Jun. 5 – The European Chamber of Commerce in China, in cooperation with Roland Berger Strategy Consultants, recently released its annual Business Confidence Survey (2013). The survey had 526 respondents, questioning European companies on three main issues:
- Financial performance and market optimism;
- The changing Chinese market within a stagnant regulatory environment; and
- The importance of China as a key market.
Financial performance and market optimism
According to the survey, the financial performance of European companies in China deteriorated in 2012. Only 62 percent of companies reported increased revenue compared to 75 percent and 78 percent in 2012 and 2011, respectively.
Notably, the proportion of profitable small and medium-sized enterprises (SMEs) decreased from 67 percent in 2011 to 52 percent in 2012. This challenge can be attributed in part to the fact that larger companies and those who have been in China for longer than five years are performing better than smaller companies and those new to China.
As the financial performance of companies in China weakens, so does their level of optimism in their companies’ growth and profitability. The survey found that the number of companies who are optimistic about growth over the next two years is at its lowest level since 2009. Only 29 percent of companies said they were optimistic about profitability potential over the next two years, a significant drop from the relatively stable response range of 34 percent to 36 percent supplied over the previous four years.
However, despite the overall decrease in financial performance and lower level of optimism, most companies are still growing (62 percent) and are optimistic about future revenue growth (71 percent).
The changing Chinese market within a stagnant regulatory environment
More respondents than ever before (75 percent, up from 72 percent in 2012) said that the primary reason for being in China is to serve the domestic market; yet competition from domestic Chinese companies is increasing. Competition from Chinese private owned enterprises ranked as the seventh most important factor affecting European companies net profits, up two places from last year.
Rising labor costs in China was ranked by 63 percent of companies as the most significant challenge that they will face in the future. More than any other market or regulatory factor, 52 percent of European companies regard rising labor costs as a significant factor affecting net profit margins.
The stagnant regulatory environment and lack of effective reforms have persisted in being a key disadvantage for European companies. Companies cited the rule of law and transparent policy-making, including unfair competition in markets dominated by monopolies, as the most significant potential factors for China’s economic performance.
For European companies, the top regulatory obstacle for doing business in China is market access difficulties, reinforcing the need for China to continue liberalizing its markets while promoting fair trade. Ranking second and third as the top regulatory issues are administrative issues followed by discretionary enforcement of regulations. This problem stems from China’s geographically inconsistent jurisdictions and regulations.
China’s regulatory barriers translate to tangible financial shortcomings for European companies, with 61 percent of the surveyed companies estimating their missed opportunities to be equivalent to or greater than 10 percent of their annual revenue. While China’s unfair regulatory environment towards foreign companies persists as a prominent problem, few companies are optimistic and many are uncertain about the government’s likelihood to reform.
The importance of China as a key market
Nonetheless, China is still key to European companies’ global strategies, with 94 percent of respondents stating that China either maintained the same level of importance in their global strategy as it did the previous year, or increased in importance.
European companies are primarily in China for China, with 75 percent of respondents stating that their number one reason for operating in China is to provide goods and services for the Chinese market.
Despite the decreased financial performance and lower optimism of European companies, coupled with China’s regulatory environment, Europeans companies ultimately intend to continue their expansion in China to serve the domestic market. As competition increases from domestic Chinese companies, the need for market liberalization will become more urgent if China wishes to remain the focus for investment by foreign companies.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia.
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