There have been countless articles written on how the end of cheap China will mean the end of foreign companies going to China, but that has barely happened at all.  This article, “Analysis: Investors make $100 billion bet on China’s drive up value chain,” by Kevin Yao of Reuters, nicely encapsulates what is going on out there by way of foreign direct investment (FDI) into China.

Essentially, FDI has slowed a bit, but is still massive and all of the talk of companies going into places like Indonesia or Vietnam has been to a large extent just talk.  This is what I have been seeing as well and I have to admit that it is NOT what I have been predicting:

I am particularly surprised at how so few of my law firm’s clients have moved over to Vietnam, especially those in industries, like clothing, shoes, and pet toys where to me it makes complete sense for them to do so.  I am even more surprised at how few of our new clients going into Asia for the first time are looking to countries other than China for their manufacturing.

And I have a new theory as to why this is the case.  My theory, which may be less a theory than a fact-based observation, is simply that these companies do not know how to go into any country other than China. I will call this the “I would love to, but…” theory.

Let me explain.

My law firm represents a large number of clothing and shoe companies, most of which are fairly well known brands and have fairly high margins, but most of which are not massive.  In the last year or so, these companies have seen an increase in bad product from China. The typical scenario goes something like this:

  1. Chinese company provides US company with bad product.
  2. US company refuses to pay whatever is still owed for the bad product.
  3. Chinese company goes ballistic and threatens US company that it will do horrible things to it if US company does not pay.
  4. US company complains to me and I suggest that now might be a great time for US company to just walk away from China and set up manufacturing in a place like Vietnam.
  5. US company says that it has heard great things about Vietnam and it would love to go there but it has no clue how to do so.
  6. US company then strikes a deal with Chinese company and keeps producing in China, slowly diversifying to other Chinese manufacturers.

So why does the US company not go to Vietnam?  Simply because it lacks the people in its organization with any Vietnam expertise and because there is no clear and easy path for SMEs to get into Vietnam. The path is less than clear because Vietnam lacks a “soft infrastructure” of well known and highly regarded experienced consultants with offices in the United States. Vietnam also lacks a network of people (and even seminars) in the United States who can talk of their Vietnam experience.  There is at least a couple of how to do business in China seminars in every good sized American city every year, but one on Vietnam anywhere is a rarity.   Vietnam is simply too much of an unknown.

So for SMEs, there is this massive knowledge and fear gap regarding places like Vietnam and that gap is creating an “I would love to” Catch-22.

That’s my new theory.

What do you think?

David Wolf is someone who just “gets” China and I lap up what he writes about it and I nearly always agree with it. He wrote something the other day on his Silicon Hutong blog to which my first reaction was along the lines of “amen brother, I need to write on this.” What he wrote was the following:

Interesting report provided the viewpoint you want is that of Fortune 500 companies doing business in China. Most of my clients are in that category, but I’ve also discovered that viewing the China operating environment through that filter does not offer many forward-looking insights.

By contrast, the challenges that face SMBs and foreign entrepreneurs in China are massive, arguably more indicative of the regulatory climate as a whole, and are largely ignored by groups like AmCham and the U.S. China Business Council. The next time somebody wants to do some research on business attitudes in China, ask the little guys. You would be amazed how different the picture is.

The report to which he was referring was the American Chamber of Commerce’s 13th Annual Business Climate Survey, which is nicely summarized here. No doubt many of the concerns brought out by the survey do resonate with SMBs/SMEs in China, such as IP protection and the discrimination they face as foreign companies. But other issues are, near as I can tell, pretty much non issues for SMEs. For example, both the survey and the media have made a big deal out of China’s indiginous innovation policy, but only one client of ours has ever even brought it up with us and that is a company that sells almost exclusively to governmental entities. 

I am absolutely not criticizing the survey (which is, as always, incredibly well done and informative), but I do think it important to keep in mind that the Fortune 100 and the SMEs do, in many instances, operate on entirely different planes in China. 

What differences have you seen between how small and large companies have to operate in China?

A recent San Diego Union Tribune article, entitled, Santee go-kart maker cuts costs with shop in China, but move still tricky, is a great example of how small manufacturers can thrive in China. The article’s theme is that China outsourcing is not just for big companies and its focus is on Electra Motorsports in Santee, California, and its owner, Kevin Heath.

