[Fiducia Management Consultants]
Taxation and Double Taxation Risks:
Investment promotion and protection agreements between China and other nations exist to protect their investors with internationally recognized standards. The key elements for these types of agreements include:
- Provisions for equal and non-discriminatory treatment of investors and their investments.
- Compensations for expropriation.
- Transfer of capital and returns.
- Access to independent settlement of disputes.
Governments of most developed countries show their commitment to fair treatment for investors through their membership of the Organization for Economic Co-operation and Development (OECD), European Union and/or European Economic Area; therefore there is no need for an additional investment agreement.
Double taxation occurs when a foreign country taxes your business as well as being taxed in China on the same income. Many countries have now reached double taxation agreements with China where they will only tax your income once.
Market (4 P’s) Risks:
The marketing mix is defined by Perreault and McCarthy (2002) as the controllable variables the company puts together to satisfy this target group. The marketing mix is made up of the four “P’s”. The four “P’s” are comprised of the product, place, promotion, and the price. These elements are considered in all businesses in one way or another. Each element will be discussed as it relates to a specific organization.
The first element is the product, AKLLR offers eight different models of floor based and wall mounted air conditioners. All of our air conditioners come with a remote control. Instructions come with the equipment and they are printed in English, Chinese, German, French, and Spanish. Our air conditioners are very convenient because they can be placed on the floor or mounted to the wall. Accessory materials are all packaged with the air conditioner. Fan speeds range from 2 to 3 speeds. Some models come a dehumidifier and timer modes. We have several models that are set on roller wheels for easy transport to other parts of the room or building. To top things off, we offer a five- year limited warranty on every air conditioner.
The second element is place. Our objective is for our product to be available to all costumers in the market of top quality air conditioners. When our product leaves our production facility, we would like for the equipment to be made available in local markets. We expect to sell our air conditioners in malls, electronic stores, and the Internet. We realize that the market that we are targeting will probably be regular users of the Internet. We intend on targeting three special status municipalities, they are Beijing, Shanghai, and Tianjin. The air conditioners will be transported by truck between two of the cities. This would be Beijing and Tianjin because they are relatively close to each other. Our production facility will be in Shanghai of Tianjin. The air conditioners will be trucked to Shanghai unless there is a large number of backorders. At this time, we would air freight the equipment. Shanghai is about 600 miles from Beijing so it would take our drivers at least two days to reach our distribution site in Tianjin.
Promotion is the third element. We want our target market to know that our air conditioners are the best available in the market. We are focused on acquiring new customers and retain current customers. Our promotional plan consists of billboard advertisements, television and radio commercials, and newspapers. Our salespeople will be trained and very knowledgeable about our products. We intend on having a motivated sales staff. We will target hotels, automotive industry, industrial companies, consulting firms that are renting office space, middle class and upper class people Chinese nationals. We want people that check into hotels in China to be accustomed to seeing the initials of AKLLR and associate them to our air conditioners.
The last element is price. Price must be set according to the competition in the target market and cost of the whole marketing mix. Our air conditioners will range from $100 for our base units to $600 for our higher BTU units. These prices already include markups. We believe our price is acceptable for our target market. If our units are ordered in bulk, we will offer a percentage discount according to the number requested. We will offer the top quality air conditioner but the price will be competitive while still recording a profit.
Distribution/Supply Chain Risks:
Following China's entry into the WTO, an increasing number of smaller companies from all over the globe are pursuing business opportunities in the mainland. These companies may not have the resources to fully explore the full business potential, regulatory compliance or the employment culture. Through having access to accurate timely information, such as supply chain evaluation, or the right partner, companies are in a much stronger position to make strategic business decisions. In a foreign country or at home, there are inherent dangers associated with developing suppliers.
While the situation in China is complicated by language, distance and cultural differences we hope that the rules of thumb introduced in this paper can help mitigate many of the risks in China. China's preferential pricing combined with its level of manufacturing maturity clearly emphasizes that the need to understand this market has never been greater. However, with opportunity comes risk. Having found a qualified supplier in China, often the US buyer is still hesitant to place the order as sensitive information such as branding, retail price markings, bar coding, shipping destination, order sizes and even end-buyer information could be exposed. There are three overriding concerns faced by both the first-time buyer as well as the experienced China sourcing specialist.
Supply Chains
China wants to show the world that they are living up to the World Trade Organization (WTO) commitments. But, will need to play by the Chinese trademark system and that means having brand registered in advance, as China is a first to register rather than first to market the system.
Finding the Right Supply Partner:
One of the biggest determinate that makes or breaks a sourcing program in the People's Republic of China (PRC), is finding the right partner. It seems that everything these days is made in China and that it would be easy to find a supplier. In reality, finding the right supplier can be a daunting task. China is a massive country over 700 cities making up one quarter of the world's population spread over an area of four million square miles with extreme variation in price, quality and production ability. Probably the biggest headache for American buyers when conducting supplier research is that there are no comprehensive industry guides. Furthermore, ISO certification does not carry the same weight as in the West and websites do not always realistically portray the supplier's ability. The fact of the matter is that only through physical inspection of the facilities and review of actual production samples will gain a true understanding of a supplier's ability. It is a daunting task, but the time, energy and funds spent on a trip to China during the initial supplier identification phase will pay dividends in the long run.
