With a history of five thousand years and an infinitely rich cultural and artistic heritage, China’s art treasures hold a tremendous appeal to art collectors all over the world. But while art collecting may be a pastime of the rich, it is big business to the international auction houses eyeing the opening Chinese market.

The art auctioning industry is one of the most restricted ones in China. In fact, even local Chinese auction houses were not allowed to operate for three decades under the communist rule, and art auction houses did not exist in Communist-ruled China until 1992, when the art market was partially legalized.

Currently foreign auction houses are not allowed to organize auctions on the Mainland and are therefore restricted to operating out of Hong Kong and Taiwan. Strict export controls also hamper the opportunities of foreign companies, with laws preventing all art works from the Qianlong reign (1736-95) and earlier leaving the country.

Because of these restrictions, the market for Chinese art is to a large extent a domestic market. Chinese auctioneers have been quick to exploit this protectionism. According to the Chinese Auction Association a large number of Chinese auction houses are making impressive profits, with return on investment of around 300-400% not being uncommon. At the same time, Chinese auction houses openly admit that they lack the experience and operational skills of houses like Christie’s and Sotheby’s.

With this background it is easy to see why the large foreign auction houses are viewing China as one of their major potential growth areas. Like in many other industries, the foreign players are hoping that WTO-related policy changes will open up the market.

Despite of the lack of liberalization, several foreign auction houses have already begun to establish themselves in China, and experts predict that this trend will increase in the coming years, despite unclear signals from the Chinese government regarding the relaxation of policies that govern the auctioning of art works. Christie’s and Sotheby’s both have representative offices in China, but given that they are not allowed to organize auctions they are restricted to providing information to art buyers, sourcing art works, and offering telephone bid services to local art buyers.

In the meantime, the large auction houses have to be satisfied with selling Chinese art works in Hong Kong and other locations. The success of these auctions indicates the opportunities that China will offer to international auction houses in the future: In the latest Sotheby’s auction, a set of imperial seals from the Qing dynasty (1644-1911) was sold for a staggering HK$29,182,400 (US$ 3.8 million), a world record for imperial art from the Qing dynasty.

Once a year in January, international politicians, chief executives and journalists meet in Davos, Switzerland for the World Economic Forum, discussing the most important current economical and political developments.

As such, the forum serves as indicator, showing which trends and topics have the greatest influence on the global economy. Whilst the Iraq war dominated the 2003 talks, China was the subject of numerous discussions at this year’s meeting (Jan 21-25). No matter the topic, be it the strength of the Euro against the US$, Japan’s economic recovery, innovations in hi-tech, or unemployment problems in the United States and Western Europe, the simple answer for most of the key questions simply was “China”.

Often discussed in a contradictory manner, was the question whether China is a threat or an opportunity for the rest of the world? Since its opening in 1979, the Middle Kingdom has been attracting FDI (Foreign Direct Investment) with increasing pace, so far FDI totals up to US$ 500 billion. According to the Chinese Ministry of Commerce, the country approved more than 41,000 foreign-invested firms last year, representing a 20 percent jump from the previous year. With its low-wage labor forces, China seems to be drawing jobs from all over the world. Whilst this had been limited to jobs in the manufacturing field in the past, international companies have started recently to outsource R&D as well as service jobs to China.

On the other hand, China is serving the world as an economic motor: China’s imports are constantly growing faster than its exports. This is especially true for China’s Asian neighbors such as Korea or Japan.

Another main topic at the Forum was the danger that China’s economy is overheating. In the opinion of many experts, China’s continuous economical growth of more than 8 percent will lead to rising inflation. Although inflation rate has been stable in 2003 (1.2 percent), a few sectors such as automobile, steel, and real estate have overcapacities due to excessive investments in the past years.

However, most investors remain bullish about China. A study by Goldman Sachs which was released at the Forum predicted that China would overtake the United States as the world’s largest economy by 2041. Germany as number three might already be overtaken within this decade.

One of China’s most dynamic regions is the Southern province of Guangdong. With its economic centre, namely the Pearl River Delta, the province is the engine of China’s economic growth and has developed into the country’s most important export base. 36 percent of China’s exports worth US$ 118.5 billion have been produced here in the year 2002 - the majority of these exports originate from OEM enterprises (Original Equipment Manufacturing).

Guangdong is also the home of a large number of private companies, many are foreign invested. Last year, foreign invested companies accounted for 63 percent of the province’s industrial output; the biggest investor is the neighbored Hong Kong.

Taking all this into consideration, it does not appear as a surprise that many huge retailers can be found in the region. American retail giant Wal-Mart for instance has opened a global sourcing centre in the Pearl River Delta two years ago. In 2002 Wal-Mart was sourcing Chinese products worth more than US$ 10 billion through this center. Other multinational retailers such as Metro, Ikea or Carrefour can be found in the region as well, all of them satisfying their global demand of low-price finished products.

However, not only retailers are sourcing from China, multinationals like General Electric, Siemens, Du Pont and Bosch also have well established China sourcing operations, and medium- and small-sized companies from the United States and Europe are the new wave nowadays. Given the advanced globalization and the related cost pressure, these companies often face a simple imperative: Outsource production abroad and take advantage of China’s abundant manufacturing base or loose out to your rivals in Europe, the United States, Japan or elsewhere.

In addition to its low industrial wages, China’s manufacturing sector has made substantial productivity gains (improved infrastructure, increased automation) and shows a higher product sophistication being achieved by a better trained workforce and imported technology.

