Organisation For Economic Co-Operation And Development - Research Paper Example

International Corporate Finance Background I am a business analyst for an Australian investment bank, The Flying Emu. I was asked by my manager to conduct an analysis for a Singaporean pharmaceutical company. The company seeks advice from the bank as to whether it should follow the strategy of many multinational corporations, like Acer and Toyota, and establish production facilities in Mainland China. My recommendations will be made after careful study and analysis of the Chinese market. China, an Introduction China, (People's Republic of China), is situated in eastern Asia, bounded by the Pacific in the east. The third largest country in the world, next to Canada and Russia, it has an area of 9.6 million square kilometres, or one-fifteenth of the world's land mass. Its population is estimated to be about 1,306,313,812 as of July 2005 making it the world's most populous nation. It has strictly advocated the "One child policy" in 2002 to control its population but the downside of it is that it is now one of the rapidly aging nations in the world. Its population is said to peak to 1.6 billion by 2050 before stabilising. Culture: In China, business meetings are often very slow, and the businesses are built on assurance of a good relationship. The person in charge is addressed most respectfully, and refusal of ethnic or exotic food or drink is considered as a slight. All business done in China will need to be programmed for a long term since it takes a while to establish trust and run the enterprise in the Chinese landscape. Business deals and negotiations are better done with the presence of a local partner who not only deals with the corruption in the government sector but is also accustomed to dealing with local labour and mitigates risks due to cultural differences. Analysis of the Chinese market Economy: China's economy grew at an average rate of 10% per year during the period 1990-2004, the highest growth rate in the world. China's gross domestic product (GDP) grew 9.3% in 2003, and even faster, 9.5%, in 2004, despite attempts by the government to cool the economy. China's total trade in 2004 surpassed $1.1 trillion, making China the world's third-largest trading nation after the U.S. and Germany. The Chinese government is firmly committed to economic reforms and opening up to the outside world. Government policies have moved markedly towards allowing market forces influence economic activity and have been reformed in order to assist in the progress of the price determination, foreign trade and investment, exchange rates, entry barriers, internal markets etc. All this seems to have paid off and at this current rate of growth China is supposed to have the fourth largest GDP by 2010. The immediate years to follow are crucial for China. China's accession to the World Trade Organization (WTO) in 2001, China presents a vast market that has yet to be fully tapped and a low-cost destination for export-oriented production because it is labour intensive and has a surplus of labour due to its enormous population. Environment and infrastructure: China is one of the most polluted nations in the world due to its rapid industrial advancement at the cost of its natural resources. A 1998 World Health Organization report on air quality in 272 cities worldwide concluded that seven of the world's 10 most polluted cities were in China. It is no surprise that respiratory and heart diseases related to air pollution are the leading cause of death in China. Most of its rivers are polluted to some degree and half of its population does not have access to clean water. Water scarcity is a rampant problem. China's leaders are increasingly paying attention to the country's severe environmental problems. In recent years, China has strengthened its environmental legislation and in 1999, China invested more than 1% of GDP in environmental protection, Beijing is investing heavily in pollution control, as it is the host of the 2008 Olympiad. Education: China was long lagging behind India for its mastery over the English language. This barrier to communication was a major disadvantage for China. The government though seems to have addressed the issue and English is now being promoted and China will fast catch up and it is supposed to have 94 million English speakers by 2006. China has also proceeded to implement exchange programs with foreign universities and research centre and this has increases its percentage of knowledgeable work force. Government policy and Incentives Foreign Direct Investment (FDI): As documented by the Bureau of East Asian and Pacific Affairs, China is now one of the leading recipients of FDI in the world, receiving $64 billion in 2004, for a cumulative total of $563.8 billion. Foreign exchange reserves totalled $610 billion in 2004. China's investment climate has changed dramatically from the early 1980's to the current day. China had strict restrictions on foreign investments and investors needed to form joint ventures with Chinese firms in order to invest. In order to bring in foreign investments, since the early 1990s, China has allowed foreign investors to manufacture and sell a wide range of goods on the domestic market, and allowed wholly foreign-owned enterprises. As part of China's entry the World