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Doing Business in China

The Chinese economy is roaring. But what does it take for foreign investors to succeed when doing business there?

Foreign investment in China has surged dramatically in the past few decades—from a few billion dollars per year in the 1980s and early ’90s to tens of billions of dollars per year in the past decade. Despite this, doing business in or with China doesn’t come easily to most Westerners. For those who neglect their homework, failure can come easily. Huge and not readily defined, China is as diverse as its many regions and languages and is currently in the throes of rapid change. Fueled by tremendous economic growth, Chinese people have on the whole become richer. Yet the income gap between the wealthier Chinese, who tend to live in urban areas, and the poor, who tend to live in rural areas, is growing ever wider. And while the Chinese people recognize that foreign investment can help their economic situation, they are also steeped in an entirely different culture than are Westerners.

In matters of business, the differences are sometimes subtle, sometimes not—but either way, they can have a considerable impact. NEWSWEEK’s Laura Fording interviewed Peter Liu, cofounder and chairman of WI Harper, a U.S.-based high-tech venture-capital firm, whose goal is to bring Silicon Valley and Chinese—as well as Hong Kong and Taiwanese—businesses together. The interview was conducted by e-mail. Excerpts:

NEWSWEEK: What is most on Chinese government officials’ minds these days?
Peter Liu: The potential impact of rising unemployment, especially in rural areas of China. Also some of the white-hot growth sectors, which may be leading indicators and contributors to a possible hard landing: real estate, raw materials such as cement and steel and, of course, commercial lending.

I’ve heard that the chances that a foreign business will fail in China are high—that it’s easy to invest there but much more difficult to bring the money back home. Why?
In general, this is true. Most foreign companies are handicapped by a lack of cultural understanding and patience to see [their projects] through. The most difficult thing is finding the right and trusted partner with shared interests in China. Often senior executives in these foreign companies underestimate how complex and frustrating doing business in China can be at times.

People are investing in computers and telecom. What other areas have the potential to do well in China?
Semiconductor, fabless IC design and outsourcing service sectors can be high-growth areas. Outsourcing and technology-enabled service companies, especially, will see high growth, given China’s unique features. Often cutting-edge technology isn’t what wins the day in China; rather, it’s practical applications which can address an immediate need and are directly or indirectly linked to the mass consumer. We are less enthusiastic about enterprise [software companies] such as ERP, CRM, as they tend to have very, very long sale cycles and [a] high level of customization. The investment horizon in the West is normally two to five years, but in China, it is five to eight years.

Do larger companies have advantages over smaller start-ups when doing business in China?
To certain extent, yes, as larger companies tend to have the provincial [or] central government’s support. But this is changing as smaller start-ups, equipped with foreign capital and better senior-management teams, become more and more competitive. These types of companies can change strategies quickly to better align themselves with the rapidly evolving technology-market conditions in China.

What are the some of the major obstacles encountered when doing business there?
Lack of a complete legal framework, lack of a viable and proven exit strategy and a channel for venture-capital investors, lack of strong corporate governance and, still, a lack of quality and experienced local managers with international and well-rounded skill sets.

Can you give some examples of how cultural differences affect relationships between Chinese and American businesspeople?
One example is the issue of currency [revaluation]: the more Americans push, the more difficult it is for the Chinese government to agree. There is clearly a lack of cultural understanding from Americans, if you put aside all the economic reasons for and against a revaluation.

Are products made by American companies too expensive for most Chinese people to afford?
In general, the answer is yes. American companies simply can’t compete with China on manufacturing-based operations. In my mind, there are three things American companies can do to survive: 1.) Have a China strategy and find manufacturing partners in China. 2.) Innovate and differentiate with cutting-edge R&D at the same time. 3.) Localize product lines or services with local partners.

