The China Challenge
Daniel R. Joseph
The China Learning Curve
China: The Current View
Surveys show 80+% of foreign companies earning a profit
Amidst the success, also still much…
• Failure: Shutting down and moving out
• Struggling: Losses, management turmoil, etc.
• Stuck in the mud: Now that we’re there, we can’t seem to grow/expand/make money.
Companies transitioning business in China
•
•
•
•
From sourcing to selling in China
Selling through agents but now considering direct
From exporting to making locally
Considering M&A to accelerate growth
The Bar is rising: China is part of the strategic plan
• Not just global companies are involved
• Used to be many companies were dragged into China by circumstances; now, more and more
are actively plotting how to be there
The Challenge of China
Emerging markets are new: It used to be only global giants were active in emerging markets;
even then, not often deeply involved. China is the first major emerging economy to
become integral to supply chains and growth strategies.
Economic Frontier: Managers have had no choice but to treat China like a frontier; to hack
their way through the jungle. Many have made it through, rarely without getting stuck in
the mud or thrown off track for a while. Many fell off a cliff or got lost in the quick sand.
Take a step back in order to move forward: Some times it helps to step back and look at the
bigger picture to best position oneself to move forward
Critical Differences, Killer Mistakes: Learn the critical differences (culture, economic
structure, business environment) in order to avoid the killer mistakes (management and
strategy)
Knowledge Map: Critical Differences and Killer Mistakes
Local Conditions:
History • Political System • Economic Structure • Business Environment •
Culture
Killer Mistakes
•
•
•
Strategy
Partner/Key
Person
Management
Tactical Execution:
• Mkt dev
• Sourcing
• Mfg/Ops
• Legal
• HR
• Banking
• Other
Planning
•
•
Anticipate
events
Assess future
course
Chinese Culture
Key Cultural Attributes
Hierarchical
Chinese culture has
a strong sense of
hierarchy.
Culture is pervasive.
It shows itself
throughout the
various levels and
aspects of society,
from the home to the
office to the halls of
government.
Hierarchical
Lack of social mobility: China is traditionally a very hierarchical society. Those on top stay on
top. Those on the bottom stay on the bottom.
Rank and position are important: Although social mobility is increasing in China as the
country liberalizes, the culture retains a strong sense of hierarchy. Rank and position are very
important.
People expect a clearly defined hierarchy: Chinese people are accustomed to working with a
clearly defined hierarchy and tend to desire such an arrangement if it isn't present.
Leaders are different: In hierarchical societies people tend to see leaders as being elite,
special, and above the common man. That distance between leader and subordinate can be
an impediment to developing a good team environment.
Hierarchical
Chinese culture has an authoritarian
approach to leadership.
Chinese culture is changing.
Like many things in China, its culture
is changing, which is an extremely
important aspect of understanding
China. Leadership is transforming
from authoritarian to more
empowering.
Changing approach to leadership in China
Authoritarian Leadership
Authoritarian leadership: The Chinese leadership style is very authoritarian. Leaders have all
the power and prerogative. Subordinates are expected to simply submit.
A positive work environment: One challenge is to ensure that your operation in China has a
positive work environment in which issues such as discipline and criticism are handled in an
acceptable fashion.
A team-oriented environment: The greater challenge is ensuring that you are hiring the best
candidates and getting the best out of everyone, as opposed to an environment in which all
ideas and decisions have to emanate from one person who is primarily concerned with
protecting his position.
Rule of Law
Weak adherence to the rule of law: A common characteristic of developing countries is
weak adherence to the rule of law. China is no exception.
Not just a government problem: Discussion of rule of law problems usually focuses on
politicians, the government, and the courts. But the problem is deeper and broader than
that. Corruption involves government officials. IP violators are often businesses and
individuals. It is individuals who disregard driving rules. All of these issues reflect the same
factor—weak adherence to the rule of law as a pervasive cultural attribute.
Businesses are managed by rules: Processes, procedures, work instructions, and the like are
rule-based concepts that are necessary to manage a business. Adherence to such “rules” can
also be loose in a society with weak adherence to the rule of law. Beyond accounting for
problems like IP violations and corruption, managers in China have to adapt to being in an
environment where rule-based behavior in general is weaker.
Static World View
A static world: In less developed countries, life is the same for each generation. Nothing
changes.
