Gearing Up for Adversity in Greater China
Fears of a downturn can pressure firms into survival mode. But once the dust settles, those who continue to give growth a chance will come out winning. While defensive strategies to curb risks and costs are vital, it’s equally important to seize the opportunities that adversity presents.
For businesses in Greater China who are already grappling with a “new normal” of slower growth, rising costs, and dizzying market trends, the prospect of a downturn offers one key opportunity: the chance to hit “reset” and drive changes that may well be long overdue. This is why at Fiducia, we believe that getting “downturn ready” is just another way of getting “future ready”. We’re helping clients achieve this by gearing up, getting fit, and growing selectively.
1. Gear Up: Mitigate Risks
Downturns disrupt “business as usual”. Late payments on the customer side, capacity problems on the supplier side, tighter access to credit – risks start to emerge from all sides, making it hard to keep the wheels of your business turning if you’re caught off guard. Below are some of the actions you can take to avoid this. They must be taken early, before you or those around you face financial distress.
Smart cash flow management is particularly vital in China, where you must file and pay VAT on the fapiaos (invoices) you issue monthly, regardless of when clients pay. Start by:
- Reviewing payment terms in accounts receivable/payable
- Renegotiating fixed costs (e.g. rental)
- Reducing non-essential expenses
- Taking up/increasing bank loans
Difficult times tend to increase fraud and other integrity risks within organisations, as employees come under heightened pressure, e.g. to meet their sales targets. It’s also common for tax and other authorities to increase their oversight. So stepping up internal and external compliance – already a top concern for China-based leaders – becomes even more urgent in the current context. Key actions include:
- Reviewing and strengthening internal controls (e.g. establishing a Whistleblower System)
- Reviewing tax and regulatory compliance
The last global crisis shook Chinese supply chains. In 2008, half of China’s toy exporters went out of business. Since then, China’s manufacturing base has indeed matured. Our clients have built solid relationships with reliable suppliers. And yet when we carry out supplier assessments, we continue to find established Chinese manufacturers who, for instance, lack a proper MRP or accounting system. How well can they weather the next downturn? Avoid shocks down the road by addressing underlying volatility in your supplier base early:
- Identify supply chain risks (e.g. assess/monitor existing suppliers)
- Draw contingency plans
- Diversify your vendor network (within and outside of China)
Case Study 1 | Finding and Preventing Fraud
Challenge – Our client suspected that non-compliant behaviour in the sales team was causing losses in their Shanghai WFOE. We performed a Corporate Health Check that involved analysing the clients’ financials and internal processes and speaking to relevant stakeholders within and outside the organisation.
Solution – We found proof that the former sales director and other team members had sold discounted products to shell trading companies that they set up themselves and created fake business licenses to cover up the relationship. We helped the client fix internal control loopholes to avoid a similar situation in the future.
Case Study 2 | Complying with New Transfer Pricing Rules
Challenge – A multinational group with sales and distribution entities in Hong Kong and China requested a Corporate Health Check of their Greater China companies as part of their downturn-readiness programme.
Solution – One of our findings was that the Hong Kong subsidiary’s intra-group transactions in 2019 met the recently introduced threshold that requires them to provide special transfer pricing (TP) documentation to tax authorities. We helped the client prepare the necessary reports to avoid a potential non-compliance penalty and challenge. We are now reviewing their cross-border pricing strategy to optimise tax savings.
2. Get Fit: Optimise Costs
Cost initiatives are the first thing that come to mind when discussing downturn readiness. And while they’re certainly necessary when margins tighten and revenues shrink, the focus is too often on cost reduction rather than optimisation. The former can hamper your company’s growth prospects: while trying to cut fat you can end up cutting muscle. The latter is about refocusing resources to where they matter most, delivering savings while still boosting profitable capabilities. Below are some areas where you can free up resources without losing competitiveness.
The prospect of a downturn is not the only reason why foreign companies in China are reviewing their setup. But it’s making the task all the more urgent. Many of our clients established their China operations under an entirely different market reality. Companies who started sourcing/buying here 15 years ago, for instance, are increasingly looking to sell into the local market. Their original setups have been adapted on-the-go, but not always in the most cost-effective ways. Many of our clients have been able to optimise costs by:
- Adapting their investment structure to match current needs
- Consolidating their physical footprint
- Outsourcing business/administrative functions
As with their setups, companies should regularly adapt their processes to China’s changing market and regulatory conditions to avoid prolonging obsolete operations. For example, tax authorities regularly update filing requirements – often eliminating certain time-consuming steps. This, combined with adopting the right digital tools, can free up significant resources from low-value operations. We recommend clients to:
- Review processes regularly and eliminate unnecessary steps
- Accelerate digitisation by leveraging “plug-and-play” tools (e.g. virtual team platforms to reduce travel expenses)
China’s tax burden on corporations is the 12th highest in the world according to the World Bank (2018). And anyone who has seen a Chinese company from the inside has probably gotten lost in its maze-like system of tax rules and incentives. So it’s no wonder that a closer look at your taxes in China often reveals vast room for improvement. Common solutions include:
- Restructuring cross-border operations
- Careful tax planning, e.g. ensuring all available deductions are claimed
- Tax-efficient employee compensation strategies under the updated Individual Income Tax (IIT) guidelines
Case Study 3 | Selling to China with a Low-Investment Setup
Challenge – Our client, a German furniture manufacturer exporting to China, was at risk of losing its top Chinese customer to a competitor. Unlike our client, this competitor had a WFOE in China and could therefore issue fapiaos (official VAT invoices) that allow customers to offset their own payable tax.