What is the typical reaction of the Chinese government to foreigners trying to do business in their country? Do they welcome it? Do the Chinese people welcome it?
The short answer is yes and yes. The Chinese government, both at the central and the provincial level, welcomes foreign investments in China and often has many preferential taxation treatments and better regulations to promote it. As for Chinese people, foreign investment often results in more jobs and they certainly are in favor of that, as well.

I’ve heard businesspeople say that the legal system in China is not particularly supportive of foreign business. What’s your take?
The legal system in China still has a lot of room to improve in general, not that it is particularly unsupportive of foreign business. In general, our take is: proceed with caution and work with trusted partners to prevent or lessen the chance of legal matters down the road. A company can only increase its odds of succeeding in China by doing that and doing it early to prevent an unhappy situation from happening at all. If such an unhappy situation happens, China is rapidly improving its legal and mediation system. But the process of taking legal actions in China is very long and painful, still.

What about piracy? I’ve heard it’s a huge problem in China. Is there any way to curb it?
Yes, piracy remains a huge issue, and it will NEVER go away. Instead of taking a combative and rigid attitude, one should find innovative ways to make sure the maximum benefit can be generated, given this environment. In order to operate in China, the issue of piracy needs to be taken into consideration as part of the core business strategy and dealt with in a practical way. Look at Microsoft as an example of not dealing with the issue right and now suffering from declining market shares year after year. We try to assist U.S. companies, for instance, in dealing with piracy issues. For instance, Hollywood can share their experiences with their Chinese [counterparts]. Then they can try to understand the professional way to project intellectual property. By doing so, government can support their act to balance the piracy issues between Hollywood and China.

Any advice for someone who has an idea for starting a business in China, or a business relationship with someone in China?
Be practical, set realistic and achievable goals, work with TRUSTED partners, and most importantly have a long-term view and BE PATIENT. “Patience, Patience and Patience.”

Airbus plans China assembly plant

Airbus signed a framework agreement with the Chinese authorities on Thursday to build its first aircraft assembly plant outside Europe, at Tianjin in eastern China.

It also agreed a preliminary deal for its biggest single order from China, for 170 aircraft, which could eventually be worth about $14bn (€11bn) at list prices, before heavy discounts.

Airbus, a subsidiary of EADS, Europe’s leading aerospace and defence group, is seeking to extend its industrial operations beyond its European base in France, Germany, Spain and the UK, and has made China a priority target both for increased sales and industrial co-operation.

It has failed to make much progress in breaking into the Japanese market, where Boeing, its US rival, has an entrenched position both in sales and as an industrial partner, and the European group is seeking to develop a counterweight presence in China.

Thursday’s deals provided a temporary respite for EADS and Airbus from the prolonged crisis triggered by mounting industrial and management problems, including the costly two-year delays in early deliveries of the A380 superjumbo and a recent €4.8bn profits warning.

Airbus said it had signed a framework agreement to assemble its successful A320 family of single-aisle, short-haul jets at a plant in the coastal city of Tianjin, east of Beijing. The plant is expected to be located in the huge Binhai development zone, which China’s government expects to rival manufacturing centres such as Shanghai and parts of the southern Pearl River delta.

Airbus said it would begin assembling aircraft in China in early 2009 with the aim of increasing production to four a month by 2011.

Louis Gallois, co-chief executive of EADS and chief executive of Airbus, said the aircraft sections for the A320 would continue to be produced in Europe but would be shipped to Tianjin for final assembly.

The Chinese consortium involved in establishing the plant will be led by the Tianjin Free Trade Zone and will include China Aviation Industry Corporation I (Avic I) and China Aviation Industry Corporation II (Avic II).

Olivier Andries, Airbus executive vice-president strategy, said Airbus would hold a 51 per cent stake in the joint venture and would appoint the general manager. It would invest €100m-€150m. “The main rationale in starting assembly is to build our presence in the Chinese market,” he said.

The deal was signed during a visit to Beijing by French President Jacques Chirac, France’s president, and still needs formal approval by the EADS board and Beijing.

