Entering China: opportunities, structure and strategy

13, Mar 2012

In the second in our series of articles on breaking into BRICs, we explore the opportunities for UK business in China, and consider strategies to best exploit this complex and diverse region, beginning with the three Ps…

China is regularly in the press but the views are often polarised. Is it the saviour of the global economy or the next financial bubble waiting to burst? A land paved with golden opportunities or littered with corporate wrecks?

The truth lies somewhere in between. Successful companies in China balance opportunism with thorough preparation and careful execution – a structured approach is critical to navigating the complexities of China but the rewards for those who do so are significant.

What are the opportunities?
While inflationary pressures and social and environmental issues do cause some commentators to raise questions about the long-term sustainability of growth in China, most economic analysis is that growth is likely to continue, albeit at slightly moderated pace. This is likely to create opportunities across many sectors.

For example:

• By 2015 China’s internet population is expected to reach 650 million. 
• China is predicted to become the world’s largest luxury goods market.
• Retail sales are expected to overtake the Eurozone by 2020.
• China wishes to produce 15 million electric cars and lay 18,000km of hi-speed rail by 2016.

Importantly for UK businesses, Anglo-Chinese relations are at a high, as demonstrated by the recent announcement that the City of London will become the first city outside Hong Kong and Mainland China to trade the RMB. (More on that here: Osborne’s RMB deal is a major boost for the UK.)

With UK exports to China increasing by more than 20% in 2011, there are particularly good opportunities for UK businesses. Attracting particular interest are areas such as service businesses, luxury brands and hi-tech manufacturing, where the UK has an excellent reputation in China. UK retailers are also making good inroads.

Getting the strategy right – the three Ps
China is a really a series of connected markets, each with different requirements from each other let alone with the West. It is critical to have a carefully tailored strategy to reflect this diversity, which should focus on the place of operations, nature of product and identifying partners to go to market.

Beijing, Shanghai and Guangzhou have traditionally been the gateways for businesses entering the region. While there may well be good reasons to focus on these cities, with their strong government connections, Westernised middle class and strong manufacturing base, there can also be real advantages in operating from so-called second and third-tier cities.

It can be easier to set up in these locations, they may be local centres of excellence – for example Dalian for IT, or Xian or Chengdu for aerospace – and there are often tax breaks and other incentives, especially in western China.

The China-Britain Business Council, which is a UK-government sponsored organisation for helping businesses in China, can provide some very useful information on different locations.

Products that are highly desirable in the West will not necessarily succeed in China. The most successful companies are typically those which build on their global brand but tailor the actual product to suit the particular market.

For example, IKEA identified early that DIY/do-yourself in China is actually GTTDI: ‘Get a tradesman to do it’. Meanwhile, Kraft’s world-famous Oreo biscuit was almost pulled from the market nine years after its entry. The company was forced to acknowledge that the taste and eating habits of the Chinese population matter. The result was a change in Oreo’s shape and flavour to a rectangular shape and reduced sugar.

Chinese frequently buy either on price or on brand, with the result that Western companies tend to be most successful with high-end and low-end products, for example in the food industry the UK is a leading exporter both of single malt whiskies and of pig offal.

An important decision is whether to go it alone – setting up a so-called WFOE, or wholly-foreign owned enterprise – or whether to partner with an existing Chinese business or even setting up a franchise operation.

A partnership can be the quickest route to market – and is compulsory in some sectors, such as property – as well as providing valuable expertise in local business practices.

Joint ventures are becoming common once again after being out of favour a few years ago. Care needs to be taken to protect Intellectual Property (IP), and equity joint ventures need to be structured carefully at the outset as there is little flexibility.

In certain sectors such as healthcare and education, the most important potential partner may well be the PRC Government. Whatever sector a business operates in, governmental support is particularly useful in China.

Whichever route you adopt, we recommend that businesses take proper legal and financial advice, and undertake formal due diligence as appropriate. Doing homework is critical in China.

Getting the structure right
There have been a number of high-profile cases of companies being temporarily shut down by the authorities, facing IP infringements, or having cash trapped in China. In many cases, these problems can be minimised by careful advance structuring.

Critical to seizing the opportunities in China is managing downside risks. Some of the key risks facing finance directors – getting the structure right, cash flow, financing, IP and staffing – are detailed in our recent post: How to invest successfully in China.

Taming the dragon
Overall China offers huge opportunities for UK businesses and many companies, from SMEs to multinationals, are reaping the rewards of a successful China strategy.

It is vital however to ensure that companies put in place a China-specific strategic plan rather than simply rolling out their global model.

Equally it is important to structure the operations to manage the downside risks. Investing time at the outset maximises the chances of success.

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