Outcome – Fearing a downturn, our client decided against the option of opening a WFOE now. Our trade services team provided an agency solution for them, managing their sales and issuing fapiaos in China on their behalf. Our client was able to salvage its key account and improve its competitiveness in China with a low-risk solution.
Case Study 4 | Optimising Your China Footprint to Fit New Needs
Challenges – Our client, a European industrial equipment supplier, set roots in China 20 years ago with one trading company in Shanghai and one in Nanjing, planning to turn the latter into a “China for China” plant. Over time their import business boomed, so they scrapped their plan to produce locally. The Nanjing office became less useful and profitable, so the client requested our help to consolidate its operations in Shanghai.
Solution – We created a step-by-step consolidation plan and helped the client implement it. This included gradually moving all Nanjing operations to Shanghai, changing the Shanghai WFOE’s business scope accordingly, untangling inter-company billing, and getting the Nanjing entity ready for de-registration. The new setup generated significant cost savings and, more importantly, clearer and more efficient processes.
3. Grow Selectively: Focus on Future Growth Engines
After years of fast top line growth, many foreign invested companies in China are under pressure from their headquarters to up the pace. These expectations are getting harder to meet – especially for businesses who are simply doing more of what they’ve always done. To succeed in an increasingly competitive China, companies need to identify their future growth engines and invest disproportionately in them. The problem with this is that it entails disruptive transformation, but the prospect of a downturn might give China-based executives the buy-in they need to drive a bold change of strategy.
It’s hard to overstate just how quickly market opportunities shift in China. Environmental regulations can make or break the demand for a certain industrial material overnight, online channels can gather or shed millions of users in a month, and entire sectors that were previously off-limits for foreign investors suddenly open up. Many foreign players fail to review their growth strategy often enough to enable a swift reaction to such changes. The possibility of a downturn raises the need to do so in order to avoid wasting potentially scarce resources in segments or strategies that will not be relevant tomorrow. Key actions include:
- Analysing market potential to identify growth-driving business segments
- Reviewing your sales and distribution channel strategy
- Reallocating resources accordingly
- Identifying potential M&A targets/routes
A downturn can hurt your long-term competitiveness if slashing costs becomes the main task of your HR department. Unwise redundancies can demoralise employees and a culture that rewards austerity can push managers towards bad decisions. Instead, the focus of HR professionals should be on building resilience while keeping the organisation focused on the future. For instance, by continuing to invest in attracting, retaining, and developing R&D and innovation talents that will help the company unlock new growth and “bounce back”. Forward-looking HR professionals should:
- Improve work flexibility to attract/ retain talent and save costs (e.g. telecommuting to optimise space)
- Recruit candidates who can adapt to change, especially for key positions
- Drive organisational and cultural change to improve performance
Case Study 5 | Targeting high-growth application segments
Challenge – Our client, a European manufacturer of high-performance materials, was facing lower downstream demand from the automotive and smartphone industries. They requested our support in identifying specific application segments that could help them unlock new growth in the Chinese market.
Solution – Our China Consulting Team carried out a benchmarking analysis of 10 major competitors, including an in-depth cost analysis, to identify high-potential and high-profitability application segments. Based on our findings, the client developed a new plan to target solar energy and medical applications.
Case Study 6 | Weathering the slowdown with the right sales leader
Challenge – As a manufacturer of premium machinery for the packaging industry, our client had been losing business to mid-market Chinese competitors. Fearing that this trend would accelerate now that slowing exports and rising uncertainty are making customers put off capital investments, our client partnered with Fiducia’s Executive Search Team to look for a Sales Director who could help them reverse the sales slump.
Solution – After analysing the sales team’s pain points, we advised the client to search for a candidate with a proven understanding of Total Cost of Ownership (TCO). We helped them find and hire a Sales Director who is now incorporating TCO calculations into the company’s sales proposals and pricing strategy, making it easier for buyers to gauge the long-term benefit of choosing a high-end machine over a cheaper one.
How We Can Help You
Whether it’s to prepare for upcoming headwinds or to create lasting transformation, below are some of the ways in which our consulting and outsourced service teams can help you gear up. Get in touch with us to learn more about how we can tailor our support to fit your specific situation.