It was supported by a general terms agreement for China to buy 150 A320 aircraft. Beijing also backed Airbus plans to develop the A350XWB, a new family of long-range, medium-capacity jets, by signing a letter of intent for 20 aircraft.

Separately Airbus said it had signed a firm contract for the purchase of 65 Airbus A319 aircraft with Skybus, a US lowcost, startup airline based in Columbus, Ohio. The airline is aiming to start operations in early 2007.

Ford to double China procurement

Ford is set almost to double the value of components it buys in China this year, becoming the latest global carmaker to tap low-cost Chinese parts producers to cut costs.

Bill Ford, executive chairman, said in Beijing on Thursday that the group aimed to source $2.5bn-$3bn worth of parts from China, up from $1.6bn-$1.7bn last year.

Mr Ford’s comments are the latest indication that Chinese component makers, which have long been keenly competitive on price, are now also meeting the quality levels required by multinational carmakers. Chinese manufacturers’ labour costs are about 5 per cent of those in Germany and 20 per cent of rival factories in eastern Europe.

Ford’s announcement follows Volkswagen’s move this year to raise the value of its Chinese parts imports from $100m in 2005 to $1bn. DaimlerChrysler is also sourcing more from China.

Analysts said General Motors was poised to follow suit, although the company would not comment on Thursday.

Goldman Sachs estimates that Chinese net exports of car parts will rise from $5.4bn in 2005 to $21bn in 2010 as Chinese products become more accepted overseas.

China still imports large volumes of more technologically sophisticated parts such as gearboxes and steering systems but it has become a big exporter of tyres, wheels, electronic components and glass.

Yale Zhang, analyst at the Shanghai office of CSM Worldwide, an industry consultancy, said the quality of Chinese-made components had improved thanks to increased competition and pressure from multinational carmakers that had established operations in China. The US, European Union and Canada asked the WTO last month to open a formal investigation into the tariffs China levied on foreign-made components.

China interested in hiring RP nurses

MANILA — China is interested in hiring around 500 Filipino nurses to teach there, the Commission on Higher Education (CHEd) said on Friday.

CHEd Chair Carlito Puno said that two big nursing schools in China have expressed interest in hiring Filipino nurses. “I can’t disclose yet the names of these schools pending the signing of an agreement between our government through CHEd and the China government through its education ministry,” Puno said.

He said that China has “high regard” for the country’s nurses as compared with its own nurses. “China admitted that the quality of their nursing education is not good compared with those of other countries such as Philippines. China’s nursing graduates could barely pass the National Licensure Examination,” he said.

Puno announced the news as a result of his recent visit to China where he met with 41 education ministers from all over the world to discuss trends and improvements in cross-border education programs.

He also said the country will be sending to China next year the first batch of 1,000 nursing students who will share their knowledge with their counterparts on nursing care and hospital work.

“This (student exchange) is part of a cross-border education program between our country and the education ministry of the China government that would be formalized soon between the two governments,” Puno said.

Puno said that those who will be sent to China for a one-year tour-of-duty in the student exchange program are 4th year nursing students from two prestigious schools in the country.

“These nursing students will spend their last year of practicum in different hospitals in China. “That’s the initial agreement that has still to be signed by both governments. CHEd is already considering two top schools where the 4th year nursing students would be tapped to be sent to China ,” Puno explained.

Puno also expressed confidence that the nursing profession in the country will continue to produce more competent and qualified nurses in the future.

“Despite the leakage controversy wreaking havoc in our nursing profession, some countries are still interested to share and impart knowledge with us. This is a very positive development for our Filipino nurses who should also try to go to other countries other than the United States and Europe,” he said.

Puno believes that the controversy over the licensure exams leakage that hit the Philippine nursing education in 2006 will “die down naturally.” “I’m hoping the issue will be resolved soon and let our new nurses move on with their life and future,” he said.

On Friday, the Philippine Regulation Commission (PRC) started to administer the oath to those who passed the last nursing board exams last June.

