Local knowledge sought out when investing for new market penetration in inland and western regions
Op-Ed Commentary: Chris Devonshire-Ellis
Jul. 18 – A growing trend in China is the desire for MNCs to look at China’s central and western regions for market development and growth, as these areas provide the surest bet of securing high value growth while China’s eastern provinces experience a slowdown in their economies. It also heralds a minor shift in what has been the preferred route for foreign investors to take, namely the wholly foreign-owned enterprise (WFOE).
Yet the popularity of the WFOE has only really been a 10-year cyclical model, dating back to 2002 when China liberalized the foreign investment sector and permitted a far wider range of 100 percent FDI activities than had previously been the case. The 10 years prior to this had seen joint ventures (JVs) rule as the established method of getting into China, with the consequences of running with a Chinese partner providing both amazing tales of growth and success, coupled with stories of disasters as well. Some were painfully recalled in massively popular books such as “Mr. China,” yet such accounts only told part of the JV story – many were and remain quietly successful.
Yet JVs are bouncing back. Not because of the need for Chinese capital or workforces, but for the local knowledge that partnering with a Chinese company in the more remote areas of China can bring. According to a recent report by KPMG, China’s inland economies have reached an annual economic output of US$3.5 trillion. That is a lot of money, and compares with the economies of North Africa and the Middle East at US$2.77 trillion, and with Latin America and the Caribbean with US$5.6 trillion.
China’s inland regions are also developing as consumer markets in their own right. Over the past 10 years, imports to the region have grown from less than US$100 million worth of goods in 2000, to over US$1 billion today. Put simply, China’s inland regions are its new emerging market.
Another way of analyzing the region is to look at the growth of consumers. As I reported from last year’s Economist Conference, and reiterated again recently in my comments about the Lewisian Turning Point, China’s inland regions are experiencing a major boom, as is the nation’s middle class growth. It’s a point not lost on Boston Consulting Group, who have recently stated that China’s middle class will grow from what they estimate was a base of some 150 million at 2010 to some 400 million by 2020. But of those consumers, the fastest addition will come from China’s inland regions – rising from a current 18 percent of all China’s middle class to possessing some 45 percent during the same period.
This is a trend we’re also seeing at Dezan Shira & Associates. Our client enquiries, looking for assistance with corporate establishment or with tax advice, are now just as likely to refer to investments in Sichuan or Xinjiang as they are Shanghai or Guangzhou. Just last month, we received four enquiries from MNCs looking to set up operations in Xinjiang Province. That’s the same number as we’d previously received in the last 18 months. All are now proceeding – and three of the four are JVs. Indeed, from about 20 percent of total clients handled in 2002 (our firm only deals with foreign direct investors in China), close to 40 percent are now interested in China’s inland and western regions.
Another pointer, again from Boston Consulting Group, suggests that by 2020 some 800 towns and cities across China will have a per capita real disposable income level higher than that of Shanghai. As the eastern seaboard becomes more expensive, more money is left in the hands of the inland population. Today, if an MNC wants to reach 80 percent of China’s middle class, the company needs to be extant in 310 cities. By 2020, the same company, in order to maintain that 80 percent penetration, will need to be in over 500 cities. But the way to reach that number is to go in clusters – if you are in 100 cities now, roll out the next 100. Step by step.
China’s inland regions can also be identified as being culturally diverse. Consider the RMB banknote. It contains seven languages – Chinese, Pinyin (Romanized English), Mongolian, Tibetan, Arabic, Miao and Braille. Of those seven, four represent inland regions, while Braille is a pointer to medicare issues. That alone creates cultural issues far more complex than simply setting up supply and distribution chains in Shanghai or Beijing. MNCs need to create distribution networks, hire sales representatives, create distributors, and establish logistics networks, and when dealing with market penetration in what are becoming competitive areas, speed is also important. That typically means partnering with a local business to kick-start the process.
While JVs have often had a bad rap (especially from new-to-China firms with less than 10 years’ experience to count on), Dezan Shira & Associates has been in China 20 years and is familiar with the concept of JVs and how best to see them operate. Right from the beginning, clear definitions need to be made as concerns the expectations of both parties. For the MNC, that would typically mean developing the business jointly until set targets are reached and the Chinese partner bought out. In terms of establishing a pan-China network, this concept is probably the fastest. However, it may not necessarily mean the end of local involvement should that be deemed too adventurous a step to take. Key Chinese executives can always be made minority shareholders in holding companies say based in Hong Kong or elsewhere – thus retaining their interest and assistance in earning dividends, yet reducing their influence at local board level. Such structures need to be worked out in advance.
Otherwise, the issue with JVs is largely an upfront due diligence matter – check out thoroughly who you’re contracting with – and then attention to detail over the management issues, as cultural differences remain. They can be solved, however it is best these are anticipated and dealt with up front, rather than having to mend problems later.
JVs then remain a key element of Chinese market penetration, but when seeking to utilize the structure ask for the services of an experienced China-based practice to assist you from the beginning. The type of legal structure used should after all, not hinder access to China’s inland and western regions – which are fast becoming the new emerging market within the new China middle class consumer marketplace.
Chris Devonshire-Ellis is the founding partner of Dezan Shira & Associates. 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. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.
For further details regarding joint ventures in China, please email firstname.lastname@example.org, visit www.dezshira.com, or download the firm’s brochure.
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Setting Up Joint Ventures in China (Third Edition)
This guide walks you through, step-by-step, each of the key points of setting up a joint venture in China. It includes a complete draft of both a JV contract and articles of association as well as an overview of JV laws, negotiation issues, land use rights, IP protection and technology transfer, in addition to tips on staff hiring and HR. It also describes tax and audit responsibilities in addition to buying out a JV partner and liquidating.
Reevaluating China Joint Ventures and M&As
In this issue of China Briefing Magazine, we take a fresh look at joint ventures and M&As in China – the current market circumstances, the motivations and challenges faced – and provide a few practical insights into key issues such as forming a joint venture contract and finding an M&A partner.
China Joint Ventures as Strategic Investments
Our six-part series on determining how joint ventures in China can be strategic investments. The debate over joint ventures has been going on since China opened up to the West. For some companies, JVs are a cheap way of entering the China market, others see a useful potential in the partner’s production facilities and workforce. While there is a measure of truth in all arguments, the sensible application of due diligence and an understanding of what a Chinese partner brings to a JV are paramount.
Joint Ventures in China: Equity and Capital Requirements are not the Same Thing
Co-Investing in China with Chinese Partners
China’s Provincial Retail Statistics for 2011
China’s Inland and Western Regions
China Briefing has extensively reported on the business environment and conditions in China’s central and western regions. These may be accessed as follows:
Regional – General
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The languages on the RMB note do not include Miao – rather, it is Zhuang, the language of the largest non-Han ethnic group in the PRC.
@Nathan – you are of course correct. Thanks for pointing it out. – Chris
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