Download China as a Market - American Bar Association

Is China Taking Over
the World?
Edward E. Lehman
Managing Director of
LEHMAN, LEE & XU
Past Vice Chairman of the ABA China Law
Committee
April 5 - 8, 2006
www.lehmanlaw.com
LEHMAN, LEE & XU
What is happening
in China?
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Spectacular macroeconomic evolution
Economic reforms process
market economy
but strongly monitored and controlled by gov’t
Integration into the world’s economy
Deep social changes
change in consumption
patterns
Risks: political instability, regional imbalances,
financial systems, concealed deficit...
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LEHMAN, LEE & XU
Macro Environment
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Social stability (priority) requires strong growth rate
(minimum 7%), to create employment due to:
 Restructuring State Owned Enterprises
 Increase of urban population
Growth based on foreign trade and investment (public
and foreign)
Overheating
Weak consumption due to uncertainty
Lack of welfare system
Savings of 40%, but problems with financial system
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LEHMAN, LEE & XU
FDI Forecast in China
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For 4th consecutive year China is the most preferred FDI
location worldwide
Global executives are more eager to commit FDI in China
than anytime since 1998
Also, China is seen as source of innovation and attractive
R&D location
• Lower R&D costs
• Availability and quality of local R&D labour
• IP protection
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China FDI destinations (next 3 years):
• 48% product manufacturing
• 18% R&D
• 13% distribution and logistics
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LEHMAN, LEE & XU
China Integration in
World’s Economy
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Exports 2004 → 593 billion USD
△ 2004 / 2003 → 35.4%
Imports 2004 → 561 billion USD
△ 2004 / 2003 → 36%
Foreign Direct Investment 2004 → 60.6 billion USD
Access to WTO: standardization of regulatory
framework
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LEHMAN, LEE & XU
Deep Social Changes
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Appearance of a young middle class
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Increasing urbanization
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Assimilation of Western life
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Quick development of a private industrial sector
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Appearance of a service and leisure culture
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One-child policy
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LEHMAN, LEE & XU
The Risks
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Economic Imbalances:
 Overheating
 Soft or hard landing?
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Geographic Imbalances
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Financial System
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Tax Balances? Contingent
liabilities:
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Political
stability?
 Welfare networks
 Banking recovery
 Local government investments
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Variations in the exchange rate?
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LEHMAN, LEE & XU
How does it affect us?
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China will be one of the most dynamic areas in the world
during the next 20 years
China’s Economy will be the World’s Second-largest by
2030
How it affect us:
China as a market
China as productive base / provider
China as competitor
China as partner
Not only affects each particular company, also to its
competitors, providers and clients.
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LEHMAN, LEE & XU
1. China as a Market:
Advantages
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Market with great opportunities
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1.3 billion people, myth and reality
Dynamic Evolution
Opportunities and challenges
Foreign presence in the market
Successful
• More than 400,000 FIEs
• Presence of big multi-nationals
• Presence of main companies in each sector
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LEHMAN, LEE & XU
Market Advantages
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Reputable: good reputation of financing institutions
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Continued liberalization
• Political decision
• WTO commitments
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More integrated in global economy
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Good infrastructure
• Telecommunications
• Transport
• A country “which works”
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A safe country
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LEHMAN, LEE & XU
Difficulties
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Very demanding market
• Clients want the best
• Idea of “middle technology” is rejected
• Clients know what they want
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Very competitive
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Wide foreign presence
Chinese client knows foreign markets
Compete with Chinese prices
Clients with negotiating experience
Changing
• Frequent changes in national and regional legislation
• Political changes
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LEHMAN, LEE & XU
Difficulties
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Costly
• Geographic distance
• Establishment costs are high
• Time factor. Lengthy:
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Project planning process
Project approval process
Project negotiation process
Project implementation process
Increasing capacity of Chinese companies
• Powerful and competitive companies
• Increasing industrial and technological capacity
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LEHMAN, LEE & XU
Chinese Market
in numbers (2004)
POPULATION
1.3 billion people
GDP
1.65 trillion USD
GDP / Person
1,200 USD
9.5%
△GDP
Total Imports
561 billion USD
Total Exports
593 billion USD
Imports to GDP
29.5%
Huge country with high economic growth.