Out of around 43,000 examinees, 41.24 percent or 17,323 passed.

China Launches Bank Compliance Risk-Management Guidelines

BEIJING -(Dow Jones)- China’s banking regulator Wednesday issued official guidelines aimed at strengthening Chinese banks’ compliance risk-management in a move seen as helping them combat increasing competition from foreign banks.

The guidelines ask the country’s banks to adopt better compliance risk- management practices, to boost their risk-management systems and corporate governance, the China Banking Regulatory Commission said in statements posted on its Web site.

The new policies are aimed at bringing China’s banks into line with global practices. Foreign banks will be able to carry out a full range of local- currency services starting Dec. 11 as part of China’s World Trade Organization commitments.

The guidelines – a draft of which was first reported by Dow Jones Newswires last week – are effective immediately. They apply to Chinese commercial banks, foreign banks and their branches operating in China, the CBRC said.

Other financial institutions such as policy banks, fund asset management companies and trust cooperatives aren’t required to abide by the guidelines, but should take them as references, it said.

Banks are required to set up a sound compliance system, and the top management should file a compliance risk-management report to the board of directors annually, it said.

The compliance practice should receive regular checks from independent internal audit department, and banks should submit their compliance management plans and assessment report to the CBRC in a timely manner, it said.

Deutsche Bank plans China property JV -sources

SHANGHAI, Oct 27 (Reuters) – Deutsche Bank AG is set to establish a property venture in China, in which Germany’s biggest lender expects to take a 50 percent controlling stake, industry sources and the venture’s Chinese partners said on Friday.

Zhongzhu Real Estate, based in the southern Chinese city of Zhuhai near Hong Kong, plans to take 20 percent of the new joint venture, said a senior executive at Zhongzhu who is familiar with the situation.

“We’re finalising the deal and we will sign an agreement” in the next few days or weeks, the Zhongzhu executive, who declined to be identified, told Reuters by telephone.

The sources declined to say how much Deutsche Bank would pay to invest.

A Shanghai-based banking source said Deutsche Bank had been negotiating with Zhongzhu and other parties for about half a year, though no final decision had been made yet.

The sources said a Macau company would take 25 percent of the joint venture, and another Chinese company would take 5 percent. ADVERTISEMENT

A spokeswoman in Sydney for Deutsche Bank’s asset management division, which deals with property investment in Asia, declined to comment on Friday.

China’s ICBC launches record IPO, shares soar

Chinese lender raises $21.9 billion, while shares climb 15 percent in market debut.

October 27 2006: 6:53 AM EDT

HONG KONG (Reuters) — Shares in Industrial & Commercial Bank of China, which is raising up to $21.9 billion in the world’s largest IPO, ended 15 percent higher in their Hong Kong debut on Friday after its stock sale generated huge investor demand.

The debut values the largest Chinese lender, making the first simultaneous Hong Kong and mainland China listing, at about US$139 billion, ranking it fifth among global banks, behind JPMorgan Chase & Co. (Charts) and ahead of Mitsubishi UFJ

China began listing its banks overseas last year, and all five mainland lenders trading in Hong Kong have drawn huge demand for their shares as investors downplay worries about the legacy of decades of state-directed lending.

Yang Liu, managing director at Atlantis Investment Management, bought ICBC’s IPO shares as a play on the Chinese economy, a rising currency and growing middle class, despite her preference for China Merchants Bank and China Construction Bank

“It’s too big to be ignored,” she said.

The stock leapt as high as HK$3.63, or 18 percent above its offer price, shortly after the Hong Kong market opening, compared with an IPO price of HK$3.07, before closing at HK$3.52.

ICBC was the most active stock in Hong Kong, but fell short of expectations for a first-day gain of as much as 20 percent.

“It’s better than what the average investor expected, given the size of the offering,” said Kent Yau, deputy research director at Core Pacific Yamaichi in Hong Kong.

