Investing in China: Guidelines for success

83 zyxwvu 0024-6301/93 56.00+ .OO Long Range Planning, Vol. 26, No. 2, pp. 83 to 89, 1993 0 1993 Pergamon Press Ltd Printed in Great Britain zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA Investing in China: success Duvid G. W oodward Guidelines for zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA and Boris C. F. Liu This article seeks to investigate the success of China’s open door policy and the part of U.K. corporations within it. By recounting organizational experiences, it hopes to provide some indications of best practice to be adopted in formulating and implementing strategies for penetrating the Chinese market. Before 1979, China was commercially largely closed to the outside world. However, in 1978 the Chinese Government announced its ‘open door’ policy as a means of accomplishing its adopted Modernization Programme. The aim was to permit, and indeed attract, investment (mostly in the form of joint ventures) from foreign corporations, and thereby provide the technology, both hardware and software, that was lacking. The Chinese Initiative The Chinese Government had long been aware of the fact that China had technologically fallen far behind the developed countries-perhaps by as much as 10 to 30 years. Absorption of foreign direct investment especially, was seen as a desirable solution to the lack of funds for investment and the low level of technology. In fact, China had been isolated from advanced technology for so long that its industry had little chance of reaching world levels without inviting in foreign manufacturers.’ Opening up to Western investment was nevertheless perceived as a radical move, even though the Chinese were familiar with operating joint ventures with foreign countries. In the 195Os, China had set up State-owned joint companies with the Soviet Union, but these foundered as the ideological disputes between the two countries heightened, David G. Woodward is a lecturer in Accounting and Financial Management at Sheffield University Management School. Boris C. F. Liu is a student at University College, London. followed 1960s. by the withdrawal of Soviet aid in the The primary objectives in opening China up to foreign investment are to bring in foreign capital, advanced technology, management skills and urban construction, and generally to catch up with the developed countries. Preference is given to foreign projects that are consistent with the long-term development plans of the Chinese national economy, and priorities have been assigned in the following areas : fr machinery and electronics; A export-oriented d import & communication, products; substitutes; energy and transportation. The Law on Joint Ventures Using Chinese and Foreign Investment was announced in 1979 and was brief and vague, with only 14 articles. However Chinese officials emphasized the need to fill in the gaps in the Law with contractual clauses to give greater flexibility. Under partners structure Foreign nology, tise, and the joint ventures system, the Chinese normally supply land, plant, labour, infraand some machinery, as well as materials. partners are expected to provide techcapital, marketing and management experpossibly some raw materials also. Figure 1 indicates the major developments which have occurred since the inception of the open door policy. One of the most significant of these developments is the establishment of the Special Economic Zones (SEZs), designed as political, cultural, educational and technological, as well as economic, regions. The main features SEZs are: b of the policies 15 per cent corporation applied within the tax and a tax holiday; Long 84 Range Planning Vol. 26 April 3000-mile coastline into a giant SEZ. This region is seen as the main Chinese export base for the future. 1979-‘Open door’ policy announced and Law on Joint Ventures. 198~China joins World Bank and International Monetary Fund 1980-Special Economic Zones established (four initially). 1982~Debt crisis enhanced the attractiveness of foreign capital. 1983-Joint venture regulations-permission granted to sell products on the domestic market (as opposed to exporting entire output) if ‘urgently needed’. 1984-Patents legisation. Fourteen coastal sites opened. Import licence regulations and foreign exchange retention rules. 198%Nominal tariff rates reduced on exports. Tightened access to imports. Three Open Economic Zones established. 1986-Joint Venture Foreign Exchange Balance Provisions and Provisions for the Encouragement of Foreign Investment-collectively covering remittance of funds, tax and other incentives, and the hiring and firing of workers. 13th Communist Party Conference proclaimed the need for China to join the world economy through the utilization of foreign capital, technology and raw materials. Law on Enterprises Operating Exclusively with Foreign Capital-introduced more relaxed controls Technical Economic Development Areas established in 12 coastal cities. 1987-Application to joint GATT. 1988-Austerity programme to reduce inflation-firmer control over credit creation and tax reforms. Bankruptcy laws introduced. Restrictions on economic relations with other countries loosened. 