Thursday, February 9, 1995

Getting on the Fast Boat to China

Depending on who you believe, China now has the second largest economy in the world, after the U.S. according to the UN, or the third largest after Japan according to the International Monetary Fund. Either way, it is pretty startling for a country with a per capita gross domestic product of less than $400. (Both the U.S. and Japan's per capita GDP are more than fifty times greater.) That China's economy has been under stated and under rated does not surprise those of us who have been doing business in China for years.

To others who are just getting the message about the exciting opportunities in China and are ready to join the next stampede into China, a word of caution is in order. As many business executives who joined the first wave into China in the late '70's found out: some of that glitter is pyrite. The outcome will depend on the executive's advance preparation, assumptions, motivation, Asia-related experience, and whether the objectives are long term or short. (If you're the investment banker looking for the quick hit, get there early. Don't wait until all are labled persona non grata.)

China's appeal

Specifically, why is China so attractive? China has been enjoying close to double digit economic growth for nearly 15 years. To fuel this growth, China has been a voracious buyer of capital equipment and technology. They buy from the U.S. when politics and export control don't get in the way, from others when they do. This is why Silicon Valley IC equipment companies, among others, are rushing into China.

After such sustained economic growth, the domestic consumer market is becoming one worth drooling over. Goods bearing the Pierre Cardin and Yve St. Laurent labels are prominently displayed in Guangzhou, Shanghai and Beijing and sold at world level prices. The shift from a centrally planned economy to a market economy means people are no longer evenly poor. While it's still a tiny percentage of the population that are making a lot of money, a very small percentage multiplied by a very large population base nonetheless amounts to a significant number of customers for expensive goods. Coca Cola has been in China for a long time and knows first hand about the growth in consumption. More recent entrants doing well there include MacDonalds and Campbell Soup.

Furthermore, China still possesses a large pool of motivated and reasonably well trained workers who can make goods at a competitive cost. The first ones to go to China because of this comparative advantage were the Hong Kong toy makers and the Taiwanese personal computer manufacturers. Motorola is one the first American high tech companies to establish manufacturing bases in China, not just to take advantage of the low cost labor but also to participate more effectively in the local market.

Pitfalls of Doing Business in China

So where are the potholes on this modern silk road to Cathay? First, virtually nothing stays the same about China. The economy, for example, according to most pundits and crystal ball gazers is likely to come to a screeching halt sometime this year or early next. (If Americans can't fine tune a market-based economy, what can be expected of the Chinese who are new at this game?) In the past, the Chinese economy lurched forward for 2-3 years and then hit a wall. Like a stunned drunk, China will pause and collect itself then lurch forward again.... In the meantime, if you have a contract that depended on the Chinese buyer getting easy credit from the Peoples Bank, you had better check into the situation soon.

Many people will tell you that whether your deal is in jeopardy depends on how well your Chinese counterpart is connected. Alas, that's true. However even 24 carat connections today could turn into brass tomorrow. Companies contemplating wholly owned operations in China need to be even more mindful of this issue--namely, how to track which way the political wind is blowing.

Having the right local partner to take care of the formidable amount of red tape can ease the pain of entry, and the local partner can guard your ongoing interest. Furthermore, China still has that 3rd world sensitivity about being exploited. Even though they now permit 100% owned foreign operations in China, the thought of the foreign entity taking all the profits still smacks of exploitation to them, and the approval process is bound to be long and arduous. If you leave a, say 20%, minority stake on the table for the local partner, you will find life easier now and in the future. 3M is a case in point. They had the very first wholly foreign owned venture in China, grudgingly approved in late 1984. Recently 3M took on a local partner to accelerate their business expansion of that venture in China.

Smaller American companies need not be fazed by the prospects of doing business in China if they have long term objectives and can gird themselves for the Chinese decision-making process that is almost never quick. Establishing a carefully thought out base now should pay dividends over the long haul as China's economy continues to grow.