Static expectations: When people don’t see change, they don’t develop the awareness
that people can change the world or shape their lives.
Static thinking: People who aren’t in the habit of trying to change or control events in their
life don’t develop habits such as taking the initiative, planning, foresight, and trying to
What if life never
avoid future obstacles.
changes generation
Static vs. dynamic world view: This cultural mindset is evident not only in China but across after generation?
all less developed societies. It is part of the cultural pattern that differentiates developed
societies from less developed ones. It can be said that developed societies have a
“dynamic world view” in which people can change the world and shape their future and
less developed societies have a “static world view” in which change is not possible.
Static vs. Dynamic Culture
MAJOR CULTURAL ATTRIBUTES
LESS DEVELOPED SOCIETY
ATTRIBUTE
DEVELOPED SOCIETY
Static
People don’t believe in change because nothing has ever changed.
Fate and Future
Dynamic
Man can change the world and shape his own future/destiny.
Hierarchy
Social position is fixed. Those on top stay on top, those on the
bottom stay on the bottom.
Authoritarian
Leaders can’t be challenged and as such aren’t accountable so
they tend to be harsh, heavy-handed, authoritarian.
Societal Structure
Social mobility
Anyone can get rich or be president; movement up and down social
ladder.
Empowering
Leaders are accountable to those they lead. Balanced, participatory, more
team-oriented approach.
Weak (Might makes right)
No limits on leaders means no rules. Rule of law doesn’t develop
at any level of society.
Rule of Law
Leadership
Strong (Fair competition)
Leaders are bound by rules and so is everyone else.
Static vs. Dynamic Culture (cont.)
MAJOR CULTURAL ATTRIBUTES (cont.)
LESS DEVELOPED SOCIETY
ATTRIBUTE
DEVELOPED SOCIETY
Weak and formal
Not very adept at working together without formal hierarchy,
responsibilities, etc.
Cooperation
Strong and informal
Accustomed to informal working relationships with loose and
flexible responsibilities.
Politics and loyalty
Hierarchy and lack of accountability means the only way to get
ahead is via politics and loyalty.
Good enough is best
Not trying to change future and so don’t develop the mindset
(planning, foresight, analysis) necessary to do well or improve in
these areas.
Unimaginative
If you can’t change the world you can’t see a new way of doing
things. No imagination hence no creativity.
Accountability &
Advancement
Merit
Accountability and fair competition means people have to earn
what they get.
Be the best
Search for improvement leads to methods for better quality and
efficiency.
Quality & Efficiency
Creativity
Imaginative
Essence of shaping your destiny is finding a new way or idea, which
leads to creativity.
Management Principles
Culture:
Leadership, trust, accountability, initiative,
etc.
Planning:
Process:
Performance:
Be as thorough as possible in
addressing issues upfront.
Make sure everyone knows
how work will be done
Measuring key indicators is your
best way of creating visibility.
Clarity:
Visibility:
Reinforcement:
Discuss everything in detail. Leave
nothing to chance.
Know as much about what is
happening as possible.
Don’t expect immediate change.
You have to reinforce your ideas.
Back to Basics
Own the system and
culture
Use the system to build the
culture
Actively work to develop the
management system and
culture you want.
The right system will shape the
culture.
Keep it simple. Staff is likely less
experienced.
Shaping your
corporate culture
Tactical Techniques
Tactical Principles
Strategic Principles
Credit Issues
Key Topics
Cross Border Transactions
“You can’t get your money out of China”: This sentiment is frequently repeated relative
to China and reflects the experience of foreign companies in China going back many
years.
Much has changed: In fact, much has changed in this regard such that the reputation is
not nearly as deserved as in the past.
Case #1: Repatriation of profits
• The rules for repatriating profits from China are more complicated than in developed
countries.
• The rules include a stipulation that 10% of earnings per year be retained up to a
certain amount (50% of your registered capital).
• This means that you might have to limit dividends for repatriation to 90% of net
income in some years.
Cross Border Transactions
Case #1: Repatriation of profits (continued)
• For many companies this is not important as they use their profits to finance
growth in China
• In the past, even if a company met the requirements, it seemed the authorities
would always find a reason to withhold approval or make it difficult to complete
the transaction.
