Challenges Facing Foreign Companies when Doing Business in China - Case Study Example

1.0 Challenges Facing Foreign Companies when Doing Business in China China has been relatively closed to the outside world due to its Communist ideals that is in direct conflict with the principles of Capitalism. Nevertheless, the nation has been recently embracing the idea that capitalism is necessary to ensure its well-being and the economic development of its burgeoning population. China is a place that should be considered as part of nearly everyone's strategy now. That is not to say that everyone will benefit from China, but the ability to find benefits as part of a larger strategy needs to be explored especially in the light of reforms undertaken by Chinese authorities. I will be discussing the threats foreign companies are facing in China's business environment and detail the efforts made by the Chinese government to address the said issues. Regionalism in China Multinational corporations (MNCs), such as Wal-Mart, have identified that the most troublesome feature of China's business environment is the fragmentation of supply chain and local protectionism resulting to a lack of consistency of inter-provincial rules and regulation. Chinese provinces have, for centuries, enjoyed local autonomy and have made full use of it to protect local interests. Regional and local governments have the power to implement rules and regulation so long as it is line with the core mandates and laws of the central government and they can do this without notice. Foreign companies, most of which operate on the national level, finds this situation to be confusing and costly for business operations as they have to comply with each regulations set by each local entity. It also presents problems in supply chain efficiency as each province may require the inspection of the products being transported. For example, there is the possibility that nationally approved products are barred from local distribution due to differing health and sanitation requirements of different provinces. There also localities that require wholesale purchases of alcohol and tobacco products posing problems for retail-oriented stores. This state of affairs results in fewer choices or higher prices for consumers which can be detrimental to the MNC in light of the very cheap products produced by Chinese companies. Physical infrastructure also differs between provinces due to the gap in funds to implement projects posing difficulties for road transportation whether it may be private or commercial trucking resulting to a problematic interprovincial purchasing. (McGregor 2007, p. 45) Technology and the Abundant Labour Force China's population is one of the largest in the world implying the abundance of the labour supply. While it can be argued that this presents an opportunity for the companies due to the expected lower compensation packages, it presents tradeoffs in accuracy and quality. The cheapness of labour works for industries that employs manual labour but is a nightmare for those which involves automated processes. High-end technology and electronics manufacturing from Japan, Korea and the United States relocating to China require automated processes and invest in usually expensive technologies to meet quality and accuracy standards. They are now faced with the dilemma of resorting to manual labour and risk quality or invest in automation and incur large costs that cannot be easily regained in light of fierce competition. In sectors that make use of manual labour such as those in transportation, distribution and retail, the abundance of labour can be a threat because it decreases entry barriers and forces the company to lower their prices to be able to compete in the market. As a result, foreign companies and their local providers still opt either to process manually or to contract out to local, third-party logistics companies that use manual processes thereby sacrificing quality. (Yan, Rick and Lebeberthal, Kenneth 2006, p.11) Foreign companies that need to have automation in their process could have some part of the process done manually but this result to sacrifices in efficiency. For example, they may consider 'mid-tech' processes for supply chain management such as radio-frequency-equipped forklifts instead of fully automated picking or order retrieval systems, or off-the-shelf warehouse-management systems instead of custom-designed ones. (McGregor 2007, p. 51) The abundance of the labour force does not necessarily mean an abundance of skilled professionals. This lack of skills has been the topic of most discussion regarding Chinese inadequacies. Companies are particularly hard-up in finding educated and technically capable workers who are interested in careers that enable them to use their expertise. Selective Trade Barriers According to Saxon (2004), while China has been complying with the World Trade Organization (WTO) of lowering its import tariffs, it is seeking ways to protect its own huge domestic markets. Trade barriers that have been devised are mostly concerned with the quality and safety of products which are applied to imported products but not in domestic goods. MNCs are even given a limit on how many stores they can open in China. Vague testing and labelling laws have also been selectively implemented to foreign goods. (p. 32) Like the United States, China needs domestic consumer demand to drive growth. But unlike the United States, China's domestic demand is underdeveloped. Since retail companies are at the heart of supporting consumer demand, foreign retail companies in China will be under the microscope when it comes to the watchful eye of government authorities and should anticipate government efforts to keep Chinese products on, and imported products off, shelves. Financial matters Much of China's current financial structures are relatively underdeveloped. For example, modern insurance systems are relatively new to the nation so it takes more time for the company to avail of one. The current banking, finance, insurance, and taxation structures are bureaucratic and cumbersome. Compounding the problem is the fact that most transactions rely heavily on hard-copy paper flow of documentation which adds cost, requires excess manpower, and creates opportunities for human error. (Yan, Rick