ICBC’s domestically listed A-shares, however, disappointed investors by ending with just a 5.13 percent gain to 3.28 yuan, compared with an offer price of 3.12 yuan. The Shanghai shares rallied early by 10 percent before easing.

The Hong Kong debut was crimped by a 0.31 percent dip in the Hang Seng Index, which earlier on Friday hit a record high.

Big and bigger
ICBC raised $19.1 billion and is expected to expand the offering to $21.9 billion by exercising an overallotment option.

The stock sale was the most popular in Hong Kong and China history, and unmet demand for shares, combined with a surging Hong Kong market and an offering priced at a discount to peers, helped lift its first-day trading performance.

“Investors foresee China’s economy maintaining 10 percent growth every year before the 2008 Olympics in Beijing, so they’re buying mainland bank shares now to access that growth,” said K.C. Chan, executive director at money management firm KDB International, which bought ICBC shares for its clients.

The IPO, about 75 percent of which was sold to Hong Kong and global investors and the remainder in the mainland, surpasses Japan’s NTT Docomo, which raised US$18.4 billion in 1998, as the world’s largest share sale.

“This is the world’s largest IPO ever with the biggest ever subscription rate. That speaks volumes for the quality of the offer and for global investor confidence in China,” said Damian Chunilal, president of Pacific Rim global markets and investment banking at Merrill Lynch, one of ICBC’s underwriters.

Among its rivals, Bank of Communications trades 132 percent above its IPO price, while China Construction Bank and Bank of China are up 50 percent and 13 percent, respectively. On their Hong Kong debuts, Construction Bank closed flat and Bank of China ended up 15 percent.

Billions in bailouts
China has scrambled to get its creaky banks into better shape ahead of increased foreign competition set to kick in at the end of this year under its World Trade Organization obligations.

ICBC’s IPO attracted share orders worth about $400 billion for the Hong Kong portion of its deal and 780.7 billion yuan ($99 billion) for its domestic deal.

That should hearten another mainland lender, China CITIC Bank, which plans to raise as much as US$2 billion in a Hong Kong and mainland share sale by early 2007.

ICBC’s share sale was a bonanza for foreign institutional investors led by Goldman Sachs (Charts), which paid $2.58 billion in April for about 16.5 billion ICBC shares — a stake that is now worth $7.45 billion. Allianz and American Express (Charts) also bought stakes alongside Goldman that are now worth a combined $3.5 billion.

All three investors have three-year lockups on their shares.

ICBC’s IPO values the lender at 2.23 times its forecast book value. By comparison, No. 2 mainland lender Bank of China trades at 2.35 times 2006 book, No. 3 China Construction Bank trades at 2.66, and No. 5 Bank of Communications trades at 3.04 times book.

At the end of June, ICBC had total assets of 7.05 trillion yuan, 360,000 staff and more than 18,000 branches all over China.

China’s “Big Four” state-run banks have received billions of dollars in government bailouts to help ease their bad loan woes.

ICBC received a US$15 billion capital injection from Beijing in April 2005, helping lower its non-performing loan ratio to 4.1 percent as of June 30 this year, compared with Bank of China’s 4.2 percent and 3.51 percent for Construction Bank.

ICBC’s investors will be rewarded with dividends of 45 to 60 percent of net profit for 2007 and 2008, compared with 35 to 45 percent for both Construction Bank and Bank of China.

ICBC’s global IPO was sponsored by Merrill Lynch, China International Capital Corp., ICEA, Credit Suisse and Deutsche Bank

China Lawmakers Consider Extending Bking Supervisor Power

BEIJING -(Dow Jones)- China’s national legislature started deliberations Friday on revisions to the country’s banking regulatory law, a move that could broaden banking regulatory powers to include non-financial institutions and individuals, the official Xinhua News Agency said in a brief report.

The revisions could add power to China’s primary financial watchdogs, the China Banking Regulatory Commission and the People’s Bank of China.

