With Mainland China continuing to open up to foreign companies, Nicky Burridge finds out the challenges they face to achieve business success in the world\u2019s second largest economy<\/p>\n
Global insurance broker Willis Towers Watson recently announced it had become the first fully licensed foreign broker to be allowed to transact all types of insurance business in Mainland China. The company, which was one of the first foreign brokers to enter the market in 1994, received approval to expand its operating permit in May. The move was made possible by a series of measures announced by China\u2019s President Xi Jinping to open up the financial market to foreign operators.<\/p>\n
Though the Mainland is continuing to open up its market to foreign companies, regulatory hurdles remain and businesses need to understand its rapidly evolving business landscape in order to succeed there.<\/p>\n
Ongoing liberalization<\/p>\n
At the 19th National Congress held in October 2017, President Xi pledged to further open up China\u2019s economy. Since then, several initiatives have been announced. Nick Marro, Analyst at The Economist
\nIntelligence Unit, says: \u201cThere have been a number of liberalizations to the foreign investment regulatory regime, as well as measures introduced to help encourage and incentivize more foreign direct investment (FDI) into the Mainland.\u201d<\/p>\n
The financial services sector and automotive manufacturing industry are set to be the biggest beneficiaries. Liberalization measures include allowing foreign banks to set up branches and subsidiaries, and removing the foreign ownership cap for banks and asset managers. Insurers are also being given the green light to increase their stake in joint ventures to 51 percent, with a view to removing the cap altogether within three years. Restrictions on the business scope of foreign insurance brokers have also been lifted.<\/p>\n
In the automotive sector, foreign ownership limits on joint ventures are being gradually removed, meaning overseas companies will no longer face market entry restrictions. Since 1994, China has required foreign automakers to enter into ventures with domestic partners to operate in the country, with the overseas company holding no more than 50 percent.<\/p>\n
With this, competition among car makers will intensify, says Siao Tin Soh, Analyst at GCiS China Strategic Research. \u201cForeign automakers may find it easier to do business in China. Tesla recently
\nannounced plans to build a Gigafactory in Shanghai, which will be capable of producing 500,000 vehicles a year at its peak, and also act as an R&D centre for the company. Chinese carmakers, in turn, will be under pressure to strengthen their own brands. In practice, we expect to see a mix of different operating models when the ownership limits are eventually being phased out. For instance, despite the relaxation of ownership limits, Volkswagen will continue with the joint-venture operating model in China.\u201d<\/p>\n
The liberalization measures will start with foreign ownership restrictions on new energy vehicles,
\nsuch as electric cars, being lifted by the end of this year, with limits on commercial vehicle joint ventures ending in 2020 and ones for passenger vehicles in 2022.<\/p>\n
China is both the world\u2019s largest automotive manufacturer and its largest consumer. Automotive manufacturing is important to Mainland China and has been identified as one of 10 priority sectors
\nunder the \u201cMade in China 2025\u201d initiative, which aims to transform Chinese industry through research and development (R&D) in high-tech fields.<\/p>\n
Improving conditions<\/p>\n
While the finance and automotive sectors may be the main beneficiaries of recent announcements, measures are also improving conditions for companies in other sectors. \u201cIn sectors like petrol station infrastructure building, we are seeing some interest by major foreign oil and gas companies in formulating strategies to capitalize on the relaxation of limits on the number of allowed petrol stations,\u201d says Soh.<\/p>\n
Earlier this year, Premier Li Keqiang urged efforts to promote business registration reform, separating business licenses from operation permits to improve the business environment. The measure is likely to be welcomed after China\u2019s position in the World Bank\u2019s Ease of Doing Business ranking has remained unchanged at 78th for the past three years. In May, it was announced that the
\namount of time required to start a business in municipalities, sub provincial cities and provincial
\ncapitals will also be reduced this year from an average of more than 20 to 8.5 workdays.<\/p>\n
\u201cThroughout 2017 and into 2018 we have seen a focus from central policymakers on improving the
\noperating environment for both foreign and local companies, namely through broad policy directives at \u2018optimizing\u2019 the business environment. This could include strengthening commercial regulations, to help with regulatory clarity, as well as offering more types of financing opportunities to small- and medium-sized enterprises, among other support policies,\u201d says Marro. But he cautions that many of the changes are relatively modest, and will take several years to be fully implemented.<\/p>\n
Significant challenges<\/p>\n
Despite some barriers being reduced, obstacles remain. \u201cForeign companies looking to enter
\nsectors already dominated by domestic companies will continue to face challenges,\u201d says Soh.
