By Stephanie Henry

Stephanie has been a world class legal assistant with Harris Bricken for about a year now. Stephanie will be starting the Masters in Communications program at Johns Hopkins University in Fall 2010. This is her first solo post.

Are you too late to enter China?

In the April edition of Harvard Business Review, in an article, entitled, “The Globe: Is It Too Late to Enter China?” Howard Tse presents five questions all businesses should consider before venturing into China. Businesses considering establishing themselves in China must first look at what he calls the “China context,” and ask themselves the questions that will determine the success (or failure) of their China strategy. Three factors must be assessed in developing a company’s China strategy to ensure it will endure amid China’s changing context: “Official China,” “Competitive China,” and “Consumer China.” This post covers the latter two points.

Consumer China has grown stronger from the development of a burgeoning middle class with little brand loyalty and a diverse taste in products. China’s marketplace is flooded by brands and products, meaning consumers will have more choice and companies will have less stable footing. China’s rapidly growing cities will expand urban markets and create additional avenues for businesses.

The accessibility and expansion of these markets will further the competition among established and new businesses, and should cause businesses to reconsider their preconceived views of Chinese companies and consumers. Foreign businesses must view Chinese companies as potential competitors, not just as suppliers. Likewise, China’s expected shift from a rural to urban nation should cause businesses to consider China’s marketplace as one of “differentiated and multi-tiered segments,” with tastes as differentiated as those of Western consumers.

Businesses that develop strategies rooted in a firm understanding of China will gain footing in China – footing which will enable them to go beyond previous strategic approaches focused solely on selling or sourcing from China. Tse believes these new strategies should “integrate the China business with [the companies’] operations elsewhere, so that China can provide them with a global competitive advantage.” Tse dubs this strategy a “one-world strategy with China at its core.”

To develop such a strategy, Tse presents five questions to aid businesses considering China:

1) How open is – and will be –our industry in China?

China’s government still enforces legal controls on products, services, and corporate ownership. If and when the industry in which a company operates is deregulated, executives should act quickly to secure a license and follow China’s (often complex) rules within that industry.

2) What business models should we use?

Sourcing-centric or Sales-cetric? Tse’s advice? Combine and conquer, when it comes to China’s segmented market place.

3) Can we live with China’s uncertainties?

Tse’s summary on this is a good one: “it’s better to be approximately right than precisely wrong.” In other words, “anticipating specific changes is impossible, but leaders should be ready to act when opportunities or new constraints appear.”

4) How can we integrate our China operations with our businesses elsewhere in the world?

Companies re-evaluating their business models to reduce costs in the wake of the financial crisis should consider “[integrating] their China operations with their businesses elsewhere.” Though “[this] will make management more complex… it will be essential if these enterprises are to remain globally competitive.”

5) Can we move more parts of our value chain to China?

Companies that advance their operations into China and expand their value chains from the region may capitalize on “China’s growing markets, its increasing dominance of parts of the value chain, its talent polls, and its integration with global communications and transport networks.”

Tse cites Honeywell as an example of a company with a forward thinking – and successful – China strategy. Honeywell transferred its Asia-Pacific headquarters to Shanghai in 2003, and has since established a new R&D center there. Since then, the company has introduced new products into the Chinese marketplace, which domestic competitors’ have been yet unable to challenge. As a result of their progressive strategy, Honeywell has seen profits “[rise] nearly fivefold from 2004-2009.”

Companies that have yet to enter China may be down, but are by no means out. The opportunity to take advantage of China’s burgeoning and diverse marketplace remains, and holds a vibrant future for those who wish to compete. Those businesses entering China with a strategy that considers contextual variation will be prepared to respond adeptly in China’s changing marketplace, and poise themselves for success in their global business endeavors.