1989-Democracy movement culminating in the Tian-an-men Square Massacre. Credit squeeze and devaluation. Figure 1. Major ventures developments cheap land and services (relative low labour cost (although in China) ; greater freedom zero or low simplified entry/ exit to to Hong higher in labour customs increased access Chinese market. in Chinese In spite of the combined incentives of preferential decentralized management and treatment, improved laws and regulations, not as much foreign investment has occurred as expected, mainly due to the poor investment environment in terms of the ever-changing political and economic scene, risk of expropriation, fickle government policy, infrastructure deficiencies and market protectionism. Yet further incentives have therefore been introduced, but many problems remain. For example, the seemingly low labour costs that have attracted investors have become inflated by additional expenses of housing, insurance, pensions and other benefits, imposed by the Chinese. An oft-quoted Total, the French oil giant, example concerns having to pay a Chinese expert US$9000 per month when he only took home US$54.’ The Investment ; than elsewhere management; inputs The collection and reporting of statistical data describing the pattern of investment is, however, fragmented, with data not always being consistent. As Pomfret has commented, in China there is ‘no strong tradition of reporting economic statistics’.” The figures that are available probably understate the true situation. Figure 2 (making use of data supplied in reference 6), illustrates the volume of direct foreign investment in China by both amount pledged (rather than duties; and other Pattern Growth of foreign direct investment since the open door policy was implemented in 1979 has been remarkable, even though it has not reached Chinese targets. Most of the ventures established to data are engaged in the exploitation of natural fuels, labourintensive manufacturing or tourism, plus some infrastructure projects-power (both thermal and port railways and highways, nuclear), development.” So many hotels have been built that it has been suggested by Vogel’ that this gave rise during the 1980s to low occupancy rates. joint Kong) 1993 formalities; and the internal Administrative features include the setting up of the China International Trust and Investment Corporand the Ministry of Foreign Econation (CITIC), omic Relations and Trade (MOFERT). These constitute the approval body for foreign operations, and the matching agency for foreign and Chinese respectively. Foreign businesses consienterprises, dering a joint venture in China are required to contribute a minimum of 25 per cent of the necessary investment. Various extensions of the SEZ policy have occurred, and China has recently attempted to turn its entire 7 7 6 I -.Number -+-Amount Figure 2. Direct amount pledged of ventures (in thousands) pledged (in US$ billion) foreign investment in China and number of contracts by Investing actually invested), and number the period 1979-1988. of contracts, over Within these figures it would appear that equity joint ventures and other types of co-operative endeavour accounted for the largest share, with wholly foreign-owned businesses figuring relatively insignificantly. According to figures released by MOFERT, despite the high level of investment pledged, only a much smaller amount has actually been invested-estifor the mated at only US$4.6b n, for example, period 197881985. Alternative figures published by the World Bank,’ indicate that of US8.5bn pledged up to June, 1985, only US$2.4 bn had actually been invested. Commitments accelerated rapidly during the early 198Os, but the rate has since slowed as more realistic expectations about the short-term potential of China as an investment proposition replaced the enthusiasm of early open door days.’ The wide discrepancy between pledged and actual investment is to a certain extent due to the complex bureaucratic procedures which have to be followed when investments are set in motion. In addition, many foreign businessmen, after agreeing to invest, took time to assess the investment climate and production conditions before placing investment. Since the Tian-an-men Square massacre, foreign investors have grown very uneasy about the contradictory policy signals coming from China. Whilst most of them are not prepared to write off their investments, the number of new projects is believed to be slowing down and has all but dried up in more remote parts of the country. A compounding feature was the austerity programme (which controls the foreign exchange balance), which bit hard on the economy of Guangdong during the late 198Os, and produced acute liquidity problems for both foreign ventures and local firms, and foreshadowed a major contraction of the province’s foreign trade.’ Continued uncertainty over China’s economic policies is making it too risky to commit large sums to big projects, and many investors are reluctant even to improve existing plant. It is worth mentioning that the lack of reliable and comprehensive statistical and market information in China has created a host of problems,‘” and there is even a suggestion that the reporting of economic data in 1989 was ‘doctored’ so as to minimize evidence of any disruption emanating from the Peking massacre.” U.K. Investors’ Experience The response of Western businesses generally to the opportunities presented by the Chinese incentives has not been as enthusiastic as the host country had in China: Guidelines for Success 85 hoped-a fact which is openly acknowledged. What success has been recorded is largely as a result of China’s low labour costs, huge and underdeveloped domestic market, abundant material reserves and, not least, because of the overall enthusiasm displayed by the Chinese themselves. Investors have encountered numerous problems such as infrastructure deficiencies, obtaining a share of the domestic market, getting assistance from the relevant authorities and overcoming the managerial style differences involved. There is also no doubt that the recent political power struggle in China has shaken confidence among investors, plus the fact that, given the length of time China was cut off from international markets, there has been a severe underestimation of ‘how much they would have to improve their infrastructure, upgrade cadre training, and fundamentally alter their way of thinking to be competitive with other countries.“* Some specific U.K. experiences can be illustrated from interviews conducted with executives of companies that have invested in China. In the case of all but one, this investment has taken the form of joint ventures. The exception is Cherry Valley, which operates a compensation trade arrangement. zyxwvutsrq Cable and W ireless Cable and Wireless has a long-established association with China going back to the early part of the century, and currently has two equity joint ventures operating there. The Huaying Nanhai Oil Telecommunication Service Company Limited is a A5m, 35-year contract providing off-shore domestic and international telecommunication services for oil and oilfield support companies engaged in development of the South China Sea oil-field. However, reduction in the scale of oil exploitation activities in the area has now made the company relatively insignificant. Only 70 per cent of China’s towns are equipped with telephone exchanges, and in 1987 it was estimated there was only one telephone for every 200 people, and the time from ordering to installation was over a year.‘” Cable and Wireless’ other project is the Shenda Telephone Company Limited, which provides local and international telephone services in the Shenzhen SEZ, which borders Hong Kong. Cable and Wireless holds 49 per cent of the equity, with the balance being in the hands of the public sector Shenzhen Telecommunications Development Co. zyxwvuts Cable and Wireless was considered a suitable partner by the Chinese because of its strong presence in Hong Kong, and its positive attitude towards helping the Chinese authorities help themselves. In the early stages of the project, Cable and Wireless imported engineering expertise from its Hong 86 Long Range Planning Vol. 26 Apri Kong subsidiary, whilst Chinese were sent to Hong Kong for training. Cable and Wireless, being a service-based company rather than a manufacturer, helped the Chinese design the specifications and choose the hardware, which was purchased under tender from France, Japan, and the U.S.A. In return the Chinese authorities supplied free land use and a tax holiday. The tariff for telephone calls is set according to the international rate. Since China receives more calls than it makes, and since most of the transactions are paid for in U.S. dollars, the Chinese arc very happy to earn foreign exchange to repay their share of the equipment costs. The return on investment is around 15-20 per cent, which Cable and Wireless considers unsatisfactory. The company’s expenditure to date (including loans to their Chinese partner) has been substantialaround US$50m-which it is anxious to recoup. The company has also found Chinese investment procedures lengthy and bureaucratic. It was found very difficult to arrive at a common goal through negotiations, especially with the large number of people that had to ‘pass’ a project in order for it to be approved. The most useful technique was found to be to get everybody together, but cultural diffidence made this very difficult to arrange. 993 supply of power. Tootal has found penetration of the local market difficult, and recently concentration has been upon greater value added products. The Chinese foreign balance requirement has done little to help Tootal’s two ventures, since equipment is paid for in foreign exchange. A policy of tight cash control has had to to be enforced. Trust built up among the partners has helped the businesses to run smoothly, and understanding the Chinese philosophy of ‘always placing personal qualities above rules and regulations’ has helped formulate the right tactics. Pilkington Pilkington was one of five partners who set up the Shanghai Yaohua Pilkington Glass Co Ltd in March 1983. The joint venture was to be 100 per cent equity funded, with the three Chinese partners taking 75 per cent, and Pilkington taking half