general, but I am saying that it really could not care less about whether your individual business stays in China or goes. And if your business is a polluter, it actually would probably rather see you leave.

Lastly, going after foreign companies is politically popular.

I ended that post with the following:

Bottom Line: Obey the law, particularly the environmental laws. It is good business.

Unfortunately, I still do not have any better advice for you than that.

What do you think?

UPDATE: China Law Insight has come out with a great post, “Price hikes and price signaling,” explaining in detail the legal underpinnings for the fine against Unilever.

FURTHER UPDATE: China Business Blog and China Hearsay also have good posts on this.

 

Had the chance the other day to speak with the father of a friend whose very large company was for many years involved in various mining ventures in China. This person confirmed what I had been hearing for years, that the entire “system” in China is rigged against foreign companies involved in this industry. 

According to this person, whose company eventually left China after investing tens of millions of dollars there, the system is set up to encourage foreign companies to come in to China to work with Chinese companies. The Chinese companies are then encouraged to “milk” whatever expertise they can from the foreign company, while at the same time, “doing whatever they can to pull as little out of the ground as possible.” This person believes that is China’s policy in all industries, but obviously to a much lesser extent.

Is this really true for all of China’s natural resource/mining industry? To what extent is this true of China policy as a whole? My view is that though China might in theory like this to be true for all industries, it realizes that it cannot act that way or it will get dinged by the WTO and all foreign companies will leave. It therefore goes to the edge where it can and then, just as it did with its indigenous innovation policy, backs down when it is politic to do so.  What do you think?

A manufacturing client of ours for whom we are in the process of setting up a WFOE in China sent me this article and asked me what I thought of it. You regular readers just need to read the article to know.

The article comes from the AFP wire and is appropriately entitled China warns foreign polluters. The thrust of the article is that China issued a warning to foreign companies in China that “it will impose equally harsh penalties on domestic and foreign” polluters. This warning came after inspections “earlier this year found “Unilever China and the China branch of Hitachi Construction Machinery Co. were discharging wastewater with higher chemical content than permitted.” An official with China’s State Environmental Protection Administration expressed his surprise at finding “both companies had environmental pollution problems since they were the only two foreign companies selected at random for the inspection” and he vowed to “strengthen our supervision.”

The article quotes “analysts” as saying “such a warning was likely to be driven by rising domestic concerns that foreign polluting industries were finding their way to China, thanks to lower costs and the country’s pressing need to create jobs.” Andy Xie, a well known economist out of Shanghai, is then quoted as saying, “There is a widespread concern that international polluting industries are moving to China.” Xie goes on to say “it is no longer an urgent priority to attract foreign funds, just as the need to create jobs is felt less keenly, and therefore China now is able to say no to this type of industry if the cost is deemed too high.” Xie sees these recent actions as a “signal that China no longer welcomes foreign industries which provide only limited job opportunity or low technology.”

I completely agree with Mr. Xie.

China has always and will always (at least for the foreseeable future) enforce its laws more strictly against foreign companies than against domestic companies. I am constantly writing about this not to complain about it, but simply to point out the reality. Just because your Chinese domestic competitors are getting away with something does not in any way mean you as a foreign company will be allowed to do so.

Beijing is also now at the stage where it is pretty much neutral about all but the largest foreign companies remaining in China. I am not saying it is neutral about foreign direct investment (FDI) in general, but I am saying that it really could not care less about whether your individual business stays in China or goes. And if your business is a polluter, it actually would probably rather see you leave.
Lastly, going after foreign companies is politically popular.

A year and a half ago, I did a post, entitled Is China Going Green? in which I noted the following:

We are aware of a large Fortune 500 retail company that is opening units in China that meet or exceed the toughest United States environmental laws. I estimate this company’s environmental sensitivity will cost them at least an additional $25,000 per unit, yet I am firmly convinced this company is doing the right thing. This company’s actions make sense because the odds are good that China’s environmental laws and enforcement will get tougher over time, and building environmentally sound units now will almost certainly cost less than having to retrofit existing units a few years from now. On top of this, people often get very emotional about the environment and I can see Chinese citizens getting very angry at a foreign company whose units in China are less environmentally sound than their units in the United States or elsewhere. This is obviously even more likely to be the case if there were to be some sort of environmental disaster.

Bottom Line: If you are doing business in China, you should obey China’s laws, its environmental laws.

Jason Subler of Reuters just came out with a very good article, entitled, China tax law to be double-edged sword for firms, discussing likely impacts of a China’s moving to a unified corporate tax system. It is widely expected China’s People’s Congress will soon unify China’s corporate tax rate at around 25 percent for both foreign and domestic companies.  Domestic firms now pay around 33 percent and foreign firms 15 percent.  There is expected to be a five year grace period before the rates actually change.

The article notes that this unification of rates will not be all bad for foreign companies because it will, among other things, “help China restructure its economy and prompt it to modernize its bureaucracy” and lead to increased tax incentives for particular industries:

“This new tax law is timely, and I think China is looking at it in parallel with the overall direction of where it would like to see the country headed,” said Anthony Fay, a China lawyer in Beijing.

Fay and other analysts said that, while the new law would scrap preferential tax rates for foreign firms that invest in particular areas such as economic development zones, it could introduce new ones for all companies in specific sectors such as high tech and environmental protection technology

That would not only cushion the blow for foreign firms, but also help China steer its industry up the value chain and tackle its environmental problems, said Minggao Shen, an economist with Citigroup in Beijing.

