Go into China as a WFOE

Received the following email this morning from a China businessperson I have known and greatly respected for many years.

This is a good article on what is coming down the road for manufacturing and large service WFOEs in China. The basic goal of the CCP is to drive all private enterprise away, to be replaced by SOEs.

This reinforces what we were saying about how foreign companies are crazy not to consider doing their China business from outside China.

As we discussed, Apple is ahead of the curve by doing its manufacturing through third parties. The fate of Foxconn remains unclear. The fate of all the large-scale assembly WFOEs remains unclear: Dell, HP, Nike: they all operate as WFOEs. They are the targets of the program in the forwarded article.  Not to mention KFC.

It is not clear what will happen.

The view that China will not continue with this because it will be bad for business and will harm them economically is untenable. The Chinese government does not really care about this. China is driving out Japanese companies right now even though doing so has negative economic impact. They don’t care. This is also another reason not to do big WFOEs in China. Why do a large amount of fix asset investing in a country that behaves like China? It makes little sense. The idea was that China would move more towards the EU model. The opposite is happening. Investors/companies should take that into account.

The article referred to in the email was a recent Wall Street Journal article by two Baker & McKenzie employment lawyers, Andreas Lauffs and Jonathan Isaacs, entitled, “Rebalancing the Workplace: In its drive for domestic consumption and social harmony, Beijing steps up labor interventions.”  The thesis of that article is that China’s efforts to rebalance its economy by increasing household income are related to “increasing labor unrest throughout the country.” According to the article, these two things “are related in a way, and add up to a new concern for foreign companies operating in China.”

The article then cites various CCP actions highlighting its intentions to democratize the workplace:

In February, new national regulations required that employee representative councils be established in enterprises to carry out democratic management of the enterprise. The councils are bodies directly elected by the employees at large, that are distinct from and have different powers than unions; for example, while a union would negotiate a collective bargaining agreement, councils would vote to approve or reject the negotiated agreement.

Such councils have long been mandatory at state-owned enterprises, but this is the first time national regulations have expanded this requirement to all enterprises. Although the text of the rules is vague on this point, it is generally believed that the regulation also applies to foreign-invested companies.

Meanwhile, in May, the Central Committee of the CCP circulated a notice urging lower-level CCP party committees and local governments to strengthen and improve the CCP’s work in private companies. All private companies with at least 50 staff should have at least some CCP members, the notice said, and if a company employs at least three CCP members, then a Party organization should be established within that company.

The writers see all of this as pointing “to an overall goal of asserting more CCP oversight over labor relations at private companies” and they conclude their article by calling this “the latest example of Beijing’s rebalancing process in action, and one foreign companies can’t afford to ignore.”

I agree with the Wall Street Journal article and I sort of agree with the email writer.  I agree with the email that Chinese government decisions (like those of every other government I know) are based on more than just economics.  I also agree with the email writer that foreign companies too often unthinkingly conclude that they must go into China as a WFOE, without analyzing the real life pros and cons of doing so.  And though I think that it is rough sledding for foreign businesses going into China and I do not see all that many signs of it getting any easier, I do not think for a moment that the Chinese government has the goal of shutting down or shutting out all foreign or other private companies. WFOEs do make sense much of the time for foreign companies looking to profit from China, but definitely not as often as consultants and accountants and lawyers who stand to profit from another company being formed make it out to be.

But what are the alternatives for foreign companies looking to “get into China”?  If you are looking to sell your product or service into China, doing so via a licensing or distribution or franchising arrangement might make better sense. For more on this, check out the following:

What are you seeing out there?