the remaining 25 per cent. Eventually, funding was 40 per cent equity and 60 per cent loan from the Bank of China. The project was initiated by the Chinese, who wanted to up-date their huge glass industry. They had concluded the best way to do this was to set up an operation under licence from Pilkington. The first meeting was held in June, 1980, but 16 rounds of negotiations ensued before the company was formally established in December, 1980, mainly due to State Planning Commission delays. Problems have reduced over the years with increasing experience, but Cable and Wireless still wants to see more improvements relating to screening and approval, Furthermore, the laws on investment are Other problems encountered were: brief and vague, and more clarification is needed. zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCB clearance of the chosen site was a major source of delay, with resettlement of people living on the Tootal Group site taking an unexpectedly long time; Tootal has been operating in forms of trade other than direct investment in Shanghai since 1949. It is rent for the land was high given that vacant currently involved in two joint ventures and a possession was not immediately available; management contract in China. Both joint ventures were much worse than ground conditions are spinning mills and are situated in the coastal area. expected from interpretation of the geological surveys. Piles were needed to strengthen the site The decision to go into China was a strategic move. and a diaphragm wall required for excavation; In order to supply the area, to fight off competitors, whilst local engineers and workers were comand to compliment and reinforce the group’s other petent, project management was inefficient; manufacturing bases nearby, the establishment of manufacturing bases in China seemed only logical, most raw materials had to be transported by given the existing long-term relationship with the water; Chinese, and the very attractive offerings that were the quality and volume of soda ash available provided by the host country. locally was inadequate, and material had to be imported; The equity shareholdings were agreed through discussions and resulted in Tootal owning 42.5 per labour quality was low and required extensive cent of the equity in both the joint ventures training-85 managers and operators were sent established. This was provided in the form of capital to the U.K. for 8 weeks before production (in foreign currency) and high-tech equipment began ; brought in from Switzerland, Germany and Britain. own power generators were required because of the risk of interruption in electricity supply to The export-oriented nature of Tootal’s operations what is essentially a continuous process. suits China’s ultimate goal of generating foreign exchange, and it has accordingly guaranteed both the supply of raw materials and an uninterrupted The increase in total investment (from a budgeted Investing 165.2m renminibi to an eventual 432m) made the original projected 15 per cent RoI unrealistic, and the proposed export levels would not be enough to cover the loans, royalties and dividends remittable to the foreign partners. Export sales were therefore increased to 50 per cent of production (due also to the poor state of the Chinese domestic economy, leading to low local sales whilst there was high demand abroad). in China: Guidelines for Success 87 Cherry Valley is very confident about China, although the rate of growth is not the same as before Tian-an-men Square (U.K. personnel were repatriated within 2 weeks of 10 June 1989). The company has great pride in the quality of both its stock and its technology and does not like to sell them separately. It considers this part ofits recipe for success. McVitie’ s Cakes Since the 3rd year of production the operation has Part of United Biscuits holdings, McVitie’s joint been in profit, and Pilkington distinguishes trust, venture set up in Shekou was the group’s first firm commitment and good working relations as contact with the Chinese, and is its latest addition to being important to the making of a successful reinforce its Asian markets (following co-operative operation. Indeed, the Chinese themselves are so projects in Taiwan, Singapore and Malaysia). The proud of the venture that a tour of the plant has joint venture, United Biscuits Guangjin (China) become a virtual ‘must’ for every visiting foreign Ltd, is owned 80 per cent by McVitie’s, and was set dignitary.” zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA up to produce a limited range of products to keep production costs low. Cherry Valley Farms Cherry Valley, based in Lincoln, is considered to be the leading duck breeding operation in the world in terms of technology and stock. Cherry Valley supplies parent breeding stock and technology to its sell the products through its Chinese partners, marketing expertise, and then deducts its share of the profits from the earnings, with the balance going to the Chinese. The Chinese are happy with this arrangement, since they can earn foreign currency from the export sales. Equipment for the process, such as incubators and cold stores, can be