European Investment In China - Past Performance & Future Trends

Source: Deutsch-Chinesisches Wirtschaftsforum - Zeitschrift der Delegiertenbüros der Deutschen Wirtschaft in China
Date: 01 September 1999

Fiducia Beijing, Hong Kong, Shanghai, Shenzhen

Why are some companies successful in the Chinese markets whilst others are not?
In what way are these companies different from each other?
What are presently the operational conditions form foreign companies in China?

With the support of the Delegation of the European Commission in Beijing and the Embassy of the Federal Republic of Germany in Beijing we recently conducted a survey among European managers in China to find answers to these questions.

Even though there is no ideal approach to a China investment, this analysis reveals certain success factors from which fundamental recommendations may be derived.

Judging the results of FDl in China is a difficult issue as the players (both companies an the individual managers) have much at stake and may not want to admit failure or that mistakes were made (loss of face also exists in the West).

However, we believe, especially in a country like China, that it is important to discuss issues critically, to learn from one another.

In order to obtain (as far as possible) an unbiased picture, we adopted the same method as in the first survey, by conducting the survey in complete confidence, i.e. both the respondent's name and the company is unknown to us. The survey thus reflects the opinions and experiences of managers heading operations in China.

This year's survey deals in particular with issues related to the companies' market position, performance, challenges, solutions etc. We hope that this publication helps to increase the degree of transparency, serves as a benchmarking tool and as a useful reference manual.

For a company with international activities, the question is not whether one should be in China but, rather, in which form. One needs to be present to be part of the fast moving economic developments and Chinese companies are strengthening their international presence ‑ also in our traditional markets. It is easy to criticize China, but we need to acknowledge that: Beijing's smooth handling of the Asia crisis has been impressive. China realizes that she cannot hide behind a firewall any more, and problem areas are being recognized and publicized. There is more transparency and criticism. China's commitment to reform remains, but the potential danger for negative developments requires the government to ran a stop‑and‑go policy to prime the economy‑, to fight corruption; to reform the banking system; cut unproductive labor force; to reduce over production; etc., etc.

The Economy

The Government's current policy is: As much reform as possible ‑ but stability must be maintained. In this scenario there is not much room for the concerns of foreign investors.

Current issues:

China is moving from a shortage economy (where it was easy to find investment projects) to a surplus economy (with excessive production). Also, lower consumer spending (due to the initial demand being satisfied, wage cuts, unemployment and reallocation of funds) poses the question: How can China stimulate the economy in this scenario?

Also, foreign companies suffer from the "surplus economy'. "Imports" via South China have been a major issue in the past. Now the anti‑smuggling crusade has an impact. The big trusts are probably substantially understating the weaknesses in their portfolios and there is thus stiff a lot of uncertainty. Government bailouts are not guaranteed.

The development in telecommunications was astonishing From having had no telephone at home for decades the people jumped into the final step of technology development: owning a mobile phone (Beijing alone today has over I million users). What took generations in Europe is being achieved in China within 20 years.

The next "revolution" is probably in the Internet and e‑commerce field, which is already growing rapidly. In fact, the government, seeing the possible economic benefits, is pushing programmes to link local governments and Chinese companies to the Internet. With ISPs now providing free PCs, the Internet is becoming the fastest growing mass medium in China today.

For foreign companies this development will bring an ideal marketing toot (in local language) and help to break down the barriers between the manufacturer and the customer and will help to overcome the restrictions imposed by the size of the country.

The WTO accession will have noticeable effects: it is primarily an external push for structural reforms and the immediate beneficiary would be the Chinese customer, due to the cut in import prices. For foreign companies, we see a number of consequences: The removal of trade barriers and the reduction in import tariffs may make it less attractive to manufacture in China. Instead European companies could just sell to China ‑ also from another production base in Asia.

Conversely, companies manufacturing in China will face (unexpectedly?) competition from overseas, including Asian countries. On the other hand more barriers will tumble, once China enters the WTO, bringing about new investment opportunities. All in all a new ball game.

Anyway, within a global production network we cannot expect dig foreign companies manufacture their entire range of products in China. Thus, there is definitely scope for more trade but we need the freedom to handle imports independently and we need to find effective sales channels.

Foreign Investment - From Good Times to Challenging Times

We have clearly moved from a subjective perception viewpoint to realism where issues are addressed critically. We have moved away from the myth "China is such a big country ‑ there must he a market for our products". Many companies had to learn the hard way that extensive preparations and good timing are a strong prerequisite for success. Gone are the days when investors were determined to get into the market, did grandiose project commitments but spent little time on the basics: market study, testing the market, due diligence etc. Also, it has become clear that markets change rapidly and at a different pace within the country, demanding a mechanism for constant market observation and the ability to adjust quickly.

A case in point is the white goods industry, where foreign (including European) manufacturers entered the market with confidence and now (unexpectedly) domestic brands are pushing western companies from the market, Chinese appliance makers have learned to improve efficiency, do research and develop new models. Today, appliance makers like Haier, Kelon and Konka even export washing machines to Japan and refrigerators to the USA. Contrary to original business plans we see foreign companies now acting as OEMs for domestic competitors. This was certainly not the original plan!