5% of the population have income over 10,000 – 12,000 USD.
Before the country was closed to foreign trade, now it is progressively opening.
Liberalization process; WTO entry.
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LEHMAN, LEE & XU
Chinese Market:
Geographic Delimitation
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Continental China (mainland China).
Hong Kong: Redistribution Center and service provider.
Hong Kong and Taiwan: FDI main origin.
“Overseas Chinese”: 60 million, 3rd world economy. 65% of FDI
comes from Asia.
Development is concentrated in east coastal cities:
Gulf of Bohai area (Beijing-Tianjin
corridor).
Yangze delta area (Shanghai, Nanjing,
Hangzhou...).
Pearl River’s delta area (Guangdong and
Fujian provinces).
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Priority: Development of the Center-west and Northeast areas.
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LEHMAN, LEE & XU
The Market
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Strengths
 Weaknesses
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Size
Growth and Opening
Modernization and
dynamism
Multiple opportunity
areas
Liquidity (cash)
Human Capital and
organization
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Fragmentation
Competition
Immaturity in the distribution
channels
Logistics Insufficiency
Quick changes and volatility of
commercial regulations
Financial system insufficiencies
State owned enterprise reform
LEHMAN, LEE & XU
China:
Business opportunities
 Process of public investment, concessions and privatizations:
 Infrastructure Projects.
o Roads and Highways
o Railway
 Energy Projects
 Hydraulic Projects
 Center and west country development
 Growing environmental demands:
 Garbage collection and treatment systems
 Water treatment systems
 Alternative Energies
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LEHMAN, LEE & XU
China:
Business opportunities
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Fast Urbanization (population in rural areas 66%):
Attention to collectives and public services
Transport urban infrastructures: subway and railway
Strong construction process
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Increase in living standards:
Diversification and increase of consumption
Sophistication of distribution channels
Increase on vehicle demand
Potential in the tourist market
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LEHMAN, LEE & XU
China:
Business opportunities
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Access to WTO:
Increase opening to exports:
 Tariff reduction in more than 150 key products. Average tariff
from 17% in 2000 to 10% in 2005
 Progressive quota increase (i.e. annual increase of import vehicles
by 15%)
Service sector opening: Distribution (2004), Banking
(2006), Telecommunications, Logistics,...
Clarification of the distribution system
Standarization of legal system regarding foreign
investments:
 Same rights and liabilities for foreign and national companies
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LEHMAN, LEE & XU
Olympic Games 2008
Beijing Investment area: 27.5 billion USD
Comunication
Systems
17%
Environmental
projects
20%
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Sport
Facilities
7%
Urban supply
projects
6%
Transport
Projects
50%
LEHMAN, LEE & XU
Opportunities for Olympic Games
2008
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32 Sport facilities (19 new)
 Property and management
 Conceptual design
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Beijing Public services:
 Transport (subway)
 Environment
 Parking and traffic control
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LEHMAN, LEE & XU
But some problems…
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Technical barriers: the other side of the opening
process within WTO
 Certifications:
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Industrial Products (CCC)
Cosmetics
Food
Packing
 Contingent management
 Capital requirements
• Banking
• Distribution
• Construction
 Local Competition
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LEHMAN, LEE & XU
But some problems…
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IPRs. Counterfeiting problems before WTO’s challenge:
 Not only bags, watches, DVDs or software.
 Affects everything: from elevators to pastries or wine,
books...
 Notable improvements in legislation and applicable
penalties.
 However, penalty enforcement is still weak.
 Lack
of “social censorship”.
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LEHMAN, LEE & XU
China as a Market:
Access Strategies
Export
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Small investment.
 Problems:
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Market fragmentation and real size
Strong foreign and local competition
Tariff and non-tariff barriers
Lack of distribution networks and few specialized distributors.
After-sales service.
Continuous trips needed.
Language.
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LEHMAN, LEE & XU
China as a Market:
Access Strategies
Investment
 Advantages:
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Permanent presence in the market.
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Huge market (unlimited).
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Lower competition.