Another precondition is the trend from ‘made in…’ to ‘made by…’ - The company label is getting more important than the product’s local origin, enabling Western companies to move production to contract manufacturers in low cost countries. The pioneers of this development were sport shoes, garment manufacturers, and the computer industry, which are all supported by contract manufacturers (local and foreign owned).

The result is a perfected division of labor whereby the internationally recognized company specializes in developing and selling products and cuts out the actual manufacturing process.

As China has moved up the value chain, now an increasing number of manufacturing companies in the technical field follow this trend: They are buying parts and components in China (partially at substantially lower cost) that flow into the manufacturing process in their home country. This approach is predominantly being used by machinery and equipment manufacturers and by companies looking for protection of their IPR.

This new trend can directly be been seen from the structure of Chinese exports: In the first ten months 2003, China’s machinery and electrical equipment exports grew by 42.1 percent, exports of hi-tech products (including components and semi-finished products) by 60 percent.

Several ways exist for these new entrants to engage in sourcing activities in China: Setting up of operations is generally not necessary, a China sourcing can also be conducted directly by headquarters, for example through regular sourcing trips to China, visit of Chinese fairs or with the help of an external agent.

This might be an easy and comparatively cheap solution for sourcing finished products like toys or textiles. However, if a company is sourcing components and semi-finished products from China which are flowing into the manufacturing process in the home country, quality control and assurance gain a greater importance.

One possible solution to deal with this challenge is the setting up of a representative office in China. In order to ensure the compliance to the company’s quality standards, an employee from the home country (e.g. an engineer or a member of the purchasing department) can be stationed at the representative office.

Supported by a Chinese speaking staff, this employee then serves as an interface between the mother company and the Chinese suppliers. Most importantly, the representative office is responsible for a constant quality control (through factory audits and regular inspections) and can also handle technical difficulties arising during the production process. Additionally, a representative office provides a foreign company with first-hand China experiences, information and business contacts. These are valuable, especially if sourcing is only the first step to the Chinese market and a mid- or long-term expansion of the China operations is planned (e.g. manufacturing/sales in China).

Although the representative office can also search for new suppliers and establish first contacts, a number of Western companies prefer to separate the supplier search from their China operations and conduct this task on their headquarters. The reason is that they try to avoid fraud which might happen with private dealing of the subsidiary and suppliers.

China representative offices are never allowed to conduct business themselves - ordering, signing of contracts and arrangement of payments thus need to be coordinated and carried out by the headquarters or a trading company.

The registration of a representative office takes place at the local authorities and, depending on the province, takes about 2–10 weeks for the whole process. A China representative office can already be realized with a couple of thousand Euros.

In some cases the foundation of a Hong Kong trading company is complementary to a China representative office. This trading company then takes over the contractual relationships with the Chinese suppliers, arranges the payment of goods and coordinates the shipment.

Choosing Hong Kong as a port of call provides Western companies with a safe economic and legal business environment, experienced English speaking staff, and an extensive logistic and services infrastructure. However, the most interesting aspect for Western companies is tax advantages for exports from China: Profits resulting from offshore business are tax-free (Supplier and Buyer are situated out of Hong Kong).

According to its WTO pledges, China will begin granting foreign trade rights to majority-foreign owned companies by this year. For wholly-owned foreign trading companies, the import and export business will be allowed one year later.

Currently, trading rights are only granted to foreign minority joint ventures. But many investors are reluctant to set up joint ventures with Chinese partners, due to differences in long term planning and problems in decision making. To date two possibilities remain for those companies: Working through Chinese middlemen in China is always connected with additional costs and a loss of time. An alternative is the setting up of a 100% owned company in a Free-Trade-Zone, but compared to other locations, Free-Trade-Zones have substantially higher costs.

With the regulations now being due to change, foreign companies are preparing their market entry/expansion in China’s international trading sector. China is already the world’s fifth largest trading nation, and the US$ 540 billion trade sector has seen an average annual growth rate of 20% during the last four years – no surprise that numerous foreign trading companies are eager to enter the market which is currently in the hand of large domestic state-owned companies.

Within this background, it is expected that foreign companies will increase their investment in China’s trading sector, either buying into the market and acquiring domestic companies, or increasing their share in existing Joint Ventures.

However, the new regulations haven’t been released yet, and one has to wait which requirements will be connected to a license in detail. For instance a high minimum investment or the requirement of an existing China investment could limit the attractiveness of the new regulations for many companies.

Whilst foreign trading companies are waiting eagerly for the publication of the new regulations, domestic trading companies, especially small- and medium-sized ones, are concerned that competition in China’s trading sector will get rougher. The situation is quite tense already, as mainland traders have to cope with the recent reductions of export tax rebates. Analysts therefore not only expect M&A deals with foreign involvement but also mergers between Chinese traders, trying to cope with the upcoming challenges.

Thanks to CEPA (Closer Economic Partnership Arrangement), Hong Kong and Macao service companies are enjoying a head start in China’s international trading sector: Effective January 1, 2004, the central government has given green light for them to conduct import & export business in China through wholly foreign owned trading companies. Additionally, Hong Kong and Macao service companies enjoy preferable licensing requirements.

Li & Fung, one of Hong Kong’s biggest trading companies, was the first to announce that its 100% owned Chinese subsidiary had secured a license to export goods directly from the mainland.

A far reaching structural change of China’s trading sector is ahead – it can be expected that the market will be very dynamic over the next few years. Western companies in China should watch out attentively for the future development of the market. With opportunities and interesting alternatives ahead, investment and business models which have been the optimum solution until today, might be under pressure in the near future.