  • China is maturing, but its highest growth is going to come from services. The USA is still the world’s largest exporter of services – so expertise in building service niches in b2b and b2c relationships is one advantage that western, and American firms can still leverage. We did an interview with Ian Hau of Orchestrall, who ran BPO for GlaxoSmithKline for decades and sees huge opportunity in BPO for China-based businesses. http://bit.ly/8ZU4sP is an interview with Orchestrall’s VP Marketing about China market access.
    Greater China – Taiwan and Hong Kong – also continue to serve a critical market-entry role as gateways to the mainland. When China is “hard” for international entrants – in the 1980’s when systems were opaque, or in this decade when China is increasingly self-sufficient – the two gateways are worth considering. Taiwan, for one, is home to investment vehicles like Greater China Fund for people who want financial returns driven by China’s manufacturing sector, but want a fund management team both China savvy and legally accountable. And Hong Kong continues as the ultimate buffer zone. Alex Fong, CEO of the Greater Hong Kong Chamber of Commerce has extensive commentary about Hong Kong’s future as a link between China and the world beyond, in an exclusive 2-part interview I did with him last week. http://bit.ly/bbTTMh

  • Hong Kong remains the critical Gateway to Doing Business in China . Hong Kong’s unparalleled legal system as well as its world class banking provide stability and tremendous advantages for foreign businesses who want to succeed in China . Furthermore, the ability of a company to have a zero based tax system is simply too strong a pull to ignore .
    Many companies are also now taking advantage of the low 5% witholding tax on dividends paid from a China operation to a Hong Kong parent .
    No matter how you look at Hong Kong , it is an important corporate strategy for international business … whether it is to Do Business in China or for Chinese businesses who are Doing Business in the West.

  • Hong Kong is not necessary given the relative ease at which one can register their company on the mainland these days. Having to maintain an office and staff in Hong Kong while doing little to no business in HK is a waste of money and resources. I considered a HK holding company initially then quickly decided against it.

  • Dan

    @John Wu,
    I completely agree with you and I note that Ms. Thomson works for a company whose business appears to involve forming HK companies. There are times when forming an HK company to go into China makes sense from a tax perspective, but I would say those times (at least for my firm’s clients) are few and far between (maybe 25% of the time). Most of the time, it does make sense for our clients to form a new company to own their new China WFOE or to own a portion of a JV, but in most of those cases, forming a new company in the home country (typically the US) makes more sense than forming a company in HK.

  • Tim

    A few clarifications on Ms. Thomson’s post:
    If you establish a HK holding company you will most likely enjoy little to no tax advantages in China:
    – reduced witholding tax on profit reparation for HK parent companies only applies to those with a substantive business in HK; holding companies will still be charged 10%.
    – if you are funneling revenues through the HK holding company and the effective management of the HK entity is on the Mainland, you could be subject to taxes on profits captured in HK.
    – Indirect transfer of mainland assets (i.e. selling your HK holding structure to escape approvals and capital gains taxes on the Mainland) may also be liable for taxes on the Mainland.
    Effectively, if you are looking to use a HK holding structure for tax reduction/evasion purposes, it may no longer be a viable option. That being said, a HK holding company may still hold certain advantages over other jurisdictions: favorable local tax rates and easy to restructure/sell.
    As for the relative ease of setting up a company in China; the process has not really gotten any easier in the past 5 years (or worse for that matter). The Mainland still runs a highly bureaucratic; opaque and self-centered registration operation.

  • Mullins

    Elizabeth is correct. Hong Kong is useful as a China parent domicile as profits parked there and redistributed are at a lower rate than being repatriated back to the US. Also the CEPA arrangement favors HK registered businesses. Plus changes at the China subsidiary can be enacted through the HK entity without having to endure mainland China ‘approval’. It’s that simple. Check these issues out properly before dismissing them – or Hong Kong as a jurisdiction please.

  • gregorylent

    shifting from shanghai to tokyo makes me realized how UNdeveloped china still is .. so far to go .. many many many businesses will be born there in the process of the necessary 20 years of refinement shanghai will undergo just to reach tokyo 2010