Trade Organization in 2001, China has further opened up more sectors formerly closed to FDI. To keep the momentum going, new laws and regulations have been passed. Foreign-invested enterprises produce about half of China's exports, and China continues to attract large investment inflows. Intellectual Property Rights: According to OECD, Organisation for Economic Cooperation and Development, which has more than 30 countries as its members, improving the protection of intellectual property rights (IPR) has been one of the main challenges faced by the Chinese government since its accession to the World Trade Organisation in December 2001. The Chinese government has become increasingly aware of the importance of IPR protection in the context of a modernisation strategy and being open to a global economy. But in spite of this, there is lot of infringement in the IPR and hence starting a business in China is open to risks. China's currency, and hedging: China's currency has been under the strict control of the government and over the years has been maintained fairly stable in relation to USD. Although China has recently made an effort to revalue its currency, it would take a long time period to occur. Local loans repayable as early as possible will mitigate this risk because the repayment will not be affected by exchange rates and can be used as a hedge against currency risks. Analysis of the pharmaceutical market in China With its burgeoning population and about 15% of the population below the poverty line, most Chinese lack health insurance and only a fraction of the population can afford top-end Western medical care. According to Research and Markets, a world research firm, "The Chinese pharmaceutical industry has increased with an annual average growth rate of 16.72% over the last few decades. However, the industry is still small-scale, with a scattered geographical layout, duplicated production processes, and outdated manufacturing technology and management structure." Gaining access to the WTO will further integrate the Chinese economy into the global economic environment, and Chinese pharmaceutical enterprises will face a huge challenge. As TDCTrade.com states in its report, "China's pharmaceutical industry is faced with both the internal and external environment problems". Conform to standard and enforce GMP standard: The GMP (Good Manufacturing Practices) management implemented by pharmaceutical enterprises is a common practice in the world. So far this was not mandatory for the Chinese pharmaceutical enterprises and the quality of the drugs were questionable. But after the GMP authentication as of June 30, 2004 all production of medicine, preparations and crude drugs must conform to the GMP standard and gain GMP certificates. This would definitely improve the quality of medicine but it is expensive to receive a GMP certifications. The lack of production of new drugs and patent protection: China is a large producer of drugs namely 1,350 types in 24 categories of crude drugs. However, 97 percent of them are imitated and have no patent protection. So far, China has only two innovative drugs, arteannuin and sodium dimercaptosuccinate, which were approved internationally. Therefore, China's pharmaceutical industry must positively raise its capacity for developing new drugs. For this purpose, China revised the "Measures of New Drugs Administration" in 1999 to project the spirit of encouraging innovation and strengthening the protection of new drugs with laws and regulations. Still, this process is in the fledgling stage and the lack of patents is an enormous risk. Separation of hospitals and drug stores: The separation of the medical prescription from the drugs was put in place in 1990 and tried with moderate success in a few distributed pockets. This has encouraged the emergence of the growth of drug stores. This has stopped the hospitals from over prescribing and made each entity responsible for their own profitability. The distribution channels are tiered in China and reaching the lower most lower rung distribution channels are difficult. Drug prices and production facilities: In 1997, the State Development Planning Commission has cut the prices of more than 200 varieties of centralized managerial drugs and reagents ten times. Although this was a good move supposed to pass on the savings to the common man, in a typical supply demand market, which the drug market is a part of, this backfired because the ex factory prices were required to be the same. The productive enterprises ended up soaking the most loss. Chinese drugs not widely accepted: Traditional Chinese medicine is widely accepted domestically but China maybe the only country that gives drug status to patent Chinese drugs. Although patent Chinese drugs have ready markets in Japan, the Republic of Korea and Southeast Asia, they are not major drugs. Patent Chinese medicine enters Europe and America in the name of "food additives" as they may contain unapproved chemicals and reagents. According to the Chinese Economic Information Agency in the year 2000, the export of traditional Chinese medicinal materials accounted for 64.7 percent of the total export. The main reason for the lack of acceptance is that the stringent quality controls imposed by the economically developed nations are not available with the Chinese drug