and Lebeberthal 2006, p.4) Logistics Issues In the United Kingdom and the United States, the delivery industry is very reliable, affordable and very convenient as it can handle a wide range of products whatever size they may be, whatever special handling they may require, whatever methods of delivery is detailed and wherever it is to be delivered. Furthermore, the shipped products can be tracked by the use of global positioning system on a minute by minute basis thereby ensuring the whereabouts of the shipment. China currently lacks this efficient logistics structure. While there are delivery services such as China Post and China Rail, it does not offer the same degree of reliability, efficiency and safety in the delivery of shipments as its U.K. and U.S. counterparts. Legal Impediments China is currently developing its legal system to provide a more definitive guideline for foreign investment into China whether they may be in the form of a representative (liaison) office, a wholly owned subsidiary or joint venture with a domestic enterprise. The results are remarkable considering that foreign-owned companies do not need to form a Sino-foreigner business venture implying that there is no longer the need to undergo the tedious process of finding an appropriate Chinese partner. The problem with the legal system of China is not so much in the provisions and coverage of rights but in the process of availing of approvals and registrations. Foreign companies must comply with the requirements of at least fifteen administrative departments not including local administrative departments where they plan to conduct their operations. The process is still to bureaucratic and would require the hiring of consultants. Problems encountered by foreign companies usually include the signing of a lease agreement and payment of deposit before confirming whether and under what conditions the property in question can be registered as the residence of the office or company, the failure to define properly the business scope in the Chinese subsidiary's Articles of Association, and financing problems due to inadequate provisions of investment and registered capital. (Yan, Rick and Lebeberthal 2006, p. 15) Intellectual Property Protection McGregor (2007) relates that China has been regarded as the place where anything that can be copied will be copied. While China's copyright laws are comprehensive, legal reinforcement has been lacking and very expensive to conduct leading to the prevalence of infringement. China employs a first-to-file system of approving copyright claims which means that those who register a trademark first will be the one to be granted the rights. While this is contestable, the process is too exhaustive and expensive leading many companies to forego their claims. Furthermore, the one who was granted the rights can make use of the brand until there is no final resolution to the case and that being granted a patent even if you are the legitimate owner does not necessarily mean that your brand will not be copied by others. (p. 67) Culture Considerations The Senior President of China's Siemens' Company has rated courtesy as the top consideration when dealing with the Chinese whether they may be government officials or your employees. This is because Chinese are very much sensitive with the observance of their long held tradition of courtesy and face-saving. While Chinese people are very hospitable, but their self-esteem is very strong and they pay very much attention on how other people view them and their attitude towards them. This phenomenon can be seen greatly in Northern China, which is associated with 'face-saving'. (Seligman 2005, p. 15) Measures Employed by the Chinese Government The accession of China in the World Trade Organization has resulted to many improvements in reducing trade barriers for foreign trade. China has already reduced its industrial tariffs from 25% to 10% in a period of five years. Foreign companies are also enjoying more privileges and reduction in the threat of being nationalized. An example of trade liberalization was permitting foreign owned enterprise manufacturing in China to export not only those that they have produced but also Chinese products as long as the value of such exports does not exceed 50% of the combined value of the total export volume. There have been milestones already achieved in the financial systems due to the opening of the banking industry to foreign competition. Legal reinforcement issues are currently being reviewed to determine the most appropriate actions to be taken. (Blake, Cassels & Graydon Legal Firm 2006 p. 8) With regards to the skill proficiency, Gao Xuegui, director of the Illiteracy Elimination Division of the Ministry of Education, has disclosed to local media in November 2007 that China's central finance department has allocated RMB18.1 billion this year for the country's compulsory education sector. In addition, up to 150 million students in the country have been exempt from paying the tuition and incidental expenses for their compulsory education. This would provide for more skilled professional people to be employed. (BDL Media, 2007) With regards to physical infrastructure, China has been very aggressive in construction and development projects. By the end of 2005, the total mileage of highways reached 1.4027 million km, an increase of 51,000km. There was also a rapid development of expressways, with the total mileage taking the third place in the world, and increased length reaching 4,709km. 8 international airports have also been undergone construction or major renovation. (Zhang, Pine and Lam 2005, p. 36) All in all, the Chinese business environment still needs major reforms but it is getting there. Time will witness how this slumbering giant will become the world's business capital. References: BDL Media (2007). Chinese Hospitality Industry Faces Unified Service Etiquette Standard. Shanghai: BDL Media Publications. Blake, Cassels & Graydon Legal Firm (2006). Blakes Guide in Doing Business to China. UK: Blake, Cassels & Graydon LLP Publications. McGregor, James (2007). One Billion Customers: Lessons from the Front Lines of Doing Business in China. UK: Free Press Saxon , Mike (2004). An American's Guide to Doing Business in China: Negotiating Contracts And Agreements; Understanding Culture And Customs; Marketing Products And Services. London: Adams Media Corporation Seligman, Scott (2005). Chinese Business Etiquette: A Guide to Protocol, Manners, and Culture in the People's Republic of China. New York: Grand Central Publishing Yan, Rick and Lebeberthal, Kenneth (2006). Harvard Business Review on Doing Business in China. Harvard Business School Press. Zhang H., Pine R. and Lam T. (2005). Tourism and Hotel Development in China From Political to Economic Success. The Haworth Hospitality Press: Oxford. 