It sometimes looks as if there are two Chinas ‑ one that is the dream market to be conquered and the other a bottomless money pit. In a way, both are true. There is the old China where the authorities "manage" the competition (which is not obvious to the newcomer) to protect their domestic industry They pull the strings and place demands on multinationals (e.g. telecom equipment, automotive, chemicals).

There is, on the other side the emergence of a new‑market driven China - this is especially true for consumer goods from shampoo to fast food.

All in all, today's focus is different compared to the start‑up phase. The issues being addressed more closely are personnel development, marketing and distribution, monitoring market developments, quality of the company's accounts (accounts disclosure remains weak and is, in general, nowhere near western accounting standards), cash flow, etc.

Another material development has been the improved local supply structure to foreign companies in China, often enabling them to buy from known suppliers who now have manufacturing facilities in China.

We have seen a number of failures - companies struggling with a dead end situation (wrong partner, wrong product, wrong location etc.) and the Joint Venture is now struggling to find ways out of the crisis. Foreign investors opt for executing a restructuring or downsizing programme, buying out the local partner and restarting as a Wholly Foreign Owned Enterprise (WFOE), liquidation or simply "walking away".

We wonder why so many companies opted for a joint venture with a partner who continues to manufacture products that are more or less in direct competition with the joint venture. This approach invited problems from the start, including the loss of technology through the back door. Making use of the partner's sales channels did not work, as either little actually existed (and was not discovered because of a lack in due diligence before the "marriage") or the "competing" products could not be handled by the same sales structure.

Increasingly, companies are daring to go alone because they have been plagued by poor partners and meddlesome bureaucrats. Changing a JV into a WFOE does not guarantee success. If there is no market or if the corporate structure is wrong, this change (which may be costly) will not do the trick. We need to assess the risks and potentials first, before making a decision. A new trend has emerged: joint Ventures being formed with a strategic partner instead, i.e. a Chinese company (from a different field) looking for an investment opportunity but without any interest in the partner's business.

There have been failures but also winners - who were creative, had endurance and acted smart. They have become smarter about choosing a partner, they resisted the pressure to expand too fast.

There is no perfect recipe for success but there are champions one can learn from. Whilst a thorough risk analysis may make sense there needs to be a pioneer approach. There are many issues that are factors for success but some stand out:

• Set priorities - within the big picture, be patient, but also be aggressive, adopt practices to local conditions

• Start on a small scale and go with the flow of market developments

• Have a sound monitoring system and install mechanism to handle uncertainty

• The need for a strong China team, a culture of organizational learning at the head office to share the "real world" of China business experience

• The ability to work in a complex and ever changing business environment, having shared goals, building and maintaining trust relationships

• Business in China remains a balancing act between short-term success and survival and long term autonomy - tough decisions are needed up front.

Depending on the way one looks at China there is room for:

• Optimistic views: "The current situation gives us a better negotiation position and better terms are achievable... lets use the chance and increase our stake or take over the company' and for:

• Pessimistic views: It's time to cut losses, let's forget China for a few years". There is no easy answer - there are winners and losers!

In fact, we may see a wave of newcomers who are only entering the market now. Decisions are driven by fundamentals and living learned from the first wave, these investors may be successful faster.

Contributionssons

The survey is complemented by contributions from authors with long term experience in the China business and China investment: e.g.

Cao Siyuan is well known in China for pushing for further economic reforms "within‑the‑system". Also, he was a strong proponent and drafter of China's bankruptcy law which was promulgated in 1986.

His contribution specifically deals with an issue gaining importance: Acquisition of State Owned Enterprises.

Dr Henry Wai Chung Yeung, Assistant Professor, National University of Singapore analyzed the experiences and results achieved by Singapore Companies with their investments in China. His article summarizes the findings. In short the results are that Singaporean companies encountered challenges similar or identical to European companies. There goes another myth!

We hope that this publication is useful to strengthen the knowledge of the China business environment both for companies with existing investments and those planning to invest.

Footnotes:

1 The Chinese pharmaceutical producers last year were overstocked by about US$ 2 billion (official figure) leading to an unhealthy price war; idle investments; etc. Jumping the bandwagon is popular - when a product gains popularity everybody diverts resources to produce the same.

Resume:

• 55% of the participating companies have reached the break‑even point white 45% have not (basis: companies which started investing in 1997 or before).

• Only 9% of the unsuccessful companies are satisfied with the measures adapted during the market entrance phase, compared with 38% of the successful companies.

• Unrealistic expectations, incorrect data material, insufficient preparation and an over-estimated market volume were pin‑pointed as the major risk factors (46% of the successful companies, compared with 70% of the successful companies).

• The market conditions were characterized as disadvantageous in the following areas: complicated administration and approval processes, weaknesses in the legal system, discrimination of foreign companies compared with Local companies (product approval, customs, etc.).

• Successful companies are manufacturing products in China, which comply Largely to European standards, with respect to their manufacturing processes as well as quality. At the same time, such companies are closely co‑operating with Local suppliers (also for semi‑finished products) to reduce costs. In order to reach an international quality standard they strive for enhanced human resources development programmes.

• In the participants' opinion successful companies are concentrating their activities on industries and product groups which are less affected by the competition. 75% of unsuccessful companies' competitors are Chinese companies whilst only 26% of successful companies' competitors are Chinese.

• More successful companies are implementing human resources development programmes, e.g. staff training, performance evaluation and MbO systems.