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Better competitive position. Tariff and non-tariff
protection
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Tax relief
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In most sectors it is possible to invest in the form
of WFOE (80% of investors choose this way)
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LEHMAN, LEE & XU
China as a Market:
Access Strategies
Investment
 Problems:
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Search for the right partner, if necessary.
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Legal framework still under development.
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Not all sectors are open to FDI
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IPR problems.
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Personnel problems
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Language
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LEHMAN, LEE & XU
FDI Divisions
Encouraged
Agriculture
New/high technology
Industries which develop Western/Central regions
Restricted
Technologically-backward industries
Resource-intensive/wasteful enterprises
Prohibited
Industries which cause pollution and ruin natural resources
Projects which utilize processes/technologies which are unique to
China
Permitted
All other industries not listed in the Catalogue.
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LEHMAN, LEE & XU
FDI
Operating Structures
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Representative Office
Equity Joint Venture
Cooperative Joint Venture
Wholly Foreign Owned Enterprise
Holding Company
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LEHMAN, LEE & XU
Representative Office
Advantages
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Quick and simple.
No minimum registered capital.
Allows for collection of market information and
preparation for direct market entry.
Disadvantages
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Cannot engage in revenue generation.
Taxation regardless of prohibition on profit making
activities.
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LEHMAN, LEE & XU
Representative Office
Set-up Requirements
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Application letter signed by Chairman of the Board.
Certificate of incorporation.
Credit report by bank.
CV of foreign representatives and photocopy of passport.
Business license in home jurisdiction
Signed Power of Attorney, allowing agent to legally act on
the company’s behalf.
 Lease agreement
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LEHMAN, LEE & XU
Equity Joint Venture
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Most commonly used among the two types of Joint
Ventures
Main distinction between EJV and CJV is the
requirement that profits must be shared in proportion
to capital contributions.
Key considerations:
o Selection of Chinese JV Partner after a full due diligence
of partner/assets.
o Selection of location.
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LEHMAN, LEE & XU
Equity Joint Venture
Advantages
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Chinese partner will bring connections and an established
sales and distribution network;
Local partner will bring local and particularized knowledge
of both market and bureaucracy.
Chinese partner will usually have or can easily obtain an
operational site, which aides in efficient start-up
Disadvantages
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JV contract often difficult to negotiate
Differing objectives and management styles often result in
conflict.
Lack of control by foreign party
Difficulty in selling shares in venture.
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LEHMAN, LEE & XU
Equity Joint Venture
Setup Requirements
o
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Project Proposal
Feasibility Study
JV Contract
Articles of Association
Letter of intent
Business License
Capital investment requirements.
Minimum equity investment by Foreign investor is
25%.
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LEHMAN, LEE & XU
Cooperative
Joint Venture
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Similar to Equity Joint Venture in structure but with
more flexibility because of the following:
1.Sharing profits is governed entirely by contract
2.Foreign partner can obtain return of investment in
priority to Chinese partner.
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Setup requirements similar to that of Equity Joint
Venture.
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Wholly Foreign Owned
Enterprise (WFOE)
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Essentially a wholly owned subsidiary of a foreign
enterprise
By far, the most commonly used investment vehicle
If there is a significant amount of IP held by the
corporation then the WFOE would be the primary
selection
Generally, WFOE approval is more difficult to obtain
than JV approval.
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LEHMAN, LEE & XU
Wholly Foreign Owned
Enterprise (WFOE)
Advantages
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Quicker setup as there is no Chinese partner
Simpler management structure and objectives which are
simply those of the parent organization.
Disadvantages
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Independence is often, in itself, a shortcoming because of
lack of connections, established markets, and local
knowledge.
WFOEs cannot operate in some sensitive areas such as
securities.
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LEHMAN, LEE & XU
Wholly Foreign Owned
Enterprise (WFOE)
Setup Requirements
o
o
o
o
o
o
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Application Letter
Feasibility study
Articles of association
Evidence of solvency from bank
Business License
Name of the legal representative
CV and copies of passport
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LEHMAN, LEE & XU
Exit Strategy
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Mauritius holding company for conducting operations in
China.