• In recent years most foreign companies report that, if they meet the requirements,
they don’t have difficulty obtaining approval to complete the transaction. This is
likely to be at least partially due to China’s huge foreign reserves which means that
China has enough FX to send some abroad.
Cross Border Transactions
Case #2: Selling product sourced in China
• Many foreign companies that have been sourcing in China now find that they can
sell the China-sourced products in China
• Because some companies did not sell in China previously, they do not have an
entity in China that is licensed to sell products, i.e., a WOFE or JV.
• Companies in this situation would like to be able to drop ship from the supplier to
the customer and either receive payment overseas or receive payment in China
and then, after paying the supplier, bring the margin back home. THIS IS NOT
ALLOWED!
• If you are sourcing in China and want to start selling in China, you will have to
either export the product and then re-export it back to China or you will have to
establish an entity in China that can buy and sell products (WOFE or JV).
Cross Border Transactions
Case #3: Intercompany Loans
• Due to foreign exchange restrictions and capital controls, intercompany loans
between a foreign parent or sister company and a Chinese subsidiary are difficult
to execute.
• Such loans have to be approved by SAFE (State Administration of Foreign
Exchange) and therefore must be structured in a very formal way, i.e., including
interest rate, duration, etc.
• Intercompany loans can also be difficult due to requirements relative to the form
and amount of registered capital that must be injected into a company in China
• It is important to ensure that a company is adequately capitalized upon formation
in China and that liquidity needs are planned for thoroughly
Bank Drafts (or “Notes” or “Acceptances”)
Support domestic trade in China: Notes are issued by a bank on behalf of a client and
in favor of a beneficiary, normally to support a trade transaction
Assignable: Can be and often are assigned to another party (a supplier who receives
one uses it to pay one of their suppliers)
Maturities: Typical maturities are 90 to 180 days, though some are longer in duration.
Credit Risk: From a credit point of view, it is the issuing Bank who is on the line to pay
the beneficiary. As long as the issuing bank is one of China's major banks, there
should be no problem in collecting
Bank Drafts (or “Notes” or “Acceptances”)
Discounting: Discounting market is not fully developed; it is important to know
whether a particular note, based on its terms and the issuing bank, can be
discounted and at what rate.
Banking Regs spur use: Bank Notes have become particularly common in the last few
years as Chinese banks and companies try to work their way around banking
policies and regulations.
• Chinese banks package the notes and sell them to wealth management clients
which allows the banks to move the obligations off their books
• Chinese regulators have warned banks relative to the notes and adjusted some
rules, mainly to protect bank balance sheets
• So far issuance of bank notes does not seem to have waned very much.
Offshore RMB Market
Gradual approach: Similar to most aspects of its liberalization program, China is
taking a gradual approach to the internationalization of the RMB.
July, 2010 really started: There have been many small steps. Basically the program
really took off in in July 2010 and has been gradually broadening since then.
Hong Kong is the center: The offshore market was initially located only in HK.
Singapore, Taiwan, and London are becoming trading centers as well. Volume in HK
remains the highest by far.
Offshore RMB Market
MAJOR CHANGES
Trade: Trade in goods and services in and out of China can be settled in RMB. Trade
finance methods are available in both onshore and offshore markets.
Accounts: RMB accounts can be opened outside of China, primarily in Hong Kong (HK)
but also in other jurisdictions. Foreign companies do not need to have a legal
entity established in China (or HK) in order to open an offshore RMB account.
Capital Markets: A capital market (bonds, equities, etc.), referred to as the “Dim Sum”
market, has developed to permit RMB held offshore to be invested. Channels exist
to raise CNH in HK and use it in the mainland. Hedging products are also available
and under development.
Exchange rates: CNH is freely traded in HK, although the exchange rate has so far
mostly tracked that of CNY which is controlled by the Chinese government.
Offshore RMB Market
IMPACT ON FOREIGN COMPANIES
Sourcing: Companies sourcing from China often receive discounts for paying in RMB
because suppliers benefit from lower administrative and financing costs and less
exchange rate risk.
Exporting: Exporters in China might find that accepting RMB is either an advantage
or a requirement for obtaining business.
Hedging FX Risk: Due to the lack of restrictions in HK, as opposed to China, hedging
CNH will be easier than CNY.
Credit: For large corporations, issuing bonds in HK is a welcome addition to the
existing, limited credit options in China.
For more information…
www.chinalearningcurve.com