\n\u201cIn some automotive component sectors, domestic component suppliers will continue to have
\nan edge over foreign component suppliers because of their longstanding supply relationships with
\nChina\u2019s automakers. To benefit from opportunities arising from the easing of market access requirements, foreign suppliers may need to change their existing sales strategies accordingly \u2013 and this will take time.\u201d<\/p>\n
Hong Kong Institute of CPAs member Francis Au, Chief Financial Officer at EKPAC Holding, a procurement solution provider for cutting-edge technological equipment and financing to key services providers in the Mainland, where it has had an office since 1910, points out the challenge brought by each province and local government having its own rules and regulations. \u201cYou have to be really familiar with the local policies. You have to get approval from different departments \u2013 and this imposes challenges on foreign businesses,\u201d he says. Au adds that with the differences between Mainland law and international law, it is important that foreign entities engage local professionals, such as CPAs and lawyers to help them navigate these complexities.
\nMabel Chan, Deputy Managing Partner of Grant Thornton Hong Kong and past president of the
\nInstitute, agrees: \u201cStarting a business from scratch in the Mainland is quite challenging. It has a very complex system.\u201d Chan has served on the Institute\u2019s working group on co-operations with Mainland small- and medium-sized practices. She adds that in addition to the varying rules and regulations in different provinces and cities, there are also more than 100 different types of taxes in Mainland China. Companies also need to make contributions to various schemes such as social security, insurance and retirement provision. \u201cYou really have to take into account all of these factors before you decide whether to enter the Mainland,\u201d she says.<\/p>\n
Marro points out that companies still face stringent licensing measures, which are likely to hamper foreign direct investment inflows, and some sectors have even recently become more restricted. \u201cInvestment into the technology sector is increasingly being looked at through the lenses of national security, meaning investments in cloud computing, big data and other areas of emerging technology will be subject to different, and at times difficult, licensing and security reviews,\u201d he says.<\/p>\n
The current United States- China trade tensions could also lead to U.S. companies facing greater regulatory scrutiny over their operations in the Mainland. \u201cAssuming that trade tensions continue to intensify, greater regulatory scrutiny will become more pronounced \u2013 non-tariff barriers like regulatory scrutiny and longer custom processing times are already prevalent in China,\u201d explains Soh. \u201cBased on our interactions with U.S. companies operating in China, this is already a concern long before the recent escalation in trade tensions.\u201d<\/p>\n
John Yang, Chief Financial Officer of restaurant chain owner Tsui Wah Holdings, and an Institute member, notes that another factor to consider is rising costs. \u201cThe increases in operating costs, mainly labour costs during the past decade, is the biggest challenge to doing business in Mainland China.\u201d Rules and regulations in the Mainland, he adds, are not as business-friendly as in Hong Kong. For example, there are heavy penalties involved in winding up small companies, particularly at an early stage.<\/p>\n
Lessons to learn <\/p>\n
Once foreign companies have established operations in the Mainland, it is important they remain nimble enough to respond to change. \u201cChange happens very fast in the Mainland, and the market is very competitive. Local companies can set up manufacturing very quickly and produce a similar product in a short space of time. It is difficult to maintain your product edge,\u201d says Au at EKPAC.<\/p>\n
He gives the example of a European industrial machinery supplier that set up a factory in the Mainland five years ago. The European company put a lot of emphasis on quality, but a local company was able to produce similar products at half the price. \u201cThe end-user preferred the cheaper product because if it broke, the local manufacturer would supply a new one and fix the old one,\u201d he says. \u201cIn the end, the Chinese manufacturer bought out the European company.\u201d<\/p>\n
