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Entering China’s Market: The do’s and don’ts

It’s the world’s second-biggest economy and Western businesses want in, but they need to know how to do it, report Michael Barris and Chris Davis from New York.

When he was asked to comment on his company’s foreign growth outlook during an analysts’ meeting last month, Henry Gerkens, chairman and CEO of Landstar System Inc, a Jacksonville, Florida-based freight-transport systems provider, said he hesitated to do business with China.

“I just am a little bit leery about doing business in a communist country,” the executive said.

Says consultant and author Stanley Chao about doing business in China: “China is still the Wild West and far from our Western standards with respect to business ethics and laws.”

And Savio S. Chan, president and chief executive of US China Partners, a New York-based consulting firm that has helped American companies do business in China, says: “If you do it the right way, there’s a lot of opportunity in China, but if you do it the wrong way, you can be blacklisted and that will come back to haunt you.”

The difficult economic climate in Europe and the US combine with China’s changing demographics, rising incomes, increased consumer spending and increasingly open business environment to make the world’s most populous country and second-biggest economy attractive to Western businesses, especially small and medium-sized companies (SMBs). But doing it the “right way,” as Chan calls it, is often debated endlessly by US companies that only export to China or manufacture and sell in the country.

Chao, the author of Selling to China: A Guide to Doing Business in China for Small- and Medium-Sized Companies (iUniverse, 2012), believes now is when SMBs have a better chance than ever for going into China.

“Where else in the world are you going to find a population of 1.3 billion, a growing middle class and a GDP growing at 8 to 10 percent?” says Chao, the son of Chinese immigrants who now heads up Los Angeles-based All In Consulting.

“In the United States, we’re growing at an anemic 2 to 3 percent a year and most SMBs aren’t doing that well. China’s certainly a good new market for them.”

Gerkens’ comment on why he’s “leery” about doing business in China expresses an anti-China bias that some observers say is typical of middle-market US companies, which have annual revenue of $50 million to $500 million.

The CEO, according to a transcript of the meeting, spoke more enthusiastically about exploring opportunities in Denmark, whose GDP in 2012 was about $313 billion, a tiny fraction of China’s $8.36 trillion.

Gerkens’ comments, which followed the release of the company’s first-quarter financial results, “baffled” Charlie Welsh, group editor-in-chief of Xport Reporter, an online business-information journal which covers the export market.
“People have fears that if they go to China, they have opportunity, but there are risks there,” he said.

Xport, a unit of British publishing and education company Pearson PLC, says it analyzed more than 200 interviews its journalists conducted with decision-makers at mid-market companies. The results indicate that while some large corporations have jumped into exporting to China, mid-market companies “are not even trying to sell their products (there),” Welsh wrote.

Welsh noted that in April, Guangdong province announced plans to pour $228 billion into infrastructure, with 60 percent of the spending related to transportation. “Yet even with opportunities on this scale, a majority of [US] mid-market companies harbor significant reservations about selling their products and services to China and have prioritized smaller foreign markets that they feel more comfortable operating in,” Welsh wrote.

Statistics from the US-China Business Council tend to back up Welsh’s claim. Despite an increase of $6.6 billion, or 6.5 percent from a year ago in US exports to China, the nation’s overall share of exports to China dropped to 7 percent in 2012 from 10 percent in 2000, the council said in its latest report.

“That means that on the whole, they are losing competitive ground,” Welsh said. “That’s worrying, because if the market is getting bigger, the opportunity is getting bigger. And the US share of that is getting smaller. Somebody else is benefiting at their expense.” China remained the US’s third-biggest export destination last year, trailing Canada and Mexico, according to the report.
Welsh thinks media reports that emphasize the US disadvantage in the export market and other issues, are misleading. “They try to say there are barriers to US companies going in. Forget about it,” Welsh said. “Are American companies even making the effort in the first place?”

“It’s not just a question of the US needing to export, but they need to produce more tradable goods because they can’t rely on consumer driven demand,” he said. “So the answer has to be by growth in external markets. And the obvious place is the biggest market.”

‘Demand and desire’

Welsh said his visits to China have shown him a widespread “demand and desire” for US products. “And then you come back here and you talk to people and they go, ‘Yeah, we haven’t quite worked it out, yet.'”

Chao agrees that the medium-sized companies he handles as a Los Angeles-based consultant appear to lack drive when it comes to exporting to China. “Only two out of five companies I visit want to make a serious attempt in entering China,” Chao said.

“Basically, they don’t see China as a real, practical market for them and should only be left for the large, multinational corporations,” he said. “China is just seen as too far, too expensive, too foreign and just too wild for smaller companies to take a chance.”

