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?

Just came across an amazingly comprehensive article on the ins and outs of foreign companies engaging in construction in China. The article is written by Ashley M. Howlett, who heads up the China construction practice at mega law firm, Jones Day. The article is entitled, “China: The Impact Of The WTO On China’s Construction, Engineering, And Design Industries: Five Years Of Change And Challenges For Foreign Companies,” and it is so specialized and legally technical, I am not going to attempt to summarize it.

For those in construction trying to figure out whether and how to attempt to get into China and then how to do business in China once there, this article is a great place to start. It also makes for interesting reading for anyone with a foreign company doing business in China.

China View recently posted an article on its website describing a northern China boom in winter tourism. Heilongjiang, Jilin, Liaoning, and Xinjiang provinces are starting to reap the benefits of their long winters and heavy snowfalls by developing ski resorts and winter playgrounds for local and foreign tourists alike. Heilongjiang alone has 70 ski resorts that account for more than 60 percent of China’s winter resort facilities. There are now almost 30 ski resorts surrounding Xinjiang’s capital, Urumqi, which can accommodate 20,000 visitors a day.

In addition to developing more winter resort facilities in northern China, local governments are producing large, annual “snow and ice extravaganzas” and winter sport competitions to entice more tourists to visit their regions. Harbin, the capital of Heilongjiang is famous for its annual ice festival. This year the city worked in conjunction with the city of Montreal, Canada to create spectacular snow sculptures.

The development of an “ice and snow economy” in China has led to a major increase in tourism income for the northern provinces. The Heilongjiang Tourism Department reported that more than 3.2 million tourists visited its spring festival last year, resulting in 250 million US dollars for the province. Winter tourism earned 575 million US dollars for Xinjiang in 2005.

Interestingly, we are seeing very little by way of activity from foreign companies seeking to do business in China’s Northern Provinces, in the snow and ice industries or otherwise.

We Americans of a certain age all remember the Life Cereal commercial where three brothers sit around their kitchen table worried about the new cereal their parents just brought home.  The two eldest brothers solve the problem by deciding to have the youngest, Mikey, eat the cereal becuase “he hates everything.”  Mikey ate the cereal, his two older brothers proclaimed that “he likes it,” and a commercial icon was born.

Substitute China for the two older brothers and foreigners for Mikey and you have a pretty good measure of China’s economic reform policy.  China initiates reforms by letting foreigners do it.  Beijing seems to reason (quite rightly, I think) that foreign companies doing business in China are best equipped to initiate/handle reform and, should anything go wrong, they serve as easy scapegoats, insulating the government.

In a recent article, entitled, “China Asks Foreign Banks To Build Up Local Presence,” the Wall Street Journal noted that Chinese “regulators have also begun asking foreign banks to localize more of their operations within China. The effort reflects a desire by regulators to see foreign banks structure full banking operations in China, with a chief executive on down, rather than simply extend branch networks that are legally owned from overseas.”  In other words, the government wants foreign banks to become more involved in China’s economy.

I see this as a smart way for Beijing to improve China’s banking system.  Unlike Chinese domestic banks, foreign banks are generally run strictly on a profit and loss basis.  Because of this, their loan decisions usually depend strictly on a business decision, not on local government fiat or influence.  The more foreign banks penetrate China, the more the domestic banks will need to become more business-like to compete.

The Chinese government’s recent liberalizing of the foreign investment merger and acquisition (M & A) laws is similar.  Strategy+Business Magazine (put out under the aegis of leading international management consulting firm Booz Allen Hamilton and the Wharton Business School) just did an article on China M & A aptly titled, “Reform from the Outside in,” positing that China is opening up foreign investment not to bring in dollars, but to help push reform of its state owned enterprises (SOEs):

The big news is not that foreign companies are investing in Chinese firms; this has been going on, mainly through joint ventures, for some 15 years. What makes the latest wave of deals so unusual is that for the first time the Chinese government is offering outsiders ownership positions in its thousands of state-owned enterprises. The shift is an unmistakable signal that China has made reform at its biggest companies a top priority. No longer silent partners, foreign investors will be in a position to bring new management approaches, better incentive systems, greater transparency, and a whole new level of corporate governance. ‘This is not merely a transactional process, but a starting point for deep change,’ says Edward Tse, managing director of Greater China for Booz Allen Hamilton.

Indeed, the Chinese government’s sale of SOEs is not about gaining access to foreign capital. Marshall Meyer, professor of management at Wharton, points to China’s $800 billion in foreign reserves to make that point. ‘China doesn’t need the money,’ says Meyer. ‘For them, it’s secondary.’ Rather, China’s move is aimed at importing Western business expertise. Quickly moving state-owned firms to sound commercial footing, says Professor Meyer, requires not just cash but experience. Once a firm becomes a shareholding company rather than a wholly state-owned enterprise, it is required by Chinese securities law to install directors and corporate governance systems, which increase transparency and help companies become competitive in an open market. ‘Clearly the aspiration of the Chinese government is to raise overall management capabilities within these businesses,’ says Mr. Tse.

