Our China lawyers have been seeing a massive increase in inquiries from American companies looking to close down their operations in China. On top of that, I shared an early morning taxi today from my airport hotel to O’Hare with a guy who was heading to China to aid in shutting down his company’s China WFOE.

I do not necessarily see this increase in company closures as all that indicative of the economic situation in China. Rather, I see it as a combination of timing and the increasing difficulties for foreign companies doing business in China. By timing, it just seems that many of the companies looking to shut down their China operations have been there for 5-7 years and that just seems to be about the time that companies decide one way or the other whether to go forward. Because so many American companies went into China from 2006 to 2008, now just seems to be the right time for so many American companies to leave.

Anyway, the big issue for companies looking to leave China is how to do that.  The below is an email (slightly revised) that I recently wrote to one company asking about its closure options:

If you are going to talk with people in China about the possibility of shutting down your China operations and leaving China for good, you do NOT want to go to China to have this discussion. See, for example, this blog post as to why: The Single Best Way To Avoid Being Taken Hostage In China

If you are going to leave China, there are essentially four ways for you to do so — at least from the facts you have given us to date. One, you close up shop there by doing everything by the book. This is very expensive, very difficult, and very time consuming. This makes sense if your company or some of its key people may be going back to China at some point in the future or you have valuable assets in China that you do not wish to relinquish. Two, you just suddenly walk out “in the middle of the night” and leave it to the local government and to your employees to pick up the pieces. Ignoring the moral issues involved with this (which I will leave up to you), this makes sense only if both you and your company plan never to return to China. Three, you do some sort of middle ground departure. This might consist of your paying your employees some severance (not because you have to do so but because you want to do so) or in some form or another turning the company over to the manager. Four, you sell the company to the manager for little or nothing but by doing so, you leave China completely legally and that means that both your company and its people can return there someday. This would almost certainly be the best solution, by far, assuming it is possible.

You might also be able to sell your company and its assets to another foreign company. This might work as it is now taking about six months to form a WFOE and a foreign company interested in getting into China to engage in the business for which your WFOE is licensed might find your company and your facility intriguing.

Let’s talk more next week so we can work on figuring out which option is best for you.

What are you seeing out there?

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?

The seminar moderator, Franklin L. Dennis and R. Craig Holman, in-house legal counsel at Boeing, spoke on “Social Norms in Doing Business in Asia:  China; Japan; Vietnam; Malaysia; Thailand and Korea.” I am generally not a big fan of these sorts of talks, particularly when given by attorneys. On top of that, I am inherently suspicious of someone purporting to be an expert on the social norms of six disparate countries.

Mr. Holman was fine. He spoke very little on “social norms.” Instead, he spoke on “Communications Opportunities in Asia,” which was scheduled to follow the “Social Norms” talk. He obviously knows his stuff, but because it was on large scale communications throughout Asia, I did not keep notes.

I take issue with Mr. Dennis’s assessment of the various countries of which he spoke, including China. He talked about Acer Computers as evidencing China’s development of high end technology. Acer is a Taiwanese company. He talked about how if you want to sell a product in China, the smart thing to do is to go to one of the big Chinese law firms for assistance. Generally, I view this as a bad idea. My experience with the China lawyers with whom I have worked is that they are first and foremost China attorney, not China businesspeople. Some of them are good businesspeople, most of them are not. The China maritime lawyers with whom I have worked in Qingdao and Dalian would be an excellent source of preliminary information regarding local maritime companies and would also be a good source for introductions to them. But I would only consider going to them or to any other law firm for assistance in finding manufacturers or distributors of a particular product if I had nowhere else to turn. But there are places to turn. There are countless good China consultants that assist foreign companies in getting into China. They are much better set up to do this than any law firm and this means they are likely to be both better and cheaper.

His view of China reeked of an enamored outsider. “Those guys are my friends.” “We talked of going to Tibet together.”  “My Chinese friends tell me that communism in China was just an eleven year flirtation but I have never figured out what eleven years they are talking about.” Even China boosters like me cannot ignore that China was communist for a very long time and still is, at least politically.

He went on to state, definitively, that the Chinese are “better merchants, better traders, and better manufacturers” than Americans.  I disagree.  If selling products cheaply is the sign of a better merchant, then yes. But when it comes to merchandising, I think Apple Computers, Wal-Mart, Home Depot, Office Depot, Microsoft, Caterpillar, Coca Cola, Pepsico, Yum, Gillette, Harley Davidson, and Colgate are all far better merchants than any Chinese company. If the Chinese are such great merchants, why are they completely absent from every credible list of the world’s top brands?

The same holds true of China’s manufacturing acumen. Yes, Chinese factories have an amazing ability to produce products cheaply, but if China were tops in manufacturing, why have high-end manufacturers been so slow to set up factories or outsource there? Would you rather fly on a Boeing airplane (yes I know its parts are made all over the world, including China) or a Chinese airplane?

He also stated unequivocally that there will be Chinese cars in the United States within two years. Anyone wanna bet?

I bring these things up not to go after anyone, but to highlight the different views people have about China and to highlight the need for each company to develop its own knowledge base regarding the information information important to it.

One of the earlier seminar speakers talked of China having 1.4 billion consumers. That is somewhat true, but completely irrelevant. The important question for a company planning to sell into China is, how many consumers does China have that might buy my product? If the product is a necessity costing a dollar, then there may well be 1.4 billion consumers (ignoring, of course, that babies, toddlers, and prisoners rarely buy anything), but if it is a $2,000 luxury item, the number of consumers might be maybe 150,000,000 at most. Doing business in China is not easy and it is always a mistake to make it seem like it is.