A Brave New World?

Source: Far Eastern Economic Review
Date: 05 October 5 2000

Title: Focus: China Investment
by Lorien Holland / Beijing

Foreign investors adopt a more mature and long-term attitude to building up their businesses in China

CAN INVESTORS MAKE MONEY in China? As this Focus on China indicates, the lure of China's billion-strong consumer market is greater than ever. Over the past decade, the market has attracted many foreign companies, each believing vast potential profits lay just around the corner. But those years also generated horror stories about broken contracts, counterfeiting, corruption and bureaucratic red tape, especially following the "gold rush" of 1994-97, when investors fell over themselves to get in early on China's growth cycle. As investors nursed their bruises, profits often seemed elusive.

A 1999 survey by the American Chamber of Commerce in China showed that, while 58% of its members had lower profit margins there than in other global operations, 88% had plans to expand. And this month, that hope of good things to come has been underscored by the 83-15 margin with which the U.S. Senate approved permanent normal trade relations for China.

Does all this mean investors don't want to concede that their euphoria over China could be wrong? Some prominent failures, such as a recent rout in the brewing industry, involving Carlsberg, Bass and Asimco, and the pullout by Britain's National Power, have raised just such concerns. But creative accounting can deflate the balance sheet of many a foreign-invested venture, and those who are reaping profits aren't likely to be making a song and dance over their successes. In fact, success in China may not be as elusive as it seems.

More than that, it can be shown that foreign direct investment creates a halo effect that boosts jobs in local companies. Individual firms can still encounter problems, but reforms are under way to open stockmarkets to foreign companies. And while counterfeiting is a major issue, overall it seems that China is no more risky a place to do business than its Asian neighbours. It does, however, take hard work to find basic market data.

"In current cases like the Carlsberg venture, foreigners are realizing they can't be successful in their current situation, and they have to pay a learning fee of several million dollars to exit," says Jurgen Kracht, managing director of Fiducia, a European investment consultant that has researched profitability in China.

"But that," he adds, "isn't representative of the whole market. The market is increasingly mature, foreign investors are also more mature in their expectations towards China, and we see a lot of positive signs for the future."

It's also true that for most large foreign companies, a China presence is only a small part of worldwide investments, so there is no major pressure from overseas shareholders who might have unrealistic and impatient expectations of the China market.

GETTING IT RIGHT

Wang Zhile, a professor at the Chinese Academy of International Trade and Economic Cooperation, is one of the few people around with hard numbers-- he has done case studies on 250 foreign-invested enterprises in China and written three books on the topic. About one-third of the 354,000 foreign-invested companies in China currently turn a profit, he reckons. That figure rises when the sample is restricted to large multinationals that have spent time and money--and have the political clout--to get their ventures right.

To be sure, issues of corruption, a shaky legal system and infuriating bureaucracy have undoubtedly played a large part in shattering many dreams. But Wang pinpoints the mid-1990s gold rush into China as being itself one of the biggest obstacles to profitability. With most of the world's multinationals flooding into China at the same time, each company's market research showed large potential but didn't take account of competitors who were also looking to enter the market. The result was excess capacity, fierce price-cutting and a slow realization that China's immense market was in fact subject to strong regional protectionism.

"There were American and European and Japanese companies all in direct competition, and that created a unique scenario, which was good for research into comparative management and business techniques, but didn't do much for profitability," says Wang. "Especially those who put in second-grade technology or management found it very hard to survive in the tough competition."

STRONG LOCAL RIVALS

Those high-profile investors that lost out include the French car maker Peugeot, American white-goods maker Whirlpool, a DaimlerChrysler truck venture and Australian brewer Foster's. Their failures, coupled with the Asian financial crisis, meant that a sharp dose of reality hit many boardrooms around the globe, and the special treatment previously afforded China was replaced with a scramble for efficiency and profitability instead of market share. New foreign investment also fell off sharply, as companies waited for new concessions to come with China's entry into the World Trade Organization.

But the stiff competition didn't just come from other multinationals. In sectors like white goods and brewing, a handful of local companies such as Qingdao Brewery, air-conditioner maker Kelon and refrigerator maker Haier developed into efficient businesses themselves as they learned from their foreign rivals and turned being local into a strength.

Says Zhang Ruimin, president of the Haier Group: "For foreign companies, China remains that last big frontier; but we are already well known here, and we know the market too. So as long as we learn from multinationals and keep up our quality standards, we can have certain advantages." He points to local companies' better access to distribution networks and connections within China's rambling bureaucracy.

In fact, the Chinese government's favourite maxim as far as its domestic companies go is to "study, cooperate, compete," against foreign enterprises in China in order to build economic strength. Beijing fiercely promotes hi-tech transfers and overseas training programmes offered by foreign investors, in order to get its domestic firms up to speed.

The government has also grown more comfortable with foreign-funded enterprises, which accounted for 12% of China's industrial output in 1997, double the share for 1993. By last year, that figure had risen to 17.8%, and while leftist politicians still protest against the opening up of China to "foreign capitalist-roaders," their views continue to lose ground--as did opposition in the United States to Japanese investment during the 1980s.

"The domestic perceptions of foreign investors in China are changing. People see that they are not just a cash cow and that they are not going to ruin local industry, and that with their factories and technology here on the ground, they are part of a stable and successful China and are beneficial to national security," says Wang.

Just as importantly, foreign-invested companies provide a hefty chunk of tax revenue for China's lean state coffers. In Beijing last year, typically they each contributed 6.1 times more tax than their local counterparts. Nationally, tax revenue from foreign-invested companies rose 29.5% in the first half of the year, compared with an average increase of 20%.

The impact of foreign-invested ventures on China's economy is likely to be even more marked when China's entry into the WTO unleashes cheaper imports, opens distribution to foreign investors and prompts a raft of new investment in previously closed service industries.

This, coupled with major financial and structural reforms that Beijing is now pushing ahead, has prompted Stephen Roach of Morgan Stanley Dean Witter to become "extremely bullish on China." This has clear echoes of the oft-quoted "maximum bullish" outlook that Morgan Stanley analyst Barton Biggs gave China back in the mid-1990s gold rush.

"There is a significant improvement in the cyclical outlook, an accelerated pace of reforms and there will be a post-WTO bonanza of foreign direct investment into China," says Roach. "On this latter count, I believe that current conditions are very different than they were in the mid-1990s . . . as China has made the decision to be an active and full participant in the process of globalization and it needs two-way flows to make that happen."

That, of course, does not overcome huge gaps in corporate governance, instances of government interference and corruption, and a growing problem with counterfeiting. On the other hand, big investors in China are not looking to make a quick buck and then jump ship. The American Chamber of Commerce's survey showed that 87% of its member companies came for the market's size and its potential, and that potential still needs time to develop. "You can't pay for your kids to go to primary school and then expect an immediate payback on your investment," says Justin Yifu Lin, director of the China Centre for Economic Research at Peking University.