Taming the Dragon: Expanding into China
In the 21st century, no company with an eye on global expansion can afford to ignore China.
The country, which first launched onto the international economic stage in 1978 with its ‘reform and opening up’ policy, has been expanding at a breakneck pace ever since, reaching almost 10% annual growth on average since then, according to the China Business Handbook 17/18 from the China-Britain Business Council.
Although economic growth has slowed recently, China still outperforms many other countries. Driven in large part by an increase in middle-income citizens and growing consumer confidence, the Chinese economy continues to expand.
Companies wanting to do business in China will find themselves operating in a very different environment, where rules and relationships change. An understanding of the nuances and challenges of the Chinese market is essential before engaging this potentially lucrative region.
Language and cultural barriers
Companies wanting to do business in China should not underestimate the linguistic and cultural barriers. Mandarin may be the national language in China, but as a tonal language, it is notoriously difficult to learn.
The Chinese government only officially stipulated Mandarin as the national language in mainland China in 2001 according to the New York Times. The language is more useful the closer you are to Beijing, and as you venture further from that city, local dialects may make it more difficult to communicate, according to the China law blog.
The Han, the group which makes up 90% of the population, has 1500 dialects, says the Times, and many of them are markedly different. For example, the Wu dialect spoken in Shanghai has just 31% commonality with Mandarin (about the same lexical similarity as English has with French).
In addition, older Chinese people may still prefer Cantonese, and this language is still taught and spoken in Hong Kong and Macau.
There are also cultural differences to consider between the two countries, which can easily get a business discussion off on the wrong foot.
Some cultural nuances can lead to disaster in the boardroom unless negotiators are prepared. Start meetings with small talk, advises the International Business Times, and be prepared for it to last a while. Getting comfortable with each other is a big component of negotiating business in China. Don’t rush it.
Before you begin shooting the breeze, understand how many in Chinese culture view the world. China Daily notes disparities in Chinese and Western attitudes around several issues, including:
Chinese nationals may be open in talking about topics considered intrusive by Westerners, such as age and income.
While Westerners strive for family independence, many Chinese families are very close-knit and revere their elders, who will often live with the rest of the family.
China values community effort and collective reward, in contrast to traditional notions of self-improvement and individual achievement in the West.
The need for small talk illustrates perfectly the need for patience when doing business in China. This makes patience a particular virtue in the People’s Republic.
Don’t get frustrated while waiting for the real business to start and be sanguine as you work your way through layers of corporate and government bureaucracy. While Western negotiators might like to be aggressive and play hardball, many businesspeople in China perceive any such conflict as simply losing face. It may nix the possibility of a deal altogether.
Experts from global outsourcing company Nair & Co suggest getting a partner well-versed in Chinese business culture and markets. Many business arrangements in China are conducted informally, they say, and some of them may not even be written down.
In many cases, a lot rests on relationships with local government officials, who still play a big part in business fortunes. An overseas company entering China stands a better chance of succeeding having local expertise at its disposal.
The influence of local officials is one example of the Chinese government’s power over business. Companies should not underestimate the effect of government opinion and policy on Chinese business. As McKinsey points out, government policy continues to be the critical shaping force in China.
The government’s policy around foreign investment has become more liberal since China entered the World Trade Organization in 2001, according to Deloitte. Chinese policies that used to prioritise local enterprises have shifted, and now allow foreign companies to compete equally with domestic businesses.
Small or low-margin enterprises, especially those with a technology focus, can often enjoy incentives such as a reduction in income tax rates. Depending on the Chinese region that they’re targeting with their business, they may also find exemptions from purchase or resource-based taxes.
The Chinese government has also taken steps to modernise its internal regime, embarking on an extensive anti-corruption initiative at all levels of government and allowing for more privatisation. This is evident in the number of Chinese millionaires that have emerged over the last few years (it had 1,590,000 in 2016, putting it 6th in the world, according to Credit Suisse’s Global Wealth Data book.
Government policy creates its own bureaucratic challenges that can be daunting for many Western companies doing business there. It be difficult to understand who you should be negotiating with in a Chinese company, or in a local government structure, and in private conversation, venture capital attorneys have discussed how difficult it can be to structure and authorise payments to overseas companies from China. Expect red tape.
China may look favourably on technology companies doing business within its borders, but China’s approach to technology can often cause problems. These come in three broad categories; surveillance, censorship, and compromise of IP. They are often interconnected.
China has long maintained a regime of heavy censorship, centered around the ‘golden shield’ – a network of firewalls and government-administered policies that enables party officials to decide what those inside China can see.
