Doing Business In China: How to Profit in the World's Fastest Growing Market by Ted Plafker

From the Publisher

DOING BUSINESS IN CHINA offers the definitive user-friendly handbook of tips and insights on the top opportunities in China, currently the world's fastest growing market, from selling and marketing techniques to laws, rules & regulations, pitfalls to avoid and much more.

Every day the financial news media discusses the business world's biggest story - China is emerging as the world's next great superpower. American businesses need to understand this emerging market and DOING BUSINESS WITH CHINA provides the easy to follow advice vital to success in the 21st century. Sections in the book include:

Pinpointing the Top Emerging Markets: An overview that every investor will want to read - promising sectors include agriculture, automotive, biotech, financial services, media, retail and more.

Laws, Rules & Regulations: It's hard to imagine a more complicated legal landscape than China's, in which fast moving reforms make it tough for foreign business to keep pace. This section explains how to do that.

Understanding Cultural Differences: Vital topics include "Basic Communication,""Talking Politics,""The Little Things," and more.

Sales & Marketing: Whether it's selling to customers or government procurers, some of the basic maxims of selling and marketing are different when doing business in China.

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Doing Business In China

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Chapter One

With all you've read and all you've heard about the China boom, you might be tempted to think you could just show up in Beijing or Shanghai, pick a sector, hang a shingle, and start turning over deals. And true enough, business is booming across a wide variety of industries in China.

For just about any commodity or product or service you can think of, you can dig up numbers that show jaw-dropping growth in recent years. And even after weeding out all the most breathless and overstated predictions about China's prospects, you will still be left with plenty of confident-and perfectly plausible-predictions of sustained growth for the foreseeable future.

In short, while the China boom is sometimes the subject of exaggerated hype, it is not a fiction. For a few examples of the kind of attention-getting raw numbers you sometimes encounter, consider these:

China recently budgeted for the installation of eighty-one gigawatts of new electrical generating capacity in a single year. This addition to China's existing grid is more than the entire installed generating capacity of the United Kingdom.

After rising by 18 percent in 2005, the number of Chinese Internet users rose an additional 23 percent in 2006. By early 2006, it had surpassed 137 million. That's well more than the entire population of Japan, and about the same as the combined populations of France and Egypt. Yet it still represents a penetration rate of just 10.5 percent.

And for some truly mind-blowing numbers, how about these: China already has 461 million cell phone subscribers. The customers of just one carrier, China Mobile, paid good money to send some 203 billion short text messages in the first half of 2006.

If you think it's just high-tech, you're mistaken. In 2005, China's chemical fertilizer industry saw a 64 percent surge in profits. Chinese imports from Brazil of the humble soybean have increased more than 10,000 percent in the last decade.

Upon seeing these sorts of numbers-and there are plenty more like them-it can be easy to lose perspective. But apart from the sheer size and growth rate of any given sector, there are other things that you need to take into account. Some sectors are already relatively mature, leaving little space or market share for new entrants. In other mature sectors, entry is wide open, but cutthroat price wars pose a constant-and for some players insurmountable-threat to profitability.

In other areas, barriers explicitly work to the disadvantage of foreign firms. This is despite the sweeping open-market commitments China made when, after more than a decade of painstaking multilateral negotiations, it finally joined the World Trade Organization (WTO) at the end of 2001.

In retailing, for example, China has largely honored its commitments at the national level to allow foreign firms to open stores anywhere they choose. But many local authorities maintain their own planning and development policies, and can throw up vague or arbitrary restrictions of their own.

Foreign companies in other sectors will have difficulty gaining a foothold not because of explicit discriminatory barriers to entry, but because the lay of the land simply favors local competitors. Through their connections to local bureaucrats, Chinese firms often enjoy huge advantages in their access to land, bank credit, or even scarce supplies of power and water.

Obstacles can also emerge in what the government regards as strategically sensitive sectors. The best example of this may be telecoms. Driven by security concerns over this vital element of national infrastructure, the government has been slow to throw things open to the market and scale back its regulatory supervision of telecoms. As a result, the industry's nominal regulators remain very much involved in business operations themselves, leaving other firms, whether Chinese or foreign, in the unenviable position of trying to compete with the same bureaucrats who control their fate.

THE BEST AND BRIGHTEST

This chapter outlines eight of the sectors with the highest potential in China-ones that look certain to show continued growth, and that also have a demonstrated capacity for profitable foreign participation. Some of the industries listed here, such as telecoms and media, do suffer from the drawbacks already described. Given their size and upside potential, however, they make the grade anyway.

There are likewise plenty of moneymaking opportunities in other areas. Agricultural and food products could easily have made the list. Educational services are booming, as are travel and tourism. In these areas and many, many others, foreign players can access significant competitive advantages over local rivals and sell successfully in the vast China market. Nor is there any shortage of areas in which foreign businesses can come to China and achieve significant cost reductions in their supply or processing operations.