obtained both locally and from abroad, although the latter is often preferred because both the local equipment and information thereon is generally in short supply. The quality of feed is sometimes not as high as Cherry Valley would like, and must be supplemented through the use of vitamins and prompt rectification to prevent serious afflictions developing in the stock. In addition to the supply of technology, Cherry Valley also provides in-house training either in the U.K. or in China. Many problems are associated with this, since it is known some trainees are looking for perks in the U.K. rather than training. The language barrier poses a serious problem, and this has been solved by employing a part-time translator in Chinese. Qualified trainees are subsequently sent back to China to train other Chinese in turn. Serious problems can also be created by transportation and power supply difficulties. Quick and efficient transport is essential to the transportation of live stock; whilst a small, but constant, supply of power is required for the incubators and cold stores, and the east coast does suffer from power disruptions from time to time. Cherry Valley ensures that at any one time at least one U.K. representative is working in China. All raw materials are sourced domestically and at local prices. However, the quality and variety of materials is limited, which means the quality or product is restricted to Asian standards, which does not permit of export to the West. The start-up time for production to reach an acceptable level of efficiency was ‘normal’. However, a lot of teething troubles were both expected and encountered, relating mainly to organization and management. Approximately half the products are for export to Hong Kong, with the rest being sold domestically, and whilst there have been no difficulties experienced with the Hong Kong market, with the Chinese market problems have arisen mainly due to the poor sales distribution system. For example, purchases by wholesalers tend to be erratic, making planning difficult. McVitie’s response has been to adopt a posture of very rapid response to sudden orders and yet simultaneously to attempt to keep stocks to a minimum. Prices for products exported to Hong Kong are set according to the market price in order to make them competitive. For locally consumed products, the price is usually set according to what the market will bear. The plant is labour intensive, and the cost of production is reduced greatly by using existing imported technology and the extremely low local wages. The venture uses a U.K. manager at the top level and Chinese management elsewhere. The U.K. manager is there simply to organize and assist in the running of the business, and most of the decisions are made by the Chinese team. McVitie’s believes this use of Chinese management will encourage true commitment and minimize the communication problem. Summary of Findings A number of clues for commercial success in China emerged from the company interviews. 88 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA Long Range Planning Vol. 26 April 1993 Form ofenterprise appears significant, with thejoint venture being particularly favoured. It is preferred by the Chinese and, from the foreign partner’s point of view, this makes it easier to obtain assistance from the Chinese authorities. All the operations examined comprised an element of technology transfer from the foreign partners. In the cast of the transfer of ‘soft’ technology, due to the shortage of skilled labour, training is invariably necessary, depending upon the degree of sophistication of the ‘hard’ technology involved. Since it is expensive to either send a group of U.K. instructors to China, or Chinese workers to the U.K., an appropriate technique appears to be to train a small group of Chinese who are then used to train their fellows. Every operation that involves the obtaining of raw materials locally has experienced difficulties in one or a combination of the following: quality, volume, delivery and variety. The only successful solution to this problem so far identified is to import the necessary materials from abroad. Local conditions products up to standards. In part raw materials, but the Chinese have such high quality higher supervisor: although worker me,nted with. have made it difficult to bring the companies’ normal quality this is due to the quality of local it is also explained by the fact that not previously been exposed to standards. The usual solution is a worker ratio than ‘back home’, education is also being experi- All the enterprises have had to handle their foreign exchange balances carefully, and whilst, so far, major problems have not arisen, this is only because it has been possible to sell at least part of the output for hard currencies which can subsequently be used to cover external expenditures (the renminibi remaining inconvertible). The use of Chinese management seems to be the norm in every case examined. This is beneficial to the operation in terms of managing the human resource to greatest economic benefit. Trust is perceived as very important in running the businesses, and the use of Chinese in