China’s censorship rules have driven out both Google and Facebook, who refused to comply with the rules. Facebook has attempted to gain a foothold in China by sneaking under the radar with a stealth app, released through a local company.
Chinese censorship is sometimes closely linked to government financial policy, and can stifle the ability to conduct business freely there. One example is cryptocurrency. The People’s Bank of China has always been ambivalent about cryptocurrencies such as bitcoin, but in 2017, it took an aggressive turn.
PBOC halted the trading of cryptocurrency for fiat currency on exchanges, according to Reuters, and TechCrunch reports that it subsequently stopped people conducting initial coin offerings (ICOs). In early 2018, it also began discouraging the electronic ‘mining’ of bitcoin within its borders.
In general, China seeks a high degree of control over new technology entering its borders. For example, in 2015 Western tech companies were concerned about proposed new regulations that would force them to turn over their source code, submit to audits, and even build back doors into their hardware and software.
Many companies have capitulated to such demands, to varying degrees. For example, Apple accepted ‘network safety evaluations’ by the Chinese government on its products, although it insists that it has not created back doors, showed source code to China, or allowed for Chinese censorship in its products.
Other companies have reportedly shown source code to Chinese authorities as a condition of doing business there, including IBM and Microsoft.
All of this makes doing business in China a tricky proposition for technology companies.
Why might showing source code to Chinese authorities be a problem? For the same reason that sharing any intellectual property in China could be a problem: the country’s approach to IP law. Western countries have traditionally been suspicious of China’s treatment of IP, worrying that technology shown to companies or government officials there could make its way into domestic products and services.
A 2017 report to Congress about China by the US Trade Representative expressed concern about “serious problems with intellectual property rights enforcement in China, including in the area of trade secrets.”
The report describes incidents where “actors affiliated with the Chinese government and with the Chinese military have infiltrated the systems of US companies, stealing terabytes of data, including the companies’ intellectual property (IP), for the purpose of providing commercial advantages to Chinese enterprises.”
Moreover, China was put on a Priority Watch List in the US Trade Representative’s 2016 Special 301 Report, after an FBI survey showed a 53% increase in economic espionage cases. 95% of those companies that claimed to be victims of espionage said that attempts originated from individuals associated with the Chinese government.
China has vowed to improve its policy on trade secrets and IP, and signed separate agreements with the US and Canada. Nevertheless, companies doing business in China would do well to protect their assets.
There are several solutions. One is to set up a separate R&D centre in China focused on researching new IP in close collaboration with Chinese partners. By establishing a close collaboration, both parties have an incentive to avoid leakage, say experts. This approach can help to firewall new developments from existing core IP.
Structuring your Chinese venture
Companies wanting to establish a meaningful presence in China beyond simply being a foreign company with no on-shore presence have several options.
Open a Chinese branch
Multinational corporates can open representative offices, but their operating scope is limited because they do not enjoy the same legal status as Chinese individuals, according to Deloitte.
Wholly-owned foreign enterprise
One of the more popular approaches for Chinese investment, the WOFE only became a possibility after China entered the WTO. In this model, the overseas investor creates its own limited liability company in China.
The downside to a WOFE arrangement is that without a Chinese partner, the investor is restricted in the kinds of business activity it can pursue in China. Setting up a joint venture with an existing Chinese company solves that problem.
A joint venture also gives the overseas firm a partner on the ground and can take advantage of its local connections and knowledge. This not only opens local markets, but also gives foreign partners easier access to local incentives and partnerships.
There are two kinds of company structure open to those pursuing joint ventures. The first is a co-operative joint venture (also known as a “contractual operative enterprise”). This can be a limited liability company, in which the foreign investor provides funds and technology while the Chinese partner provides infrastructure (land and equipment). This arrangement can help reduce risk for the overseas partner, which can take a minority stake in the venture and adjust terms more easily.
Conversely, an equity joint venture enables the Western partner to take a more active hand in the enterprise. It sees both partners manage the initiative more equally and assumes more equal liability, based on their capital contribution.
Joint stock companies
JSCs are also the product of partnerships with Chinese companies, but they are eligible for listing on Chinese stock exchanges.
Doing business in China is a daunting prospect, but the potential rewards are huge. It is a massive market, with more middle-income and high-income consumers coming on-stream every year.
Companies with an eye on China would do well to enlist the help of a third-party consulting company, and appoint someone with extensive and deep knowledge of the local business environment on the ground when they make their move. And unless your Mandarin is top notch, some translation services (hint hint) would be a good idea.
When it comes to building a presence in this exciting region, Chinese Whispers is one game you don’t want to play.