Clouding the issue further, the office of the United States Trade Representative last week once again put China on its “priority watch list” of countries who it claimed failed to provide protection of US companies’ intellectual property rights, citing claims that China launched cyber attacks on US firms.

Chao says mid-market firms still cling to an “antiquated” view that only large corporations can export to China. “They had the political connections, investment capital, and most of all, the time to wait for the market to develop,” Chao said. “Though antiquated, this mentality is still pervasive among smaller companies.”
Perry Wong, director of research at the Milken Institute, says anyone venturing into the “vast, fast evolving and increasingly complex market that is China should apply “the three double Ds”: “Due Diligence, Due Diligence and more Due Diligence.”

Wong says cost advantage is the most important thing for small and medium-sized businesses to consider, because they are more sensitive to pricing and cost control. “If you go back 10 years ago, manufacturing costs were very low in China, energy costs were somewhat stable and one could make the argument that administratively it was a lot easier to operate in China compared to now,” Wong said.

Wong added that US companies can no longer assume that anything they do in China will be cheaper than doing it at home, though labor is still an advantage, if you go inland.

“China is a big country so there is a big gap between the operating costs when you set up factories in the east coastal region viz a viz the inland region,” Wong said. “There are a lot more labor regulations in terms of pay and pension than 10 or even five years ago.”

Dilworth’s experience

Wong cited recent research that he said found that China’s wages are 40 percent below US wages. That advantage, however, can be canceled out by energy costs, which are much better in the US, he said. “If you are making some very bulky manufactured goods, it almost doesn’t pay to manufacture in China any longer,” Wong said.

John Dilworth, vice-president for sales and marketing for GraphOn Corp, a Campbell, California-based developer of application-publishing software, said his company’s proprietary remote-access Internet Protocol competed directly with Microsoft Corp and Citrix Corp, and his company was having trouble gaining any traction in the US. So they decided to go worldwide in the hopes that the two giants didn’t have the lion’s share of the market outside of the US, which turned out to be true.

GraphOn left all of Asia, including China, to one employee based in Seattle and, between the problems of language and time zone, the strategy failed, he said. “Probably most important,” Dilworth said, “was the cultural difference. I don’t think GraphOn ever understood the cultural difference in how to do business in China.”

Bill Smith, CEO of VU1, a New York-based company developing a new kind of mercury-free incandescent light bulb now being manufactured in China, singled out cultural differences in doing business as the biggest hurdle his company had to overcome.

VU1 began operations in the Czech Republic, an experience Smith calls “horrific. It’s basically unionization on steroids over there.”

Lured by the lore of low costs of manufacturing and components, he turned to China about a year ago, but with what turned out to be not enough groundwork. He hired a lighting company in Guangdong, and gave all the specs and instructions. The Chinese company said, “We can do it, no problem.” Deadlines were never met, communicating dropped off, and nine months later, VU1 got a product that failed in the field, Smith said.

A board member brought in Chao, who visited the Guangdong factory, their outsource partners and their secondary suppliers. He found that many of their components didn’t meet specs, none of the in-process testing was being done, they lacked the equipment necessary to make some subcomponents and no final quality checks were done.

There was a clash, Chao said. “The Westerner blaming the Chinese company saying, ‘You lied, you cheated,’ and the Chinese company came back and said, ‘No, we did our best to meet the specs’.”

Chao said he doesn’t blame the Chinese manufacturer as much as he blames the Americans for not doing their homework, not verifying for themselves that the manufacturer could actually do what they said they could do.

Dilworth said he learned that China was a land of many re-sellers, where nobody seemed to be loyal to any kind of structured channels. “A lot of re-sellers will become distributors,” he said, “then half of the employees will leave the company and create a new company selling the same thing. Something that’s not allowed here in the States, with non-compete clauses.”

“The problem is you build a company and a distribution channel and an ERP (enterprise resource planning) system internally and you put strategies all together and then you have to completely rethink how you’re doing business,” said Dilworth. “We tried to do it our way and said ‘No, this is our policy, you have to follow it’ and we failed.”

Language is half the problem and the difference in time zones is the other half, he said. “But I honor the contract, I honor the three-tiered distribution channel that is traditional in the US and Europe,” he said. “You have to think of it differently in China if you want to be successful.”

‘Bricks and mortar’

Microsoft and Citrix “put bricks and mortar” in China to try to infiltrate the country, Dilworth said. “But they have not done a lot better than we have in China.”

Bricks and mortar and a hundred employees aren’t the answer, as far as Dilworth is concerned.

“The right answer is having the right Rolodex and understanding the culture,” he said.

“I’ve had four attempts of trying to get into the Asia market with different technologies. I failed every single one. I can’t say that this one was wildly successful, but it’s up and it’s running and we are profitable with the venture and I’m very happy.”