Companies must also be prepared to localize their products to appeal to Mainland consumers\u2019 preferences. American food company Kraft Heinz recently created a new biscuit for the Mainland market, after disappointing Oreo sales \u2013 with local people finding them too sweet. With the help of a local team, it produced Jif Jaf biscuits, which look like Oreos with flavours such as matcha green tea, chilli, and cheese. Not only are the new flavours not as sweet as traditional Oreos, but they are also designed to appeal to younger consumers who are more experimental and adventurous in their tastes.<\/p>\n
With regions so diverse, McKinsey & Company have argued that China should rank as more than just one country. According to a report titled, Meet the 2020 Chinese Consumer, \u201cconsumer needs could become so varied across regions that local insight and strategic decision-making power will be vital. Regional offices should therefore be given full responsibility for their own profit and loss accounts, strategic planning, consumer research, innovation, tailoring of the portfolio, development of the route-to-market model, and marketing.\u201d<\/p>\n
Au believes companies should pay a lot of attention to changing consumer tastes particularly in very developed areas, such as the south and around Shanghai. \u201cDifferent regions have different lifestyles, and the products that companies offer in China have to be totally different as the market matures,\u201d he says. \u201cThe local companies are much better than those overseas at adapting to these changes.\u201d<\/p>\n
Chan at Grant Thornton agrees. \u201cBecause of the cultural differences, when overseas companies invest in Mainland China they often think something is workable, when it is not.\u201d She adds that building up trust is a very important part of doing business in the Mainland, but many foreign companies fail to understand this.<\/p>\n
Yang of Tsui Wah also cautions companies to not expand too quickly. \u201cFast expansion can be a disaster for companies without the correct planning and budgeting. Many companies want to expand their market in the Mainland without thinking about their cash inflow, but capital markets will not support these companies,\u201d he says<\/p>\n
Hong Kong\u2019s advantage <\/p>\n
While China is opening up to foreign investment, Hong Kong companies continue to enjoy significant advantages. Under the Closer Economic Partnership Agreement (CEPA) between Hong Kong and the Mainland, first signed in 2003, Hong Kong companies get greater access to the Mainland market, while Hong Kong is also used as a springboard for Mainland firms looking to expand overseas. Foreign investors can tap into these benefits by establishing businesses in Hong Kong. \u201cThe CEPA allows Hong Kong-based companies access to licenses that are normally off-limits to foreign investors from other countries, such as cloud computing services,\u201d Marro explains.<\/p>\n
Au also thinks companies in Hong Kong are well-placed to benefit from other policies, such as the Belt and Road and Greater Bay Area initiatives, which he believes will boost demand for the expertise provided by professional services firms, both within China itself and in Belt and Road countries.<\/p>\n
Yang points out that Hong Kong\u2019s exposure to both eastern and western cultures gives the city\u2019s companies an edge over foreign companies expanding into China, while further advantages are gained through common language and lifestyle.<\/p>\n
Hong Kong companies also have the ability to quickly respond to changing tastes in the Mainland, notes Chan.\u201cThey can communicate smoothly with those in the Mainland, so they are more adaptive,\u201d she says. \u201cCompanies in Hong Kong have substantial experience in doing business in China and serving people from the Mainland and that accumulation of experience is an advantage.\u201d
\nYang advises companies looking to expand into the Mainland to play to their strengths and focus on having a stable management team in place. \u201cI focus on our brand and gradually expand the business,\u201d he says, adding that having a strong network is critically important.<\/p>\n
Au urges companies to pay attention to localizing their product. He adds that the Mainland is developing very quickly, exemplified by its rapid adoption of cashless payment systems. \u201cCompanies have to be agile and embrace this change,\u201d he says.<\/p>\n
building the right partnerships and taking advice. \u201cAny overseas company that really wants to invest in the Mainland should talk to professionals in Hong Kong,\u201d she says. \u201cWe can share our experience and support. That is definitely the way forward.\u201d<\/p>\n