There is also talk the new tax laws will include “fresh tax breaks” for investments in China’s less developed central and western regions.

Perhaps most importantly, many think these new laws will benefit foreign companies doing business in China by leading to substantially increased enforcement of tax collections against China’s domestic companies. China is likely to feel some pressure to enforce these tax laws equally between domestic and foreign companies so as to comply with world trade body standards.

There is also a sense that “foreign companies, asked to play by the same tax rules as Chinese ones, might also start to take a closer look at rules that put more restrictions on them than their local competitors”:

“That may raise some issues,” Fay said, mentioning the higher registered capital foreign companies have to put up, as well as limits on the debt they can assume, as potential examples.

Ian Stones of Four Seas Investment Consultants in Beijing does not see this tax change as a “primary driver” of decisions on whether to invest in China:

“You’ve just got very good, efficient infrastructure here and a big market. So the fundamentals are pretty obvious — the tax issue is not a primary driver,” Stones said.

Because the current preferential rates are largely aimed at manufacturers, the new rates will have less impact on foreign companies in “the real estate, trading and service sectors.”

I think this article and its commentators are right on as I too think the new tax rates will have little overall impact on foreign companies in China, at least in the short term. I also think that if there is indeed a five year grace period, much can happen with China’s new unified tax in the meantime.

A couple of our China lawyers recently engaged in a long e-mail discussion with a company that contacted us wanting to start a business in China that is forbidden to foreign companies. Because this is an ongoing matter for my firm, we cannot mention the type of business, but that is not necessary to convey the gist of our discussion.

Our China attorneys would explain that what the company was proposing to do in China is prohibited to foreign companies in China.  The company would respond by noting how good its business would be for China’s economy. Our China lawyers would then explain the risks of the government shutting down the business once it became at all visible. The company would then talk about how difficult it would be for the government to shut down a business that was doing so much to help so many Chinese businesses.

Finally, we started talking politics and how the Chinese government, above all else, acts to maintain its power. The company then noted how its business would help to lift up China’s economy, which would in turn help the Party maintain its power. The company noted that this was the whole reason China has gone so capitalistic in the first place.

The company is both right and wrong, but mostly wrong. China’s Communist Party does want to see China’s economy expand, but it wants that mostly so as to maintain its legitimacy in the eyes of its constituents. Faced with a choice between allowing a foreign company to conduct business in China that will expand the economy, while at the same time presenting a real challenge to the supremacy of the Party, China will forsake the economy every time. Power will trump the economy every time.

And this should not be a surprise, because this is pretty much true (to varying degrees) of every government in the world. It is true of the United States, where certain industries are either formally or informally off-limits to foreigners and it is certainly true of present day Russia, where the government seems more interested in controlling its oil production than in maximizing it.  For more on Russia, check out this post, entitled, Russia Kills the Oily Goose. One can argue that in the United States we are talking about protecting the security of the country as a whole, not just the government, but when it comes to the impact on business, that is a distinction without a difference.

China is very interested in expanding its economic pie, but not so interested that one can analyze its actions strictly by using an economic model. Applying a strict economic model to Chinese government decisions regarding something as fundamentally economic as foreign business could prove to be a mistake. Using such a model as the basis for believing an illegal foreign business will eventually be allowed in China could prove disastrous. Not saying it could never happen (because there are examples of Chinese companies starting in prohibition of current laws and the laws then being changed to permit them), but I am saying the odds are heavily stacked against it.

Bottom Line: If you are a foreign company interested in doing business in China, choose a legal business or you run a very real risk of getting shut down. It is that simple.

Okay, so I blatantly stole the title line from my friend Jeremy Gordon over at the China Business Blog, but since he has been on a blog vacation since December 7 (why is it that Europeans go on vacation — or as they put it —go on holiday, and we Americans don’t?), I figured I would borrow it.

I liked the following quote so much, I had to do something:

Chinese authorities may not have a great sense of humor in many respects, but they absolutely LOVE applying western-inspired regulations exclusively to foreign-invested companies doing business in China. They think it’s hilarious ‘ and it goes over GREAT in the Chinese blogiverse.

So says Andrew Hupert of the Diligence China blog, in his post, “The Evil Industrialist in the Mirror.” The post is on how the New York Times delights in painting foreign companies in China as bad guys and the quote nicely dovetails with our recent posts,China Consultant, Protect ThyselfChina’s Foreign Business Blame Game, and “URGENT ALERT: Register Your Business In China NOW“) on the Chinese government’s mounting crackdown on foreign companies seeking to skirt China’s laws.

I actually learned of this Diligence China post from a loyal reader who e-mailed us with the link in response to our recent posts, eBay: How To Fail In China 101 — What’s Politics Got To Do With It? and eBay As China Failure, Part II — Guilty As Charged, attacking the New York Times for its fawning (and inaccurate) coverage of eBay in China. The loyal reader, who has spent many years in China, has this to say about the Times’ China coverage:

The NYTimes’ approach to journalism is as follows: to look for poignant or otherwise revealing “local” stories that somehow transcend their specific place/time to reveal something paradigmatic about the country as a whole.

The value of that approach is that it is often entertaining and emotionally laden; the danger is overreaching. This approach tends to veer closer to storytelling than to to fact-telling.

What troubles me about the NY Times on China is that it implicitly presents itself as neutral while adhering conveniently to a pre-conceived story arc or moral lesson. Other papers do this as well, but the Times, perhaps due to arrogance, tends to presume a certain divine authority.

What do you think?