1.0 Indicators of Sustainability in the Future Population as an Edge China's main defining feature, its huge population, is one of the strongest reasons why the growth rate of China can be sustained. Much of China's growth can be attributed to the fact that it has enjoyed large Foreign Direct Investment (FDI) which gave rise to the booming of several industries. There are two reasons why FDIs is flowing to the China. First, the Chinese population serves as a huge market that is largely unexplored. Capturing the Chinese market could lead to millions, if not billions, of dollars in profits. Establishing a presence in the said region is vital in achieving this end. Second, Chinese labour is cheap as compared to American and Western Europeans due to the fact that cost of living is technically very low and that competition for jobs is very fierce. Only a small portion of the Chinese population has been tapped for labour and most of them are in cities. Estimates point out that out of China's 1.4 billion inhabitants, 800 million people live in the countryside. Out of these figure, 400 million countryside dwellers were found to be underemployed and could serve as a huge source of labour for the years to come. The importance of this huge labour pool is that it assures the industry that the wage levels will not be rising significantly. A research conducted by a Hong Kong based business analyst showed that the basic salary for unskilled workers in China has not varied significantly over the past decade. In Guangdong, for example, the basic wage was $100 in 1996 and was still $100 in 2006. This only implies that the country remains attractive as a manufacturing site because of its cheap labour. Western companies have reported that they had to increase the salary of their workers by as much as 10% annually to keep them staying in the company. This increase is inevitable no matter what country one operates in and China offers a large pool from which one can draw replacements. While other countries such as Thailand, Indonesia and the Philippines also offer cheap labour, none of them offers the huge market China has. Therefore, China can be guaranteed of a continuous pouring of Foreign Direct Investment because of its large population. (Tuuli 2006, p.3) Improved Training, Education and Industry Standards One might argue that although China has a large labour reserve, most of them are unskilled and illiterate. The Chinese government are also focusing on tertiary education and not on giving access to free basic education in general. Most of Chinese schools are also lacking in educational resources. The Chinese government has recognized this early on and have already established an Illiteracy Elimination Division under the auspices of the Ministry of Education. Gao Xuegui, current director of this division, has disclosed to local media in November 2007 that China's central finance department has allocated RMB18.1 billion this year for the country's compulsory education sector. In addition, up to 150 million students in the country have been exempt from paying the tuition and incidental expenses for their compulsory education. In effect, business firms are assured of the availability of skilled professionals. (BDL Media, 2007) There are also efforts to implement higher standards in professionals. In the hospitality industry for example, government agencies headed by the Chinese National Tourist Office issued the "Suggestions on Reform the Qualification Examination of Tourist Guides, Professional Ranking Examination and the Manager Authentication Work of Travel Agencies." This manual aims at improving the examination of tourist guides in a scientific way and accelerating the pace of construction of the contingent of tourist guides. It also implemented the G-TELP, a system for China's hotel vocational English standardized training and tests and was introduced to various places in the country. (Zhang H., Pine R. and Lam T. 2005, p. 45-47) The latest improvement also came from the hospitality industry which is very active in light of the 2008 Beijing Olympic and the Shanghai World Expo. In October 2007, the China Tourist Hotel Association has made known to the public the creation of a new criterion entitled, "Chinese Hospitality Industry Service Etiquette Criterion (Trial)", which details practical training standards for the regulation of the service etiquette of China's hospitality industry and creation of a civilized and professional hospitality image. (BDL Media, 2007). The significance of this development is that it shows that China is trying to eliminate the global conception that most of its products and services come in low quality. To assure Foreign Direct Investments from continuously flowing into the country, it must be able to show that it can meet Western standards of quality. This is particularly important in light of the many controversies surrounding products sourced from China. Most prominent of this is the pullout of China-made Mattel products from shelves around the world due to safety and manufacturing issues. While it is not an assurance that the efforts to improve public perception will be successful, it is still one good way of attracting foreign investment. High Savings Rate China also enjoys from its high savings rate enabling it to fund investment from domestic resources. While other countries have been financing their projects with foreign debt from the World Bank, the European Union and the United States, China has been able to stand for its own and is technically a net exporter of capital if foreign reserves are included. Major foreign investments pouring in every sector contribute to higher revenues providing further initiative and funds to develop and promote the domestic projects. (Nesvisky 2007) Trade Liberalization