Anniversary Publication Series | Part 2/3: Localising Your Production in China
Amid geopolitical tensions with the United States and the impact of the global pandemic, China sought to stabilise its economy by focusing on its domestic market and incentivising companies to produce locally “in China for China” (ICFC).
Despite the growth opportunities for our Clients already operating in China, recent policy shifts, such as the Dual Circulation Policy, coupled with the significant challenges posed by China’s zero-COVID strategy are leading them to question future growth.
In the second part of our anniversary publication series, we explore strategic options for international firms to seize opportunities of producing in China.
1. A Shift Towards Local Manufacturing
Policy Changes Affecting FIEs
Key to the goal of greater self-reliance is the Chinese government’s Dual Circulation Strategy, the emphasis of which is on domestic production and consumption as the catalyst for growth and stability.
This policy consists of two circular economies that aim at increasing resilience against external disruptions. The internal circle focuses on strengthening the domestic market by:
- Increasing the role of consumers by enabling greater access to e-commerce.
- Fostering technological focus through dedicated clusters (e.g., Greater Bay Area).
- Pushing for “Made in China 2025″ to improve the technological level of locally produced content.
The external circle refers to China’s cross-border economy through:
- Integration through trade agreements such as the Regional Comprehensive Economic Partnership (RCEP).
- Economic reforms and liberalisation.
- RMB internationalisation.
The focus on self-reliance is evident in local content requirements – measures that limit market access for imported goods and promote the development of local brands. For instance, if we look at China’s growing healthcare market, we see an increase in locally produced medical devices. For many industries, localised production and sales – “In China For China” (ICFC) – becomes progressively the only viable approach to stay competitive in the mainland.
However, the government is not closing doors to foreign investment. FIEs in “encouraged industries” can be incentivised through tariff exemptions on imported equipment, lower corporate income tax, relaxed regulation of land use and access to preferential land prices.
In the Dual Circulation concept, domestic and international economies are connected through special economic zones, which includes Free Trade Zones, bonded warehouses, and special administrative regions such as Hong Kong. These areas play a key role in attracting foreign investments into China.
Taking a regional approach
First-tier cities are often favoured by FIEs looking to expand in China. However, many businesses are expanding successfully in lesser-known regions. Each offering a unique set of pros and cons, the suitability of a 2nd tier city or a special economic zone must be analysed against the specific needs of your business.
Special Economic Zones are a popular choice for foreign companies in China for many years. Offering numerous benefits such as tax advantages, simplified administration, and good infrastructure, manufacturing companies often leverage these zones to gain flexibility and efficiency with their inbound and outbound logistics.
Free Trade Zones (FTZs) are particularly attractive as they offer custom duties and VAT exemptions, with FTZs in the Greater Bay Area, Shanghai Lingang and the Hainan Free Trade Port among the most popular areas as they are in a strategic geographical location, fully integrated into a highly effective supply chain infrastructure.
For instance, Hainan Free Trade Port is an attractive location for trading and manufacturing companies, offering the following tax advantages:
- Maximum 15% IIT rate for qualified employees.
- Favourable VAT conditions: tax saving from imported self-use production equipment, and an exemption on import VAT, customs duties, and consumption taxes.
- Accelerated and one-off depreciation policy on capitalised expenditures.
In a time of global economic insecurity, FTZs offer a supportive business environment in which foreign companies are better positioned to ride out the storm.
2. Your Pathway to Localisation
Finding the Optimal Location
Establishing a manufacturing base in China or transforming existing operations can be a daunting prospect. Often our Clients have a host of concerns such as inadequate market knowledge, cultural differences and navigating complex legal systems.
Experience tells that the success of a market entry strategy – especially for manufacturing companies – is pre-conditioned by the thoroughness of three essential preparation phases: Market Analysis; Location Assessment; Planning and Budgeting.
Market analysis: an in-depth assessment of market conditions and your business environment will help you bridge your knowledge gap with the market reality to support your strategy.
Location assessment: each factor varies depending on the type of manufacturing site, and which factors are most important, including:
- Commercial environment and transportation.