Some of the issues covered here in the context of one industry also apply in others. One example is the section on biotech, which discusses some of the pros and cons related to moving R&D operations to China. Many of those same considerations are equally relevant to anyone weighing such a decision in the chemical or IT industries.

Two other sectors-retailing and manufacturing-are among those with the greatest potential of all. But since they are covered in considerable depth in chapter 4, "Sales and Marketing," and chapter 6, "The China Price," respectively, there is no need to include them here.

Taken together, these sectors cover the vast bulk of the China business scene. So whether or not your business falls directly within their scope, it will be well worth your while to learn more about them, and about the unique peculiarities-be they bright spots or pitfalls-of each one.

Lastly, though it should hardly need saying, let's say it anyway: None of the areas listed here is a guaranteed gold mine. Plenty of foreign companies have already tried and failed in each. But they do represent eight of the biggest opportunities that foreign companies can exploit if they are properly positioned to begin with, and if they go about it in the right way: carefully, rationally, and forearmed with the necessary knowledge and understanding.

1. The automotive sector

2. The biotech and medical sector

3. The chemical sector

4. The construction and infrastructure sector

5. The energy sector

6. The finance sector

7. The IT/telecoms sector

8. The media and entertainment sector

Start Your Engines: The Automotive Sector

It is hard to think of another sector that has had as great an impact on China-for better and for worse-than the automotive industry. Ribbons of new superhighway now crisscross the land, and hordes of passenger cars clog the streets of Chinese cities (while their exhaust fumes, of course, clog the air).

Car ownership has become a common dream of China's emerging middle class. Whether in glitzy downtown showrooms or vast open-air car markets on the edge of town, you can watch the seduction happening up close as newly prosperous Chinese families wander around admiring the lines, kicking the tires, checking out the interiors, and leafing through the glossy brochures. Chinese yuppies are discovering both the hassles of urban commuting and the joys of weekend road-tripping. The once ubiquitous bicycle is going out of style, and the once unimaginable fast-food drive-through window is coming in. In short, "car culture" is now in full blossom in China, presenting foreign business with enormous opportunities.

Many Westerners-all too familiar with the dark side of car culture-have wondered why China would choose this path. Rather than make the same mistakes that so many other countries have made, wouldn't China be better off investing in mass transit instead of highways? Wouldn't cities (and waistlines) across China be better off if people were encouraged to keep biking, as they had been doing for decades? Seeing how their embrace of the car has led so many developed countries to oil dependency, polluted skies, and urban sprawl, why would China want to follow suit?

Well, the central government had its reasons, and it had a plan. These policy makers understood perfectly well that the advent of the car would transform China's landscape. But they also knew it had the power to transform the economy, which was exactly what they wanted. In the early 1990s, China's central government resolved to establish carmaking as a so-called Pillar Industry, one that would-on its own-serve as a central support for dozens of others.

With this single decision to nurture the automotive industry and make private car ownership commonplace, China hoped to provide economic stimulus, create jobs, and boost growth in industries like steelmaking, glass, rubber, energy, and construction. These in turn were expected to stimulate higher demand for the extraction and processing of related commodities, such as iron ore, aluminum, cement, and more. On top of it all, there would emerge an entire automotive service sector ranging from gas stations, repair shops, and car washes to dealer and distribution networks, along with the car financing and insurance industries.

The logic seemed to make sense at the time, and it has largely panned out in the years since. China has already become the world's third largest car market, after the United States and Japan, and that has been achieved with relatively tiny penetration rates. By 2006, China had just eight passenger cars per thousand people. That compares with rates ranging from four hundred to six hundred per thousand among developed countries.

With numbers like that, it is not surprising that just about all of the world's major carmakers have already made their way into China, and some have laid down multibillion-dollar bets for their place at the table. The "must-be-in-China" logic is probably more compelling in this sector than any other.

As global majors have paired up in joint ventures with the biggest and the best of China's local producers, overall quality standards and competitiveness have gone up. Their higher demands have in turn forced improvements in the quality standards of Chinese parts producers-so much so that foreign firms that have thus far hesitated to source parts or components in China because of quality concerns should now reconsider.

Another direct result of increasing competitiveness is that China's highly fragmented car industry is facing sharp pressure to consolidate. At the end of 2005, China had 145 vehicle producers and more than forty-three hundred parts manufacturers. These were joined by nearly eighteen hundred more automotive enterprises engaged in activities such as engine production or vehicle refitting. Those numbers used to be even higher. In recent years, the least efficient and least viable firms have either failed or been gobbled up. A very high proportion of the remaining players still lack the scale, the capital, or the management and technical expertise they need to succeed, and no one doubts that coming years will see a dramatic further paring down of the number of firms.

