I N V E S T I N G I N C H I N A

Why Invest in China?

Hillman, Wertheimer, YeapFebruary 7, 2004

Guanxi(personal connections)

I N V E S T I N G I N C H I N A

Outline

• Background: the Diamond Model• Investment Factors• How to Invest in China• Conclusions

China GDP 10 years ago

China GDP

in 10 years

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Background:the Diamond Model

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Diamond Model

CultureManagerialSystems

Financial Systems

Entrepreneurship

Political Systems

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Political System: Economic liberalization with limited political reform

• Committed to continued economic reform: stated objective to become “socialist democracy”– Political change more limited and uncertain– One-party rule by CCP continues as status quo; recent transition

to 4th generation leadership

• Internationalization of economy provides pro-reform momentum– Large export sector and growing foreign presence– WTO entry conditions– Enhanced foreign policy stature in region

• Ongoing transition into two tier-system: public versus private sector– Complex bureaucracy intertwined with commercial activity

Source: Economist Intelligence Unit – Country Report 03/04

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• Banking system weak, but moving in the right direction– Creation of a regulatory body to oversee the banking sector  

• Two Stock Exchanges (Shanghai, Shenzhen) + Hong Kong (H shares) and emerging IPO market

• Foreign Exchange pegs the currency to the dollar– Highly criticized

– Promotes exports at the cost of slower GDP growth per capita

• Credit: too much going to the state– Not enough competition for capital

– Upper limit of lending rates raised so market forces would determine availability of credit

• Foreign investment plays a significant role in China's remarkable economic growth (US$51bn in 2003)

Financial System: Increasing liberalization but still volatile and high-risk

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Managerial Systems: Reliance on culture and connections

Source: “The Great Transition,” Lieberthal and Lieberthal, Harvard Business Review, Oct. 2003.

• Communist party once stressed enterprise management: state was responsible for P&L, not the organization

• Led to quality control issues that persist even now; “just in case” mentality instead of “just in time”

• Improvement process undertaken in 1970s– Stronger economic responsibility (forecasts, accounting, controls)– Reorganizations that promote good workers and avoid overstaffing– Stronger penalty system for worker discipline– Better financial controls

• Workers now receive many incentive plans, including group and personal rewards

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Entrepreneurship

• Chinese are naturally entrepreneurial in spirit

• Focus is on small- to medium-sized family businesses

• Limited focus on knowledge-intensive entrepreneurial ventures

• The non-state sector, contributes 74% of industrial output, 62.2% of GDP, and more than 100% of the increase in employment.

– Non-State Sector includes private companies, self-employed businesses, shareholding corporations, joint ventures with foreign investment, and community-owned rural industries.

• The emergence of the non-state sector highlights the Chinese entrepreneurial spirit

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Culture: Modern façade can cover strong cultural differences

• China has long and ancient history as world power, with periods of great turbulence– Continued impact of Communism legacy

• Key Cultural Differences:– Community and group harmony– Hierarchical with emphasis on relationships– Holistic and circular analysis– Wariness of foreigners– Unreliability of “rule of law”

• Regional and class differences between urban elite and rural classes

Source: Harvard Business Review (10/03 – “The Chinese Negotiation” Graham & Lam

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Investment Factors

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Strengths – Economic Performance

• Quadrupling of GDP since 1978

• By 2020, region’s GDP will be 50-60% of global economy

• Huge potential for certain American exporters

• In 2003, was the second-largest economy in the world after U.S. (measured on a purchasing power parity basis)

• 8.6% in 2003 and close to 8% growth in 2002

• Exceeding a $1 trillion figure for economic production

• Partial transition to a market economy– The emergence of the non-state sector indicates a trend towards a more

open, diverse economy

• Consumer demand growing at rates far exceeding expectations

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Strengths – Manufacturing

• Used WTO transition period to develop products in which it has intrinsic strengths– These areas include machinery and equipment, toys, consumer

electronics, automobiles, bicycles, motorcycles, precision instruments, textile and garments and consumer goods industries

• Chinese are expected to undercut less efficient neighbors and beat them in competing markets– Produces 50 percent of the world's cameras, 30 percent of the

air-conditioners and televisions, 25 percent of washing machines and 20 percent of refrigerators.

