A recent Dun & Bradstreet survey revealed that the threat of non-payment and high risk exposure was of paramount concern to nearly all foreign-invested enterprises in China, and it seems that matters are likely to worsen. "We see the risks of non-payment more likely to grow in 1997 and beyond," says Mr Padraig Lehane of Dun & Bradstreet's Shanghai office.
The main reason for this say experts is increased competition between FIEs. As more foreign enterprises come on stream, fierce competition ' to capture market share is leading to a scramble to offer the most flexible credit terms to cash-starved customers.
In addition, and despite evidence of an easing of the central government's credit policy, Lehane expects the problem of state enterprise 'triangular debt' will continue to worsen for the foreseeable future. The more generous credit terms on offer are not supported by any improvement in the cashflow position of customers. New market entrants, lacking local expertise to manage prompt customer payments, are likely to be particularly badly hit by cash flow problems and bad debt.
The situation varies according to sector and geographical area. In line with national prosperity levels, cash flows and delinquency rates are generally less severe in coastal areas compared with hinterland. But within this broad pattern there are regional fluctuations related to market conditions. For example, in Guangzhou, where credit terms are generally the most flexible to buyers, Dun & Bradstreet noted a significant cluster of companies experiencing a deteriorating bad debt position last year.
Generally cash flow is easier in the consumer goods sector. United Biscuits, which has a 90 per cent stake in a joint venture in Shekou in Shenzhen, has experienced a variety of credit conditions since it began producing biscuits there in 1990. While initially most of the business was in cash, by the second year of operating profit in 1995 competitive pressures had led the venture to offer credit of three months on sales. The credit pinch has eased somewhat since then. According to China manager Richard Ward: "Credit terms offered to customers are now substantially less than three months, with credit obtainable on accounts payable close to international levels."
One of the biggest problems that China enterprises face is obtaining reliable credit information on potential customers. While accounting and law firms can provide valuable advice, credit information firms are also used to good effect by some investors. Hong Kong-based credit agency Daily Credit Services (DCS) has had a 'full operational base' in China since 1987. It opened its first representative office in Guangzhou in January 1993 and has liaison bases in major cities such as Shenzhen, Shanghai and Beijing. It boasts a team of trained credit reporters and collectors under the supervision of an expatriate manager as well as affiliations with local information and collection companies. In terms of institutional linkages, the company values its agreements with the Guangdong, Shanghai and Beijing Administrations of Industry and Commerce (AICs). The AICs are not only in charge of registering all Chinese businesses but also play a role in supervising the business activities of companies once they have been set up.
DCS provides credit risk assessments ranging from a top rating of 'CAI' through to a highest credit risk of 'CA6'. CA5, the second worst credit rating, carries a recommendation that credit should only be extended under guarantee to a small amount, otherwise cash on delivery should be the basis of transaction. Credit is not recommended to any company with a CA6 rating.
These credit ratings are based on a composite of scores weighted in the following way: financial condition (30 per cent); ownership background (20 per cent); payment record (15 per cent); credit history (15 per cent); market trend (10 per cent); and operational size (10 per cent). In the case of newly established companies, unlimited companies or lack of financial data, more weight is given to ownership background and payment record.
The firm highlights six difficulties in assessing credit-worthiness of customers:
* A backwardness in telecommunications and transport makes the job of visiting and analysing a company's credit standing time-consuming
* while civil litigation records are publicly disclosed in Hong Kong and most Western countries, this is not the case in China
* company registration information held by government departments is often not up-to-date
*the Chinese public's limited understanding of the concepts of credit information and credit management some times makes management very sensitive to outside enquiries and reluctant to disclose information
* a Chinese enterprise's stability is, to a certain extent, influenced by some political factors outside the usual economic and financial parameters
* the laws governing the activities and conduct of Chinese enterprises in the fields of accounting, auditing, bankruptcy, mortgage etc. are somewhat confusing and not properly implemented.
Dun & Bradstreet provides credit information on companies in China. From 1981 this was undertaken by correspondents sending reports to the Hong Kong office. In 1994, Dun & Bradstreet obtained a licence to operate in China and moved its China database to a new Shanghai office in April last year. Credit information is now obtained from a variety of sources including reporters in Shanghai and Beijing, information from the China Statistical Information & Consultancy Centre (commercial arm of the State Statistical Bureau) and scanning of national and regional newspapers. The company has just launched an information polling service which will allow non-competing companies to share their payment experiences of individual clients.
As in other markets, Dun & Bradstreet recommends that companies develop their own information systems that allow them to monitor customers. With proper training, the sales force can play a critical role in feeding back information that may affect the ability of clients to make timely payments. Signs to watch for include changes in senior management, significant growth of inventory and large purchases of new equipment made by the customer. The US credit firm advises that salespeople should receive commissions based on actual customer payments rather than contracted sales.
"The best strategy to avoid delinquency is to ensure an integrated customer service approach," says Dun & Bradstreet's Lehane. Once the goods have been delivered, there needs to be a mechanism confirming that they have arrived on time. The written confirmation should also affirm that the quantity and quality of the goods which have arrived are satisfactory.
Once this has been 'signed off' the accounting or sales staff should contact the customer by telephone and in writing to double check the acknowledgement and remind the customer of the payment terms. "This [should be] done in the context of a customer service call and not a payment demand," he adds.
In cases where it is felt that a payment will be disputed, Lehane believes that a site visit by the sales manager can be useful. Whether this turns out to be a sensitive strategy depends on the individual case. "The value of the transaction, the location of the customer and his relative importance to the business need to be considered," he says, stressing the value of personal relationship building in the speedy and amicable resolving of disputes.
