Changing channels

In a country where infrastructure bottlenecks can create lead times of up to 18 months, the advantages of an efficient distribution chain are obvious. As a result, a growing number of foreign firms in China have identified direct sales as the way forward. However, while a handful of firms have initiated sales forces of their own, this mode of operations has suffered from a lack of unified regulatory guidelines. With the release of Administrative Measures for Direct Sales, foreign investors will now be able to better plan their distribution strategies.

Going nowhere fast

A recent survey of distribution problems in China by Arthur Andersen noted that, despite the upsurge in highway infrastructure; road transport remains risky for producers attempting to comply with supply deadlines and budget limits. The report estimates that a 10-tonne truck transporting cargo from Shanghai to Beijing requires at least eight days to reach its destination at a cost of US$3,735. Rail is potentially quicker and cheaper; the same route takes five days by rail and costs US$845. However, rail carriage is contingent on full capacity ? a train will not begin its run until it is fully, laden. In the slow season, an enterprise may wait more than 15 days just to see its shipment leave the rail yard. The inventory build-up this causes can have serious implications for cash flow.

One way to overcome distribution difficulties is to establish a number of production sites throughout China, rather than one central site. Producers can make up losses in economy of scale by saving on inventory and distribution costs. The disadvantage is that such enterprises have to develop relationships with local distributors in each area where a plant is located. Unless, that is, the enterprise creates its own local distribution networks – in the form of a direct sales force. Direct sales may not be practicable for every . product, but can dramatically shorten lead times and provide greater control over marketing and presentation.

The Administrative Measures for Direct Sales, published on March 19, 1997, comprise seven chapters addressing general principles of direct sales in China, the. approval and registration of enterprise sales forces, direct sales staffing; sales activities, supervision and examination issues and relevant Chinese laws and regulations.

Multi-level playing field

The measures distinguish between 'multi-level' and 'single-level' direct sales. In a multi-level marketing structure, members of the sales force are responsible for, and manage, new members they recruit to the team. Staff may be rewarded with bonuses or other material incentives for bringing in new faces. Under a single-level marketing structure, no middle layer is interposed between the sales staff and the enterprise which recruits them. Enterprises must register for either multi-level or single-level status when they apply for the right to conduct direct sales.

Applications for direct sales rights should be made to the branch of the State Administration of Industry and Commerce (SAIC) which handled the enterprise's original business registration. Applications which meet the relevant criteria will be passed on to the provincial and state-level SAIC offices for examination.

To initiate the approval process, an enterprise must:

* possess legal person enterprise status in China (no foreign enterprise or foreign individual may directly engage in sales activities)
* have a registered capital of at least Yn5m (US$600,000)
* seek to sell only those products which the enterprise manufactures in China
* demonstrate that the enterprise has a direct marketing strategy which adheres to Chinese regulations, along with a sales force administration system.

Successful applicants will be issued a relevant multi-level or single-level direct sales approval certificate. Direct sales rights may not be transferred or assigned.

The measures devote an entire chapter to the selection and treatment of sales staff, outlining the relationship between the enterprise and its sales force. It is emphasised that sales recruits must not be required to pay any joining fees, deposits or other charges as part of their recruitment. Several other varieties of fees, such as training fees, are also prohibited. The detail devoted to these prohibitions may indicate government concern over past abuses of the direct sales system.

In addition, the measures place restrictions on who is eligible for recruitment. For example, recruits must be at least 19 years old and enjoy full civil rights. Civil servants, active military personnel, full-time students and all individuals prevented by law from holding two or more posts concurrently are banned from engaging in direct sales work.

Training requirement

Enterprises considering a multi-level structure should bear in mind that prospective recruits must hold local residency in the region approved for the enterprise's direct sales activities. It is not evident from the measures whether this restriction applies to single-level direct sales forces as well.

Enterprises must provide their sales staff with proper training to ensure familiarity with the sales process and any relevant laws or regulations. The measures include an incentive to monitor staff progress. Where an enterprise displays insufficient management responsibility toward sales staff who have engaged in illegal direct sales activities, both parties will share legal responsibility for the misconduct.

Clearly, not every enterprise can make use of direct sales to market its products. However, the measures should encourage some manufacturers, particularly those which are able to establish multiple production sites, to cultivate local sales forces which target specific areas and population groups.

Freshfields is an international law firm. Most of its offices throughout Asia, Europe and North America include China specialists. For further details, contact Matthew Cosans through its offices in Hong Kong, tel: (852) 2846 3400 or Beijing, tel: (86) 10 6465 4795