Last year, Electra set up a machine shop in Shenzhen to manufacture electric go-karts. Electra now employs 20 people in Shenzhen and setting up there cut its operating costs in half. Heath’s original “dream was to have this great American workshop,” but, according to Heath, “by the time workers’ comp [compensation] and everything else is done with me, we could have a $3 million or $4 million business and still end up with nothing.” Electra’s cost for machinists to build the go-karts has gone from $50 to $60 an hour to $5 to $6 an hour. Of course, its shipping costs are far higher and obtaining the factory, business licenses, export permits and other approvals “was a very complicated and tedious job.”

The article goes on to note the recent surge in small and medium enterprises (SMEs) setting up operations in China and talks of how venture capital (VC) firms are telling their small start-up companies to have a global strategy. “They are saying, ‘We want to see now how you’re going to reduce costs and increase your efficiencies.'”

Smaller companies have historically been cut out of China because they lack the resources necessary “to keep up with changes in governments, laws, intellectual property and piracy,” but that “has changed in recent years.”

Electra’s Shenzhen machine shop is about 10,000 square feet right now, but Heath plans to add 18,000 square feet and offer his low-cost manufacturing services to other small businesses.  Electra has already started making foam surfboard blanks for a local (California) surfboard maker and conveyor belt equipment for a San Diego construction-equipment company. Sales last year amounted to $1.2 million, Heath said.

We too have been seeing increasing numbers of American and European small and medium sized enterprises (SMEs) leveraging their China knowledge to make money off other American/European SMEs seeking to take advantage of China, but without their own capabilities to do so. China is very difficult for small companies inexperienced in the ways of China business and many of these companies can save money and reduce risk by dealing with the pioneers already doing business in China. Our own law firm does this to the extent that about a third of our China work comes to our China lawyers from American and European law firms that do not have their own China legal practice.

I would love to hear of other examples of companies who started doing business in China for strictly “internal” reasons, but ended up using their China knowledge to expand into manufacturing, outsourcing, or consulting for “outside” companies.

What are you seeing out there?

Just came across another thoughtful set of predictions for China 2007, this one from Shu-Ching Jean Chen of Forbes Magazine:

  • “The Chinese Communist Party will continue to entrench its one-party rule. It is pursuing a Singapore-model, both on the mainland and in Hong Kong, of managing two seemingly contradictory tasks: ruthlessly stamping out political dissent while opening up its economy to global trade. Singapore, with a population of 3 million, has proved the success of combining a benign but autocratic political rein with the friendly face of a capitalist economy. Hong Kong, with 7 million people, could easily follow this prescription. Whether the same formula can work with the mainland’s diverse population of more than 1.3 billion will decide the future stability of China.”
  • “Chinese banks are still corrupt, ineptly bureaucratic and ill-managed, but can remain that way and still prosper.  The government controls all of the banks and will bail them out of any problems “short of a financial meltdown.”
  • China’s “economy is far more open to foreign investors than most believe.” There will always be bureaucratic foot-dragging and red tape to make foreign investing difficult, but the very top of “Chinese officialdom” — those “who make the final decisions” — still “lean toward using foreign investment to jump-start a cumbersome state-dominated economy. Foreign companies doing business in China will for the most part continue to thrive.
  • China’s second tier cities will reign in 2007.  “China’s provincial cities will be the pulse of the Chinese economy in 2007 more than the showcases of Shanghai and Beijing.”
  • Pollution will “darken the sky and blacken the earth.” “Green-minded investors will take notice and diversify their Asian holdings from China to other developing parts of the region.”

I agree with the first three, but disagree with the last two. Shanghai, in particular, will continue to boom in 2007, more so even than in 2006. SMEs [small and medium sized enterprises] and service businesses love Shanghai because it has so much infrastructure in place for them. And yes, we all know it is more expensive than the second tier cities, but what’s a couple thousand dollars a month to be able to participate in such dynamism? When our China lawyers assist service businesses on where to locate in China, the resultant list of potential locations nearly always includes Shanghai. Beijing will also do just fine in 2007 as China’s center for government, technology, and media and entertainment, all of which will continue to thrive. Oh, and there is this little thing called the 2008 Olympics that will play a major role in Beijing’s economy as well. Doing business in China will continue to get easier.