Ability to Control Quality:
In an ideal world, the manufacturer could handle their QC internally and defective goods would never leave China. In reality, there is often a lot of hand holding required to ensure the suppliers fully understand your specifications and quality concerns, especially during initial production runs. Setting up your own sourcing center in China is not a realistic option for most US buyers. However, there are some simple rules to keep in mind, which can limit risks.
- Always see an actual production sample from the actual supplier before issuing payment or placing a Purchase Order (PO) This lack of transparency complicates service, price and communication.
- Ask the supplier to provide their internal QC documentation as part of the buying process.
- Employ local auditors and independent laboratories if unable to conduct final QC on the systems. Their service fees are very small compared with cost of faulty products in your supply chain.
Security:
To ensure blueprints, design specs, tooling and brand names are protected. This is a concern shared by most international purchasers doing business in the PRC. Do not disclose the product's final use or branding and remove confidential information from prints and samples. Consider dividing your product into individual components or focusing on only key components to conceal the big picture during the request for quotation stage. Let the supplier quote based on the product and order size. This may involve employing a sourcing agent to conduct the initial research on your behalf with out disclosing your vital information.
Distribution Centers
The lack of efficient distribution channels is a serious obstacle for foreign companies looking to sell their products in China's vast consumer base. Many foreign companies hope that a Chinese joint venture partner will be their ticket to quick access to the local market. This strategy does not always work often; the foreign company later finds out that the local partner had little to offer in terms of a magic key to unlock the market, since the distribution infrastructure simply is not there. In addition, many Chinese companies are still trying to understand how a market economy works, as opposed to the past where China's economic planners simply told them what and how much to produce as well as whom to sell its products and services.
The perception of China's lax enforcement of intellectual property rights also remains an impediment to foreign businesses which main competitive advantage is often their well-known brand names and patented technologies. AKLLR, biggest concerns are how we can protect our intellectual properties and whether or not we can source qualified local management staff. The maker of air filters is planning to establish a joint venture with its current Shanghai-based distributor that would import key components for its heavily patented filters from the United States for local assembly.
Socio-cultural Risks:
“Guanxi” literally means "relationships", stands for any type of relationship. In the Chinese business world, however, it is also understood as the network of relationships among various parties that cooperate together and support one another. The Chinese businessmen mentality is very much one of you scratch my back, I’ll scratch yours. In essence, this boils down to exchanging favors, which are expected to be done regularly and voluntarily. Therefore, it is an important concept to understand if one is to function effectively in Chinese society.
The importance of "Guanxi"
Regardless of business experiences in ones home country, in China it is the right "Guanxi" that makes all the difference in ensuring that business will be successful. By getting the right "Guanxi", the organization minimizes the risks, frustrations, and disappointments when doing business in China. Often it is acquiring the right "Guanxi" with the relevant authorities that will determine the competitive standing of an organization in the long run in China. And moreover, the inevitable risks, barriers, and set-ups you’ll encounter in China will be minimized when you have the right “Guanxi” network working for you. That is why the correct "Guanxi" is so vital to any successful business strategy in China.
Although developing and nurturing the "Guanxi" in China is very demanding on time and resources, the time and money necessary to establish a strong network is well worth the investment. What AKLLR could get in return from the favors for our partners is often more much more valuable, especially in the long run. Even domestic businesses in China establish wide networks with their suppliers, retailers, banks, and local government officials. It is very common for individuals of an organization to visit the residence of their acquaintances from other organizations, bringing gifts (such as wine, cigarettes, etc.).
To start, AKLLR must pay close attention to our immediate Chinese network, and try to establish good "Guanxi" with them. They can indirectly link us to new acquaintances and information resources, thus helping us to develop other right "Guanxi" we may need.
How business is conducted:
The Chinese culture is distinguished from the Western culture in many ways, including how business is conducted. For example, the Chinese prefer to deal with people they know and trust. On the surface, this does not seem to be much different from doing business in the Western world. But in reality, the heavy reliance on relationship means that western companies have to make themselves known to the Chinese before any business can take place. Furthermore, this relationship is not simply between companies but also between individuals at a personal level. The relationship is not just before sales take place but it is an ongoing process. AKLLR has to maintain the relationship if it wants to do more business with the Chinese.
How relationship is established:
- A relationship does not have to be based on money. Treating someone with decency while others treat him/her unfairly could result in a good relationship.
- It starts with and builds on the trustworthiness of the individual or the company. If a company promised certain things and delivered as promised, the company is showing trustworthiness and the Chinese would be more inclined to deal with them again.
- Being dependable and reliable definitely strengthens the relationship. It is like being friends, and friends can count on each other in good and tough times. A good example is related to the 1989 political instability in China. [Companies that stayed found their relationship with the Chinese strengthened as they were viewed by the Chinese as friends who did not abandon the Chinese when they needed friends].
- Frequent contacts with each other foster understanding and emotional bonds and the Chinese often feel obligated to do business with their friends first.