Mr Andy Lu, general manager in charge of marketing research and strategy in Arthur Andersen's Shanghai office, agrees. "'he relationship you build up with the purchasing and financial managers of long-term customers is very important," he says. "When you have that, they will make sure that they pay you first."
In some cases Lehane believes it is worth considering solving payment disputes through renegotiating fees. It can at least ensure some form of payment, while maintaining the customer relation-ship for the future and offering a quicker solution than many alternatives. "[But] this is risky if not managed properly as it may send the wrong message," says Lehane.
A creative approach can sometimes be useful when the customer lacks cash. "One US company recently took some of its customer's products and shipped them out of China," says Lu. "If the goods involved do not require export quotas and you have the support of the customer, that can be fine."
Ideally, payment disputes should be built into the pricing structure, advises-Dun & Bradstreet, but this can be a difficult option in a competitive environment. Any interest to be charged in the event of late payment needs to be stated clearly in the purchase contract. In most cases, a carrot may be more effective than a stick. Lu notes that the offering of a 10 per cent discount if payment was received within 10 days was a successful strategy, especially with larger orders, when he was marketing manager of a large Shanghai joint venture.
Another option is to seek guarantees or security over customer assets to cover the eventuality of bad debt. Despite recent legislation regulating the use and enforcement of security, the courts have little experience in implementing these laws. Foreign banks lending in China, for instance, still prefer to take security on offshore assets.
"Guarantees are used from time to time," says Mr Jack Chow of KPMG Peat Marwick's Hong Kong office. "The problem is 'are they enforceable?' If the customer fails to meet payments do you take the guarantor to court? In many cases this may effectively mean taking the government to court."
In the absence of detailed information, there are other more rough and ready methods of assessing credit risk. When in charge of a 10-strong joint venture sales force, Arthur Andersen's Lu operated a policy of looking closely at the ownership structure of the customer in assessing credit risk. "We tried to avoid selling to state-owned enterprises and if possible sold to joint ventures, which tended to be new and financially healthy," he says.
Learning to assess risk
The assessment of risks inherent in specific structures often vary. Peat ' Marwick's Chow places state-owned enterprises high on the hierarchy of credit-worthiness. While conceding that "they always delay on their payments", he feels that in many cases the security of payment is "at least comparable to" selling to foreign-owned entities. He believes that enterprises connected directly to central and local government are the most reliable, while there may be a bigger risk in dealing with the subsidiaries of state-owned enterprises. The ' biggest risk, in his view, is with privately-owned domestic companies.
The location of a customer can also be a factor in procuring timely payment. "It [getting paid] was relatively easy in Shanghai where we could use relationships and the courts, but outside Shanghai it was very difficult because local protectionism was very strong," says Lu. "We had a very bad customer in Henan province who ordered some grinding wheels." One month after the payment was due, the joint venture had still received no payment and the customer was always unavailable when they telephoned him. "We sent a salesman down to Henan and we discovered that he was a professional cheat. We had to ask for help from the Public Security Bureau, but in the end we had to write it off as a bad debt," he recalls.
Dun to death
Payment dispute handling tends to be a lengthy process, but the investment of time is a necessary evil as the alternatives are limited. A growing number of debt collection companies emerged in 1994 and 1995 ? some even linked to the People's Liberation Army ? but this had the unfortunate side-effect of leading to a number of fatalities in north-east China. Consequently, it was no surprise when in January 1996 the State Administration for Industry and Commerce and the Public Security Bureau moved to ban such third-party debt collection agencies.
Legal pressure can be exerted in payment disputes through the use of law firms but dunning (persistent demands for debt repayment) is often seen as an ineffective strategy in China. A more formal legal dispute settlement is possible through litigation or arbitration. Both also bring their own problems.
Litigation is the least successful route, being an expensive and time-consuming process and cases are even sometimes left unresolved. Even when a favourable adjudication is achieved, the actual enforcement mechanism is very poor, says Lehane.
Arbitration, the strategy recommended by most lawyers, has a better reputation in China but enforcement remains difficult. Mr Frankie Fan, Assistant General Manager of DCS notes that "over 90 per cent of our debt assignments are using personal collection and lobbying". Fewer than 10 per cent are taken to litigation or arbitration ? an experience familiar to Chow. "The best approach is to send someone to the customer," he says. "If you take court action you may find that they have no cash or assets available and you are just waiting in a queue."
The difficulty of managing credit risk in China seems unlikely to diminish in the near future. Increasing marketisation will not eclipse the need to cultivate relationships in inter-company financial dealings ? especially in an economy where reliable information is at a premium. Enditerm
Credit policy survey
A Dun & Bradstreet survey of China ventures (members of the Beijing, Shanghai and Guangzhou American Chambers of Commerce) last year produced 34 responses on credit policy. The most common approach was a mixture of 'letter of credit' and 'open account' strategies used by 44 per cent (15 companies). Amok these companies letter of credit was used for per cent of transactions, restricting open account customer relationships to 40 per cent. Companies dealing exclusively with cash transactions made up 25 per cent of the total, while 21 per cent used exclusively open account and 12 per cent used only letter of credit. Manufacturing companies were more likely to use open account terms than transport and service companies.
Geographically, the most generous credit was offered by companies in Guangzhou with 38 per cent granting exclusively open account terms, a proportion which was only 8 per cent in Shanghai. Overall, 39 per cent of firms reported 'high' or 'very high' pressure to loosen credit terms – but again there were wide regional variations. In the competitive south China market, 58 per cent of firms reported 'high' or 'very high' pressure to extend more credit while the proportion in Beijing was 50 per cent. Surprisingly in Shanghai, where relatively inflexible credit policies predominate, the pressure to loosen credit was only stressed by 16 per cent of firms.