China’s environmental problems will lead to more investment, not less. It will lead to environmental investing and, unfortunately, to investing by those who wish to take advantage of China’s lax environmental enforcement.

Please check back in a year to see who was right.

George Mason University’s Business Alliance will be putting on a U.S.-China Business conference on January 24, 2007, at the Ronald Reagan Building and International Trade Center in Washington, DC

The Chinese Government’s National Development and Reform Commission (NDRC), the State Development Investment Company (SDIC), the US Department of Commerce’s International Trade Administration (ITA), and George Mason University will be participating in this conference on doing business in China, along with “business leaders from 14 Chinese provinces representing the financial; mining and minerals; information technology; telecommunications; biotechnology; energy; automotive; textile, and steel sectors” will also be on hand.

The conference will include a networking breakfast with a welcome from George Mason University President Alan Merten and remarks by US Commerce Under Secretary Frank Lavin and NDRC Vice Chairman Ou Xinqian and “breakout sessions on banking and risk management; compliance issues; investment criteria; protecting intellectual property; shipping, logistics and documentation; investment strategies; business incubators and accelerators; opportunities for small businesses in China, and the role of venture capital.”

It appears this conference will focus on SMEs (small and medium sized enterprises) interested in China.

Small is the new big in China too.

I borrowed that phrase from Seth Godin, from whom I often borrow.  Godin is one of the best and certainly one of the most entertaining of all marketers.  To grossly summarize his marketing thesis, it is that companies must find a story that connects them to their clients, truly believe in that story, and the rest will follow.  I often quote Godin to the young lawyers in my office.

Godin is a big believer in small.  A couple years ago he wrote an article/post entitled “Small is the New Big.Godin also gave this same title to one of his recent books, which is essentially a collection of blog posts from his absolutely first rate blog.  Like his other books, including Purple Cow, All Marketers Are Liars (which I read and loved), and Free Prize Inside, the Small is The New Big book has received virtually nothing but positive reviews.

I almost hate summarizing the article because it is such a delightful and insightful read, but it essentially says that in most businesses, big is out and small is where it’s at:

Big used to matter. Big meant economies of scale. (You never hear about “economies of tiny” do you?) People, usually guys, often ex-Marines, wanted to be CEO of a big company. The Fortune 500 is where people went to make a fortune.

There was a good reason for this. Value was added in ways that big organizations were good at. Value was added with efficient manufacturing, widespread distribution and very large R&D staffs. Value came from hundreds of operators standing by and from nine-figure TV ad budgets. Value came from a huge sales force.

Of course, it’s not just big organizations that added value. Big planes were better than small ones, because they were faster and more efficient. Big buildings were better than small ones because they facilitated communications and used downtown land quite efficiently. Bigger computers could handle more simultaneous users, as well.

Get Big Fast was the motto for startups, because big companies can go public and get more access to capital and use that capital to get even bigger. Big accounting firms were the place to go to get audited if you were a big company, because a big accounting firm could be trusted. Big law firms were the place to find the right lawyer, because big law firms were a one-stop shop.

And then small happened.

Enron (big) got audited by Andersen (big) and failed (big.) The World Trade Center was a target. TV advertising is collapsing so fast you can hear it. American Airlines (big) is getting creamed by Jet Blue (think small). BoingBoing (four people) has a readership growing a hundred times faster than the New Yorker (hundreds of people).

Big computers are silly. They use lots of power and are not nearly as efficient as properly networked Dell boxes (at least that’s the way it works at Yahoo and Google). Big boom boxes are replaced by tiny ipod shuffles. (Yeah, I know big-screen tvs are the big thing. Can’t be right all the time).

Godin then extols the virtues of smallness, the following of which (for somewhat obvious reasons), I am particularly fond:

  • Small means the founder makes a far greater percentage of the customer interactions. Small means the founder is close to the decisions that matter and can make them, quickly.
  • Small means you can tell the truth on your blog.
  • A small law firm or accounting firm or ad agency is succeeding because they’re good, not because they’re big. So smart small companies are happy to hire them.