- Rental cost advantages and local benefits.
- Supply chain proximity.
- Site feasibility.
- Labour availability and labour cost.
Business plan & investment calculation: foreign investors tend to underestimate the costs and complexity of setting up a new manufacturing site. Drafting a detailed investment plan will help you to avoid unexpected events such as cashflow shortages and help prepare for future supply chain squeezes.
Hiring the Right Talent
The availability and cost of talent are central to the success of a new production plant. Many foreign firms operating in China struggle to find the right talent to help them realise their growth plans.
Moreover, hiring Western talent will remain problematic for the foreseeable future. Due to the strict COVID-19 restrictions, many expats have left China.
Adapting to this new reality, companies should consider the following:
- Target local talents: experienced local executives with a specific and deep understanding of new markets can help drive business expansion.
- Re-evaluate key characteristics and skills: should you be looking for a heightened aptitude for tech, empathy, agility? Consider what traits can best help your business thrive amid continued economic uncertainty.
- Take a long-term view: candidates have become increasingly reluctant to relocate. Companies with the resources to invest should seize the opportunity to secure executive talent for the future, amid increased competition.
- Remote interviews: improved communication technologies, new online assessment tools and localised partners are your best assets to hire executive talents, and overcome the lack of face-to-face meetings amid the on-going travel restrictions.
Keeping up with rapidly changing compliance regulations is a challenge, and even more so for manufacturing entities. Many clients are reporting compliance issues surrounding:
- Limited visibility and control over bookkeeping practices.
- Suspicious business transactions with lack of supporting information.
- Low Corporate Social Credit score involving key business areas.
- Internal complaints or whistle-blowers.
- Continuous losses with high operating costs.
The Fiducia Corporate Health Check
Through our audit investigations, we help clients to identify compliance risks and substantial cost savings, focusing on five key business areas:
- Corporate set-up: investment structure, corporate functions and shareholders, license usage, company chop management process.
- Financials: review of cost structure and operational expenses, revenue cycle and cash flow management, tax payments, credit checks.
- Process and operations: standard operating procedures, internal control for fraud detection, inventory stock count.
- Contracts and HR: validity and enforceability of contracts, compliance of labour contracts, dispute resolution methods, staff background checks, payroll IIT, social insurance contributions.
- China’s Corporate Social Credit System: maintain a high score across all criteria and towards your business partners.
3. Client Success Stories
Case Study 1: Stock Taking for Electronics Manufacturer
After our client’s HQ noticed discrepancies in its China inventory, Fiducia performed a Health Check at their South China warehouse. We discovered a large amount of obsolete inventory and generally poor stock taking habits by the local team.
After a thorough clean-up, the Client divided their assets, separated the outdated stock, and was able to report the real value of the inventory back to the HQ.
Case Study 2: Medical Devices Production Localisation
A leading global manufacturer of medical inhalers engaged Fiducia to evaluate the feasibility of production localisation.
Step 1 – Market voice: our team performed an in-depth market investigation of the local products in tenders. We also conducted an impact analysis of related government policies and regulations.
Step 2 – Entry options: we presented a route to market evaluation complemented by case studies as well as a summary of any IP / technology infringement issues among international / joint venture competitors in China and possible solutions.
Step 3 – Risk assessment: outlined potential risks and corresponding risk management measures for each entry option.
Outcome: The Client opted for a joint venture with its distribution partner and engaged Fiducia to support the joint venture negotiations.
Testimonial by Leading Plastics Compounder
“Fiducia conducted an extensive location analysis that provided us with clear recommendations on where and how to proceed with the set-up of our manufacturing plant in China. As a next step, we entrusted Fiducia with the incorporation of our China WFOE and a variety of related corporate services to improve and streamline footprint in China. In addition, Fiducia’ Executive Search team has filled several of our vacant manager positions in China and Hong Kong. We were kept in the loop along the way by Fiducia’s clear communication style that made us feel confident to have the right partner for our significant investment project.”
— Philip Krahn, (former) Managing Director, Albis Plastic (Far East) Ltd.