Therefore a vital first step for any foreign player involved in any aspect of the automotive business in China is to cast a realistic and skeptical eye over all potential suppliers or partners. Simply put, do they have what it takes to survive the massive cull now under way in this industry? The right answer to that question up front can help you avert costly false starts and disruptions down the road.

One very predictable consequence of the vast overcrowding in the Chinese automotive sector has been lower prices and thinner margins. The undeniable long-term potential of this market means that all the foreign firms now piling in are probably right when they conclude that they need to be in China. But there is also an undeniable reality at this stage: Profits are not keeping pace with the skyrocketing sales numbers.

Passenger car sales in China in 2005 totaled nearly four million units, a 21.4 percent increase over the previous year. But with so much aggressive price cutting, that translated into just a 1 percent rise in sales revenue. Taken together, it added up to a 30 percent year-on-year decline in profits. (Motorcycle manufacturers, with a modest 5.5 percent increase, were the only segment of the industry to see any positive profit growth in 2005 at all.)

The message for foreign players in this field is clear: You may well need to be in China in these early stages to establish your presence, build market share, and simply avoid missing the boat; but you will need patience when it comes to seeing payouts. Most analysts are confident that overcapacity and downward price pressures will remain a part of the China car story for a long time yet to come.

Riding Shotgun in the Auto Sector

Chapter 4 will talk more about the peculiarities of marketing cars in China. But regardless of how the winners and losers shake out among the global majors now in the driver's seat, China's automotive sector is also generating plenty of opportunities for anyone willing to ride shotgun across a range of related products and services.

Demand for electronic navigational services, for example, has begun to take off. Satellite-based systems are already widely available and increasingly popular across China. So-called location-based system (LBS) services are also emerging, which use the ability of cell phone networks to pinpoint a driver's location and provide navigational support. Worth about $28 million in 2005, China's LBS market is expected to reach three hundred cities and mushroom to a value of $656 million by 2008.

Auto financing is another field with strong potential. Currently only about 10 percent of Chinese car buyers take out loans for their purchases. China will take a long time to reach the 70 percent level that is common in more developed markets, but there is no doubt it will be moving in that direction.

One reason for the difference is China's greater general aversion to consumer borrowing. Unlike the vast numbers of Americans who are perfectly comfortable with the "buy-now-pay-later" ethic, many Chinese remain reluctant to take on debt, especially for discretionary purchases. But this traditional attitude is already showing signs of changing.

Another factor has been China's poorly developed systems for tracking credit histories and evaluating risk or creditworthiness. Largely because of those shortcomings, the early entrants into Chinese car financing have not fared well. But those systems are now developing and, as they do, the volume and profitability of car financing can be expected to climb. While many major foreign carmakers have already been allowed to establish financing subsidiaries of their own, regulations for the most part restrict them to operating in a single location. The field therefore remains very much open.

Opportunities abound in still other related businesses. For example, China's State Environmental Protection Administration (SEPA) issued new regulations in 2006 mandating tough recycling and recovery standards for the end-of-life disposal of old cars. Material recovery rates that now stand at around 20 percent are to be lifted to 90 percent by 2017. China is likely to need a good deal of foreign technology and expertise before it gets anywhere close to that goal.

Then there are the less obvious opportunities. A great example of an American firm that found an imaginative, if roundabout, way to tap into China's burgeoning automotive sector is eChinaCash. Chaired by Peter Norton (of Norton anti-virus software fame), the company has partnered with Sinopec, China's largest gasoline retailer, to run a customer loyalty program based on a gas card.

The idea is simple enough. Customers prepay to store value on their cards, which they use to buy gas and earn award points across Sinopec's vast nationwide network of thirty thousand outlets. EChinaCash gets a tiny slice of each transaction. Sinopec, meanwhile, gets the benefit of streamlined management of its cash receipts and a valuable mechanism for generating customer loyalty.

But Norton, describing the venture in eChinaCash's sleekly furnished office in central Beijing, grew more animated as he came to the heart of the matter. "There's all that data," he said, "with its potential for data mining, and of understanding your customer better, servicing him better, marketing the right things to him, finding out who's buying what kind of gas, what kind of volumes. Are they moving around, very mobile? Or are they buying everything in the same neighborhood?"

Analyzing that data, eChinaCash works with Sinopec to build cross-brand and cross-sectoral marketing campaigns. In essence, it functions as Sinopec's internal marketing department. In Norton's mind, it all comes under the rubric of bringing Western expertise in "advanced consumer capitalism" to a huge Chinese enterprise that badly needs it, and doing it at just the right moment.

(Continues...)

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Excerpted from Doing Business In China by Ted Plafker Copyright © 2007 by Ted Plafker. Excerpted by permission.
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