My international law firm’s mantra is the “international law firm for small business,” but I have always been a little wary of using it outside the West because small in Asia (and Russia too) does not have such positive connotations.  I have been told that if you say “small business” in China, most people think of something along the lines of selling food at a roadside stand.

But the concept of small in China may be changing.

Small businesses are booming in China, and just as in the West, they are oftentimes more dynamic, more nimble, more flexible, and faster growing than the large.  If you want to do business with an ossified Chinese company, do it with a large state owned entity, or SOE.  Not all of these companies are dinosaurs, but many are. Certainly, my firm has seen more than its fair share of small and medium sized U.S. based companies that have thrived in doing business in China.

China Daily just ran an article, entitled “SMEs an Important Engine of Foreign Trade Growth,”  touting the role of China SMEs (Small and medium-sized enterprises) in China’s increasing foreign trade.  The numbers (not unusual for China), are staggering:

More than 40 million small and medium-sized businesses make up about 99.6 percent of China’s enterprises, and they accounted for 70 percent of the country’s total foreign trade worth 1,422.12 billion US dollars last year, according to the China Small and Medium Enterprise Index of Economic Development released by Nankai University.

The index shows that nearly 60 percent of China’s gross domestic product was generated by small and medium-sized enterprises last year. SMEs account for more than 48.2 percent of the country’s taxation revenue and 60 percent of the total sales volume.

Seventy-five percent of urban-based employees work for SMEs, said the index.

Small is big.

What do you think?

When it rains it pours.  I know I have been writing a lot lately on what it takes to succeed in doing business in China, but all of a sudden there has been so much good writing on this that I would feel remiss not to put it out there.

Anyway, I just came across a post on the Diligence China blog [link no longer exists] that rises beyond good to essential.  It concisely sets forth what SMEs (small and medium enterprises) must do to succeed in China:

Learn the market. Familiarize yourself with the customs. China has been accessible for years, so there’s no excuse for basic lapses in knowledge. There’s a large body of reliable information out there. There are books, movies, websites, magazines and people you know who have been here. You don’t have to be an expert, but you can take the time to familiarize yourself with the basics of the culture. Shanghai, Shenzhen and Beijing are quite developed, the countryside is not. People really use chopsticks. Most really don’t speak English. Compliment people. Be polite. Make an effort not to be condescending. Nice small gifts are appreciated, but make them unique to your company, town or some group. Chinese markets offer just about everything regular US markets do, so go with traditional or unique.

Visit. Visit BEFORE you get too far into your China planning. I’ve known guys who speak perfect Chinese and worked in Taiwan and HK for 15 years who were completely shocked by their first visit to China. Whatever you expect, it will be different. Get a feel for what’s going on here, and then attack your business plan for China. Nothing takes the place of a 30 minute walk through the downtown business district of a big Chinese city. And make sure you get to a smaller city, an industrial park, and maybe the countryside.

Plan. Find people who can help. This website gets emails and questions that only a lawyer could answer. There are China lawyers and business entry experts who can help you get started. If you’re cheap (bless your hearts brothers), then do the research yourself. There are books and sites. A reasonable plan should be at least 5 years. The market is huge and tricky. Manufacturing is getting easier and better, but more expensive. It’s competitive and difficult, but the rewards are going to be tremendous. You do not want to be unprepared for China.

Execute. Plan on being here a lot, and working very closely with your senior managers here. If you are hiring a country head, work out a good system of communication and reporting. Manage much more closely than you would back home. Develop multiple sources of information. Plan on visiting often. Assume nothing.

If you are a small or medium sized company in or planning to get into China, I suggest you read this again and take every word of it to heart.

It is that good.

The New York Times just ran an article, entitled, “Chinese Economy Grows to 4th Largest in the World,” which muses that by most measures, China is actually third largest.  Today’s International Herald Tribune ran what could be seen as a complementary article, entitled “World’s CEOs Focus on China for Growth More than Cost.” This article discusses how “a majority of the world’s top chief executives plan to invest in China over the next three years to win customers” and to win market access, rather than just to reduce costs, which are expected to rise quickly over the next few years in any event.

SMEs should be thinking likewise.

For how much longer will China remain the world’s factory?