industry. China's pharmaceutical market players: The domestic market for ordinary medicine has experienced the supply exceeding demand for years. The saturated domestic market has brought down the overall profit margins. The foreign entities do not find the high production costs coupled with low margins very appealing. At present, China's pharmaceutical industry has numerous foreign invested joint ventures as well as wholly subsidised ventures. One of the well known Joint ventures is that of is Xian-Janssen Pharmaceutical Ltd. All the top pharmaceutical giants including Squibb, Glaxo, Pfizer and Merck Kgaa, have made investment in China. Nearly 1,000 such ventures are in the fray in today's market. In 2000, drugs produced by joint ventures accounted for 30 percent of the market in China, and imported drugs for 23 percent. The domestic counterparts are not intimidated by the foreign arrivals. "For example, AstraZeneca, one of the leading five corporations of the global medicine industry, has set up a production base in Wuxi, Jiangsu Province -- its biggest investment in Asia (also the biggest ever by MNC's China), which cost US$100 million". Their products include Losec, which is in the global medicine sale list, and the well known Betaloc and Bricanyl. (Source: Ministry of health, China Daily). Conclusion and recommendations China is projected to become the fifth largest drug market in the world by 2010. Its big size, recent participation in WTO, a relatively stable currency, the demand for drugs for the large ageing population with increased life expectancy, the large and cheap labour force, easy access to participants for the low cost clinical trials are all factors favouring China as an attractive alternative venue. A number of barriers to foreign investment, absence of transparency in governmental matters, inconsistently enforced laws and regulations, the lack of adherence to rules, corrupt legal infrastructure is an area of concern to be addressed. In addition, the highly competitive domestic market with low profit margins is to be taken into consideration. To give the Chinese government credit, they are trying to bring in reforms, open up the economy and improve the quality of life of the people by addressing the environmental pollution and lift them above the poverty line. Their entry into the WTO has induced the advent of more stringent certifications and lenient reforms related to both intellectual property and the legal system. Based on the above analysis I would recommend the Singapore Pharmaceutical company to seriously consider the setting up of a production plant in China and should try to capture both domestic and export markets. The benefits of market size and revenue potential far outweigh the associated risks of entry, which can be mitigated using appropriate strategies. Singapore already has a lot of investments in China and a favourable government relationship. Having a predominantly Chinese population, cultural conformity is better, which is decidedly an advantage for the above firm. Forming an alliance with a local Chinese partner or government agency will smooth start-up issues, help address infrastructure, cultural gaps and handling of local politics and corruption. The foreign country can make itself more valuable to the host by hiring local labour and hence contributing to the local economy. Sourcing local raw materials helps reduce currency risks in procurement costs and adds to political mileage by contributing to the local economy and local jobs. Borrowing locally or having a local partner investing in local currency mitigates currency fluctuations and exchange losses and lets the host country have a vested interest in the enterprise. In this case, domestic market has enormous potential and attempts should be made to gain a sizeable market share, in spite of the competition. The export market is still untapped and has enormous potential. With the reforms and policies being put in place, the market is definitely poised for take off and seems to offer a lot of promise. Sources: People's Daily Stability of Yuan key to further reform Retrieved 4th October 2005 from http://www.iht.com/articles/2005/07/22/business/yhot.php Bizchina China Daily Introduction to Foreign Investment in Medicine Retrieved 4th October 2005 from http://bizchina.chinadaily.com.cn/guide/industry/industry14-02.htm World fact book China Retrieved 4th October 2005 from http://www.cia.gov/cia/publications/factbook/geos/ch.html Organisation for Economic Co-operation and Development OECD economic survey of China published 6 September 05 Retrieved 4th October 2005 from http://www.oecd.org/document/21/0,2340,en_2649_201185_35331797_1_1_1_1,00.html Boraks, David. Doing business in the Chinese-speaking world. Retrieved 4th October 2005 from http://chinese-school.netfirms.com/doingbusiness.html Background note: China US Department of State Retrieved 4th October 2005 from. http://www.state.gov/r/pa/ei/bgn/18902.htm Jiahe, Wang 15 july2002 The internal and external environments facing the domestic pharmaceutical industry Retrieved 4th October 2005 from http://www.tdctrade.com/report/indprof/indprof_20703.htm Barboza, David. The New York Times 23rd July 2005 China's freer Yuan brings risk of speculators Retrieved 4th October 2005 from http://www.iht.com/articles/2005/07/22/business/yhot.php Read More