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Benefits:
• Cost
establishment is US $1,500
(company secretary, nominee shareholders and bank account)
• Exit Strategy
1) easy transfer of interests in the China operation
2) no approval needed for divestiture of interest in case of direct
investment relationship
• Transfer Pricing
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LEHMAN, LEE & XU
Exit Strategy
Limiting Liability
liabilities incurred by the Chinese entity will be the
liability of the holding company rather than the parent
Tax Benefits
• In Mauritius: any money held by the holding company will be
tax free
• In China: impact of China taxation can be managed by
licensing the IP from parent company.
Parent
Company
IP
Mauritius
Company
IP
Chinese
WFOE
• In Spain: money can be repatriated at a tax advantageous
time or reinvested in other international operations.
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LEHMAN, LEE & XU
2. China as a
Productive Platform
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Competitiveness of China production implies not only
potential on producing to supply local market, but also
positions:
 China as a competitor
 China as a provider
 China as a platform to third markets
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LEHMAN, LEE & XU
China as a
Productive Platform
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Competitiveness derived from:
 Labour costs: Unlimited labour reserves (lower wage
preassure).
 Technology contributions and Western management
through FDI.
 State policies to support foreign sector, critical for its
growth (tax relief...).
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LEHMAN, LEE & XU
China as a Competitor
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WTO entry also opens international markets to
Chinese products
Foreign Trade evolution
FDI resounds in technological development: quality
products...
Development of its own industrial infrastructure
Protection instruments (anti-dumping measures...).
Market Economy?
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LEHMAN, LEE & XU
China as a Provider
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Competitiveness of Chinese products is not only a
threat but also an opportunity.
Wide and increasing range of products
Need to make purchasing process more competitive
Another way of investing in China: central purchasing
office
Cooperation agreements, licensed production. Risks
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LEHMAN, LEE & XU
China and Third Markets
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Production investment in China, not only for Chinese
market but also to export
As Chinese industrial network improves, the foreign
projection will be wider
FDI companies in 2004 carried out 57% of the total
exports (54.8% in 2003)
Foreign companies are already taking profit from
Chinese foreign competitiviness.
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LEHMAN, LEE & XU
3. China as a Partner

Official interest for the Internationalization of Chinese
companies. Supporting measures:
 Goal: establish 6,000 multinationals by 2015
 Sectoral Priorities:
o Electrical appliances in developing countries
o High technology in developed countries
o Mining, hydrocarbon, raw materials
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New aspects which can include:
 Chinese companies investing abroad
 Chinese companies interested in partnership with foreign
companies to make use of their knowledge and
experience of international markets.
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LEHMAN, LEE & XU
Some advice...
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1- Get rid of the myths
2- Get trustworthy information
3- Identify the oportunities
4- Have a clear strategy
5- Professional assesment
6- Conduct market research and due diligence on
partners
8- Long term commitment is necessary
9- Ensure that IP is fully protected
10- Watch for personal relations and local customs
11- Success in China implies dedication and big effort
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LEHMAN, LEE & XU
Challenges for China to
Take Over the World
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China must modify its development model to:
• resolve the new problems created by the actual growth
• avoid jeopardizing the country’s stability
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Objective: SUSTAINABLE DEVELOPMENT
• Social point of view; Minimize social differences
 Improve welfare services
 Increase public expenditure in health and education
 Unemployment
• Environmental point of view
 Avoid exhaustion of energy resources
 Use of new renewable energies
 Fight against environmental pollution
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LEHMAN, LEE & XU
Challenges for China to
Take Over the World

Change from extensive growth (exports and FDI) to
intensive growing (internal demand and local companies)
• Reduce export participation in its GDP
• Increase local consumption
 Increase income in rural areas
 Increase expenditure on social welfare, health and education

Maintain growing stability
Soft landing process
• Reduce growing rates
• Not affect social and economic stability
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LEHMAN, LEE & XU
THANK YOU
LEHMAN, LEE & XU
10-2 Liangmaqiao Diplomatic Compound
No.22 Dongfang East Road Chaoyang District
Beijing 100600 China
Tel: (86)(10) 8532-1919
Fax: (86)(10) 8532-1999
E-mail: [email protected]
Web site: http://www.lehmanlaw.com
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