That was the explicit purpose of the December 2005 sale of a 24.975 percent stake in the country’s third-largest insurance company, China Pacific Life Insurance Co. (CPIC Life), also to the Carlyle Group, for $410 million. At the time of the transaction, Carlyle announced the partnership would provide CPIC Life with ‘strategic, operational and industry expertise to strengthen the company’s performance and competitive position.’ Carlyle outlined additional areas of support, including ‘corporate governance, risk management, investment management, product sales, marketing and IT systems.’

I agree.

Mikey ended up both liking Life cereal and becoming famous.  No reason the same thing cannot happen to foreign companies taking up China’s reform cudgel.

Update:  The Going Global Blog has a thoughtful take on this same Strategy+Business article in a post entitled, “Business Processes and Investment in China’s SOE’s — The American Export that Won’t Show Up in the Balance of Trade.

Imagethief is such a good blog I would read it even if it were not about China.  It is a great example of what a blog should be.  It is consistently interesting, with a clear, distinct voice, and often very funny.  As a bonus, it provides great insight into China, particularly its media and its consumers. It is without a doubt, one of the best China blogs on the net.

Its recent post, entitled Chinese Bloggers Smack Dell, [link no longer exists] gives a telling lesson on how foreign companies must deal with Chinese consumers and the role of the Internet in that equation.  The post describes a class action lawsuit against Dell in Chin, involving allegations that Dell’s computer speeds did not match promised specifications and on how Chinese consumers used the Internet to band together against Dell.

The reason to read this post, as well as its comments section, is to see how Chinese nationalistic fervor is so often just beneath the surface for foreign companies doing business in China.  Note this key paragraph, and remember it is written by a veteran of PR in China:

Bluster? Probably. But it reveals a sentiment that often runs just below the surface in China: that foreign companies don’t treat Chinese consumers the way they would treat consumers in their home countries.  Jeff Jarvis might not entirely agree with that conclusion, but it is something that those of us who do PR for foreign companies encounter regularly in China. Often one of the first accusations leveled at a foreign company in a crisis is that it is giving Chinese consumers second-rate treatment. In effect, it’s a charge of racism that seems to have its origins both in the nationalism that has been cultivated as a unifying ideology and in a post-colonial insecurity complex that invites quick suspicion of the motives of foreigners.

This is valuable insight and foreign companies (especially consumer companies) doing business in China must think about and prepare for this type of situation.

Business Week magazine elaborates on how Chinese bloggers influence Chinese consumerism in “Mad as Hell in China’s Blogosphere” and Sam Flemming nicely describes Dell’s China problem in a post entitled “China Dell Hell (aka Processor Gate).”  In “Is China Going Green, Part VIII? — Well The Wall Street Journal Says It Is So You’d Better Believe It,” we wrote about how foreign companies in China are held to higher standards in the environmental arena as well.

I do not for a minute think this sort of thing is confined to China.  I just finished a long layover in Seoul, Korea, and while there read of a similar incident in one of Seoul’s English language dailies.  I also saw this same sort of thing happen with surprising regularity when I lived in Istanbul, Turkey.

So what’s a company doing business in China to do?  I advocate the following:

  • Take your consumer relations as seriously in China as you do in your home country.  If you are not prepared to do this, do not go in.  As a lawyer, I am always advocating companies protecting their brand in the Chinese legal arena but companies must protect it in the public arena as well.
  • Monitor what is being said about your company on the Chinese net and be prepared to react.  Realize that bulletin boards are still a very big thing in China so be sure to monitor those as well.
  • Contact CIC Data in Shanghai and see how it can help.  Near as I can tell, this is the only company in China that monitors the Internet for foreign companies doing business in China.  Or, as CIC Data puts it:

We have self-developed search, harvesting, text mining, and trend analysis tools that have been customized for Chinese language and Chinese social media including BBS message boards and blogs. Every month, we collect tens of millions of consumer messages. Depending on the client, we use our Natural Language Processing tools to categorize millions of messages thousands of different ways to provide fine level analysis of buzz volume and sentiment. This allows for a a detailed understanding of consumer perception and experience regarding our clients, their competitors and their industry as a whole.

  • Retain a good PR person who truly knows China.

Bottom Line. If you value China as a market, act with due care.

China will be giving provincial and local governments greater authority to approve foreign direct investment (FDI).  China’s Ministry of Commerce just announced that, beginning March 1, 2006, local commerce departments and state-level economic development zones will be authorized to approve the establishment of foreign invested companies.

Despite this announcement, we find it hard to believe Beijing will not continue playing a decisive role regarding entry of certain kinds of foreign business.  At the same time, however, we view this announcement to be of major importance to foreign companies wishing to enter the China market.  It is always irritating to hear someone say “I told you so,” but, we did tell you so here, where we criticized an article for claiming a relationship with Beijing is critical for every foreign business, and here, where we talked about how Beijing’s power over business is devolving to the regions.

Foreign businesses wanting to go into China must do more than simply decide to “go to China” or to set up in Shanghai.  They should also consider the legal, tax, and business climate in various regions for their particular type of business.