Revisions to Chinese laws are often a long and drawn out process. China’s corporate bankruptcy law was approved in August by the Standing Committee of China’s National People’s Congress after 12 years of drafting and deliberation.

China’s Spending on Research and Development Growing Faster than U.S.

While the United States still has a bigger share of the global R&D market, second-ranked China is gaining ground.

U.S. companies are falling behind on research-and-development spending, while their Chinese counterparts have upped their investments in recent years, according to a new report.

The study, conducted by R&D magazine and Battelle, a Columbus, Ohio-based research firm, could spell trouble for small businesses that benefit from local R&D activity.

This year, the United States is responsible for 32.4 percent of global R&D, but that number is down slightly from 32.7 percent in 2005, and is expected to drop to 31.9 percent in 2007.

China ranks second for most dollars spent, and while it’s only responsible for 13.4 percent of the world’s R&D, Battelle projects that number will rise to 14.8 percent in 2007. The percent changes may be small, but on a global scale, they translate into large figures — R&D magazine reports that global spending on R&D topped $1 trillion in 2006.

“There still is a considerable gap, but it’s closing,” Jules Duga, a senior Battelle research scientist and co-author of the report, said in a statement.

Chinese growth has been fueled by the liberalization of Asian economies and the ongoing development of a highly educated, technology-oriented population, according to Battelle.

The report explains the results in terms of an evolution in international competition: After the global arms race subsided, focus shifted to a “hands race” for lower-cost manual labor. Now shifting once again, the world is entering a “head and brains race” for technological advancement.

Falling behind in the “race” could have a negative impact on small businesses in the United States. Earlier research has shown that small-business formation and growth is directly linked to local R&D.

A 2002 study published by the Small Business Administration showed that communities with larger amounts of university R&D activity are home to more start-ups, and those companies significantly benefit from R&D during their early stages of growth.

This is due in large part to a “spillover effect” of knowledge and technology to the surrounding area.

The SBA research found that there is generally a two-year lag between the year of R&D expenditure and the spike in the launch and growth of new firms, during which the spillover takes place. That means that universities, government laboratories, and corporations need to consider changing trends of today in order to protect the vitality of small businesses in the future, according to the SBA

“These challenges can be accommodated only by long-term strategic investment and will,” Duga said.

Ex-Motorola China head joins Pepsi to sell cola

SHANGHAI (Reuters) – Former China president of mobile phone maker Motorola Inc. Daniel Shih has joined PepsiCo Inc. to help the U.S. company to sell its cola products in China, industry sources said on Thursday. Shih is now the president for Pepsi’s beverages business in China, two sources familiar with the situation told Reuters, a market where Pepsi is facing tough competition from its U.S. rival, Atlanta-based Coca-Cola Co.

Shih, a Taiwan-born Amercian, joined Pepsi before the week-long Chinese National Day holiday last week and will report to Zhu Huaxu, current China chairman of Pepsi, the sources said.

“Shih will be working very closely with Zhu and finally Shih will take over all Zhu’s posts, becoming his successor,” said one Beijing-based source close to Pepsi.

Shih, who left Motorola late last year, will take over Pepsi’s China operations in the second quarter of 2007, when Zhu plans to retire after working for Pepsi for nearly a decade in China, the second source said.

Multinational corporations, from global banks to toy makers, have poured tens of billions of dollars in the past few years into China, the world’s fourth-largest economy where personal savings have reached a total of roughly $2 trillion.

Global chief executives have long complained that a shortage of senior industry talent may be the biggest challenge that companies face in China. Foreign firms see China work experience and language skills as vital when hiring senior executives.

The first source said Pepsi’s Zhu first brought up the idea of retirement with management late last year, after which Pepsi began to cast around for a successor.

“Pepsi is a big multinational corporation in China, so it needs some time to assure the handover … will be done very smoothly,” said the source, adding that profit margins in China’s beverage sector may be larger than in its electronic industry.