the management decision-making process is seen as the best way to avoid conflict between work practices and mangement styles. This approach also exploits every potential for the benefit of the organization and avoids many of the problems which have been experienced by expatriates, in terms of adapting to a way of living, and having to cope with the cultural differences, of a foreign country. Almost all the operations examined had experienced infrastructure problems to varying degrees. Whilst in developed countries energy, transport and housing are taken for granted, no such assumption should be made about China, even within the relatively favoured environment of the SEZs. The most common problems encountered have been inadequate transportation and power cuts. These problems had been foreseen in most cases and their effects minimized by locating plants near their markets and installing own generators. A further common problem has been delays in bringing production on stream. This is attributed (variously) to poor organization, local project management deficiencies, and the very high degree of bureaucracy associated with the Communist system. As an illustration of this problem, it has been reported that it took one company 2 years and 173 stamps of approval to import a single piece of machinery.5 Whilst no easy solution has been found to the bureaucracy problem, any prospective investor would be well advised to carry out a thorough investigation of the structure of Chinese officialdom if some of the more protracted potential delays are to be avoided. The art of cultivating a personal relationship with those in power is known asgtlanxi, and potential investors are well advised to develop this skill. Conclusion Chinese desire to ‘catch up’ with the West in technological terms is beyond doubt, and some success has been recorded, albeit not as much as the Chinese themselves would have liked. Joint vcntures zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJ have introduced new technology even if not of the very latest variety, and a significant modernization of parts of Chinese industry has occurred because of the level of imported hardware and software. Difficulty has, nevertheless, been experienced in introducing radical change into an economy cut off for so long from commercial and technological developments occurring elsewhere. Although a vast number of foreign investors bringing in substantial foreign capital has been attracted, not all investments have been as fruitful as anticipated, and most investors have experienced numerous problems related to the inadequate investment environment, complicated procedures, and the difficulty of negotiating with the Chinese. Most companies have not experienced all the difficulties mentioned, and experience suggests that once the initial hurdles have been overcome, the majority of joint venture investments seem to operate reasonably successfully.‘6 The attitude of the Chinese Government itself has been crucial in providing an impetus to overcome the problems imposed by an inconvertible currency, exchange control regulations and a general management ethos seriously out of line with twentieth century requirements. Mere investment incentives and policy changes of themselves would have been Investing in China: Guidelines 89 for Success insuffkient to achieve even the limited success that (5) Pomfret, ibid. p. 25. has occurred. Whilst many problems remain, (6) Pomfret, ibid. p. 26. corporations have been able to develop strategies (7) World Bank, China: External Trade and Capital, p. 254, (1988). which enhance their possibility of success. A study China, (8) Economist Intelligence Unit, Country Profile 7990-97: of the problems those corporations have encounNorth Korea, p. 55, The Economist Publications Ltd. London tered and the responses they have developed (1991). provides useful clues to success for those wishing to E. Cheng, Why foreign investorssee China as a gamble: goodbye (9) invest in China. zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA cruel world, Far Eastern Economic Review, 18 January, p. 40 (1990). (10) References (If) Pomfret, ibid. p. 69. Guangdong Under (12) Vogel, ibid. p. 126. Press, Cambridge, Massa- (13) China’s Opening to the Outside world: the Politics of Empowerment, p. 114, Praeger, New York (1989). J. Irvine, M. Croft and M. Kelly (with additional contributions by others), China: market is waiting, Accountancy, 99 (1123), 67-75, March (1987). (14) J. Swain, (1) E. F. Vogel, One Step Ahead in China: p. 125, Harvard University chusetts (1989). Reform, (2) J. R. Woetzel, (3) R. Pomfret, Investing in China: Ten Years of the ‘Open Door’ p. 103, Harvester Wheatsheaf, Hemel Hempstead (1991). Policy, Business (15) (16) (4) T. W. C. Lo and A. Yung, Multinational service firms in centrally-planned economies: foreign advertising agencies in PRC, ManagementlnternationalReview, 28 zyxwvutsrqponmlkji (1 ), 26-33 (1988). Vogel, ibid. p. 136. Shanghai surprise, World Supplement, The Sunday Times p. 38, 10 November Magazine, (1991). op. cit., p. 37. B. Stavis and Y. Gang, A survey of Shanghai joint ventures, Review, pp. 46-48, March/April (1988). China Business