• Two-thirds of foreign manufacturing in China is for the domestic market

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Strengths – Manufacturing

• Not sure how the following fit into the previous slide

• China has been a “marketer's dream come true”

• The second wave of FDI is characterized by:

– Shift from low knowledge base industries to medium and highly knowledge-intensive industries and

– Geographic shift from the coastal and southern areas of the country inward.

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Strengths - Trade Agreements

• WTO

– Accession to the World Trade Organization helps strengthen China's ability to maintain strong growth rates

• ASEAN

– intention to establish a Free Trade Area (FTA) within ten years.  Would solidify trade within the region and present the region as a larger market

• 2008 Olympic games

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Weaknesses – Governmental actions

• There are still remnants of a planned economy, prone to over investment and overproduction, unrelated to supply and demand

• No predictability in its business environment– Lack of a consistent body of laws and regulations

– Government known to backtrack and retighten central controls

• Government protects local and state-owned firms from imports while encouraging exports – shielding from competition by subsidies

– Keeping state-owned enterprises afloat even though they have been losing and are unable to pay wages and pensions

• Foreign Exchange – pegging the currency to the dollar

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Weaknesses – Financial

• Weak banking sector

• Too much credit going to the state sector

• Administrative monopolies are a drain on the economy

– Government is proactively moving to dismantle these and create a more competitive framework (injected competition into telecom services and broke up the State Power Corporation of China)

• Occupancy rate in most high-rise buildings is less than 50 percent

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Weaknesses – Financial

• Just $5,000 per capita due to population

• Unemployment is rising– Estimates vary between 3.6 percent and 20 percent (depending

on whether the figures are official or independent)

• Unemployment is expected to intensify further in 2005– 150 million Chinese small farmers will be rendered jobless as

American, Australian and Canadian large farmers dump their mechanized produce in Chinese markets under the WTO agreement

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Weaknesses – Country Issues

• Corruption – levels are still very high despite governmental actions aimed at

reducing corruption and other economic crimes

• China's population control program– Essential to maintaining long-term growth yet it has weakened

• Environment – deterioration in the environment, air pollution, soil erosion, and

the steady fall of the water table

• Arable land – continues to diminish due to erosion and economic development

• An aging population– one of every 10 Chinese is over the age of 60

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How to Invest in China

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Investing in ChinaA how-to

• Get guanxi– show respect– network extensively– avoid jewelry and white items

• Pick a production region: find a location geared toward manufacturing, engineering, or sales

• Pick a distribution region: find a location based on internal distribution or export

• Hire staff that can manage the local initiative• Guard intellectual property

Sources: Hong Kong Trade Development Council; BusinessWeek

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Investing in ChinaWhere to go?

Source: adapted from BusinessWeek via Mike “Don’t call me Norton” Coppola

China has established regions for targeted manufacturing

Best resources and skills for a particular sector can be found in specialized areas

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Successful Venturing in China: The Right Leader

Source: “The Great Transition,” Lieberthal and Lieberthal, Harvard Business Review, Oct. 2003.

• During initial entry, an entrepreneurial manager is needed – creative and flexible – experienced with international startups

• During development, a strong senior manager– good ties to home base, communication skills

• During a global integration, a global manager – comfortable working across business divisions

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Source: "Guide to Doing Business in China(2003 Edition),” tdctrade.com

• Employees are found through two avenues: – job fairs – recruiting agencies

• Placing want ads is less common – requires local government approval

• Employees are usually hired with contracts – terms can be determined individually or collectively

Successful Venturing in China: Staffing the Firm

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Source: “The Great Transition,” Lieberthal and Lieberthal, Harvard Business Review, Oct. 2003.

• Vital to establish local country management with strong senior staff– coordinate activities– show a united face for the company

• Understand management goals of the partner in a joint venture– JV company often looks to expand labor force

• Hire managers who can interpret and understand internal issues and devise strategies

• Avoid sharing sensitive technology and data – Chinese are good at pirating ideas

Successful Venturing in China: Managing Risk

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Successful Venturing in China: Negotiation Factors

• Guanxi– Personal Connections

• Zhongjian Ren – The Intermediary

• Shehui Dengji – Social Status

• Renji Hexie– Interpersonal Harmony

• Zhengti Guannian – Holistic Thinking

• Jiejian – Thrift

• Mianzi – “Face” or Social Capital

• Chiku Nailao– Endurance,

Relentlessness

Source: Harvard Business Review (10/03 – “The Chinese Negotiation” Graham & Lam

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Conclusions

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