Trade liberalization is also being implemented in the country in accordance with the requirements set forth by the World Trade Organization (WTO). Average tariff rates have dwindled from 25% to 10% and the number of import quotas and licenses has declined. Foreign companies are also able to export Chinese company manufactured products unlike before where they can only export the products that they manufactured. It has also intensified its campaign against copyright infringement by strengthening their police and intelligence capabilities. (Blake, Cassels & Graydon 2006, p. 9) 2.0 Obstacles in Achieving Sustainability Environmental and Safety Issues Our analysis so far would point out that China can sustain its rapid growth rate. However, the issue is so complex and depends on many factors that there can be no definite conclusion that can be made. One pressing issue that affects the sustainability of the Chinese economy is the increasing concern for environmental degradation as well as health and safety of products and employees. China has been lax in its environmental laws so as to attract foreign companies who face stringent environmental legislation in Western settings. Much of the world today is also targeting Chinese products for safety issues such as what happened with Mattel. Addressing these concerns would prove to be costly as the government must now relocate funds towards these endeavours. (McGregor 2007, p. 315) Social Restlessness Saxon (2004) relates that many social scientists are also pointing out that the Chinese people are becoming restless due to the rising disparity in Chinese society. In the Communist era, the Chinese people have enjoyed a social security system that makes sure that everybody has something for himself. With the coming of capitalism, a gap has risen not only between rich and industrial coastal provinces and poor western and north eastern provinces, urban and rural areas but also in rising income differences in the cities. The country is said to have experienced thousands of protests during the transition to a capitalist economy occurred. (p. 256) Social stability is important to ensure that businesses run smoothly and without fear of debilitating protest and mass actions. The Chinese government is still Communist in nature and being so, it has adapted measures that ensure and widen local administrative decision powers. This move is to ensure that there is still equality in the nation. This widening of political and economic powers of local administrative units is problematic as it enables them to formulate their own set of rules and regulations so long as it does not stray too far away from the core principles of the central government. This presents a problem for foreign especially those who make interprovincial purchases as they have to comply with different set of requirements per province. Conflict between National and Local Governments The question that now comes to mind is whether this regional fragmentation could have dire results when in fact the United Kingdom and the United States have its local administrative body also empowered for their self-determination. According to Nesvisky (2006), the problem with regional government in China is that they are focused in short term development while the central government aims at lower, but more sustainable, economic growth than its predecessors. For example, local administrative bodies did not heed to the demands of the central government to curb investment and credit rates so as to minimize inflation. They did not heed to this demand because they wanted their own provinces to have the same economic development as achieved by Shanghai and other industrial cities. Losses from Non Performing Loans (NPLs) Estimates of international rating agencies have placed the cost incurred by NPLs at around 35% of GDP with some analysts stating that it can reach as high as 50%. These non performing loans presents failed opportunities and badly invested funds that could have been used to finance activities for the development of other profitable industries. Compounding this problem is the fact that new loans believed by most analysts to be non-performing in the future are still being given out. (Koivu 2006, p. 8) Scarcity of Resources China is one of the worlds biggest exporter of goods but these goods must be processed from raw materials which China cannot completely supply. The basic law of supply and demand would tell us that when demand is high and supply is low high, the tendency is for prices of that commodity to rise. This is indeed the case when China caused the upward spike in steel prices in2003 and early 2004. Aluminum, oil prices and transport costs have also been strongly affected by China's rapid development. (McGregor 2007, p. 242) Concluding Remarks There is no definitive answer on whether China can sustain its rapid growth due to the complexity of the issues involved. While China holds certain resources that can improve its economy in the future, social issues such as disparity and conflicting policies present obstacles that can be hard to overcome. In this regard, Chinas future is still uncertain. References: BDL Media (2007). Chinese Hospitality Industry Faces Unified Service Etiquette Standard. Shanghai: BDL Media Publications. Blake, Cassels & Graydon Legal Firm (2006). Blakes Guide in Doing Business to China. UK: Blake, Cassels & Graydon LLP Publications. McGregor, James (2007). One Billion Customers: Lessons from the Front Lines of Doing Business in China. UK: Free Press Nesvisky, Michael (2007). Will Super High Chinese Growth Continue. Retrieved Dec. 11, 2007 from http://www.nber.org/digest/nov06/w12249.html Saxon , Mike (2004). An American's Guide to Doing Business in China: Negotiating Contracts And Agreements; Understanding Culture And Customs; Marketing Products And Services. London: Adams Media Corporation Koivu, Tuuli (2006). The sustainability of Chinese growth. Finland: B a n k o f F i n l a n d BOFIT - I n s t i t u t e f o r E c o n o m i e s i n Tr a n s i t i o n Yan, Rick and Lebeberthal, Kenneth (2006). Harvard Business Review on Doing Business in China. Harvard Business School Press. Zhang H., Pine R. and Lam T. (2005). Tourism and Hotel Development in China From Political to Economic Success. The Haworth Hospitality Press: Oxford. Read More