"Guanxi" or relationship with high rank officials are still important for doing business in China, though declining to some extent. Political and administrative interference in business have declined. More and more companies have found themselves on their own surviving without government subsidiaries. If they are not getting any help from the government they are more reluctant to be influenced by government officials. So government "Guanxi" may have less influence with these companies.
Since "Guanxi" and relationship could function as an information network, companies with wide "Guanxi" and relationship networks often have much higher performance than companies with little or no relationship with the Chinese.
Final Words on "Guanxi":
"Guanxi" can take on many forms. It does not have to be based on money. It is completely legal in their culture and not regarded as bribery in any way. So, there is no need to feel uncomfortable about it. Trustworthiness of both the company and individual is an important component. Following through on promises is a good indication of this. Treating someone with courtesy while others treat him or her unfairly is another aspect. Frequent contact fosters friendship as well. The Chinese feel obligated to do business with their friends first. There are risks with this system, as well. When something goes wrong, the relationships are challenged, and friendships quickly disappear. "Guanxi" can also be very one-sided. When "Guanxi" is involved, there is a risk of obtaining an invoice of twice the amount that you bargained for.
SWOTT Analysis
In late 1978 the Chinese leadership began moving the economy from a sluggish, inefficient, Soviet-style centrally planned economy to a more market-oriented system. Whereas the system operates within a political framework of strict Communist control, the economic influence of non-state organizations and individual citizens has been steadily increasing. The authorities switched to a system of household and village responsibility in agriculture in place of the old collectivization increased the authority of local officials and plant managers in industry, permitted a wide variety of small-scale enterprises in services and light manufacturing, and opened the economy to increased foreign trade and investment. The result has been a quadrupling of GDP since 1978.
Measured on a purchasing power parity (PPP) basis, China in 2003 stood as the second-largest economy in the world after the US, although in per capita terms the country is still poor. Agriculture and industry have posted major gains especially in coastal areas near Hong Kong, opposite Taiwan, and in Shanghai, where foreign investment has helped spur output of both domestic and export goods.
The leadership, however, often has experienced - as a result of its hybrid system - the worst results of socialism (bureaucracy and lassitude) and of capitalism (growing income disparities and rising unemployment). China thus has periodically backtracked, retightening central controls at intervals. The government has struggled to:
- Sustain adequate jobs growth for tens of millions of workers laid off from state-owned enterprises, migrants, and new entrants to the work force.
- Reduce corruption and other economic crimes.
- Keep afloat the large state-owned enterprises, many of which had been shielded from competition by subsidies and had been losing the ability to pay full wages and pensions.
From 80 to 120 million surplus rural workers are adrift between the villages and the cities, many subsisting through part-time, low-paying jobs. Popular resistance, changes in central policy and loss of authority by rural cadres have weakened China's population control program, which is essential to maintaining long-term growth in living standards. Another long-term threat to growth is the deterioration in the environment, notably air pollution, soil erosion, and the steady fall of the water table especially in the north. China continues to lose arable land because of erosion and economic development.
Beijing says it will intensify efforts to stimulate growth through spending on infrastructure - such as water supply and power grids - and poverty relief and through rural tax reform. Accession to the World Trade Organization helps strengthen its ability to maintain strong growth rates but at the same time puts additional pressure on the hybrid system of strong political controls and growing market influences. China has benefited from a huge expansion in computer Internet use. Foreign investment remains a strong element in China's remarkable economic growth. Growing shortages of electric power and raw materials will hold back the expansion of industrial output in 2004.
Strengths:
- Market Oriented System.
- Second Largest Economy.
- Member of the World Trade Organization (WTO).
- Cheap Qualified Labor.
- Amiable Government Policies.
- High Market Demand-Population of 1.2 billion growing by 17 million annually.
Weaknesses:
- Communist Controlled
- Partnering Requirements
- Distribution
- Financial Systems
- Low-speed on-line payments
- Less mature Venture Capital Financing
- Inefficient Stock Markets
Opportunities:
- Standard of Living Moving Upward
- Poverty Level Under 10%
- Fastest Growing Destination for U.S. Exports
- Fourth Largest U.S. Trading Partner.
- Increasingly Affluent Working and Middle Class.
Threats:
- Air Pollution
- Soil Erosion
- Fall of Water Table in North China
- Shortages of Electric Power
- Shortages of Raw Materials
Trends:
- 400 Brands of AC Reduced to 50
- Market Capacity 15 million units and growing 38.2 % last year.
- Intense Competition in this sector.
- Quality Improvements
- Production Capacity Expanding
- Prices Falling.
References
China Business Resources: Article by
First published in CBBC in Jan '03 - a resource for companies looking to do business in China
Fiducia Management Consultants – Beijing – Hong Kong – Shanghai – Shenzhen,
Political, Legal and Regulatory Factors, Managing Change Strategic Interactive Marketing, Last Updated: March 1998 © Managing Change 1997-98
Perreault, W.D. & McCarthy, E.J., (2002). Basic Marketing (14th ed.), McGraw-Hill/Irwin: New York, New York.
