In the l980s, before Beijing had opened up to welcome foreign direct investment, corporations tended to consider market entry strategy as best explored sequentially: by the turn of the millennium, with more options available, corporations could choose across a range of options from opening up a wholly-owned operation for licensing their technology to locals, or just dipping their collective toe in Chinese waters to test the temperature.
So the first step could involve establishing a representative office in Hong Kong, possibly manned by an overseas Chinese with local savvy, or at least by a tried and tested manager with knowledge of the Asia-Pacific. A Hong Kong base could be used, of course, to service global markets while exploring opportunities on the Mainland. As soon as the corporation began to find domestic customers and start importing through an import agent, officials would start to push for local production, either through a licensing arrangement with a state enterprise, or by a joint venture.
Full foreign ownership
Realising that corporations would only start to transfer technologies to China only if they could be assured of some control over operations, Beijing widened the entry option in l996 to full foreign ownership. In 1993, the holding company formula received official sanction, allowing corporations to start using it as a mechanism for integrating their activities China-wide. That would be a necessary condition for them to fit China activities into their global business
The entry mode is one question that top management must weigh. Their answer, which depends on two other considerations, yields a simple matrix (see table): the expect-ed significance of the China market to a corporation's global operations is measured on the vertical plane as ranging between low and high, and its expected bargaining power with the government is portrayed vertically as flinging from low to high. The matrix produces four broad predicaments:
1. If the significance of the market and the bargaining power of the corporation are both low, one approach is to avoid trouble by not going in, or to limit commitments while keeping options open for the future. Many corporations have taken this line. Japanese investors, for example, only became moderately bullish about China in the early 1990s, with the possible exception of electronic firms such as Hitachi concerned with reducing production costs as a priority. By the mid-1990s, Hitachi had 28 joint ventures operating across China.
But in general, Japanese investors looked at China and saw trouble, preferring to invest in other Asia-Pacific markets or in the US and the EU. Toyota, the global auto giant with an annual output of about 5m units, decided in 2000 to produce 30,000 units a year in a joint venture with Tianjin Auto-mobile Xiali. A year before, Honda began producing the Accord model in China.
Another example of limited initial commitment came from GE's Jack Welsh, who got fired up about China's potential after his visit in 1992. Over time, China has become a "massive opportunity", in the words of GE's new chief executive, Jeff Immelt, and the group now has more than USS I .7bn invested there. But GE's own procedures ensured that Welch's early enthusiasm was reigned in.
Consider the joint venture with China's biggest light-bulb manufacturer, Shanghai Jiabao. Too much time was spent bringing the production side up to scratch, while ignoring the market. Welch drew the lesson and axed projects that he considered to be heading for trouble, by sticking to his 20 percent return on investment rule while leaving GE business units to experiment on a limited basis. Examples of GE success are scanning equipment for hospitals, plastics and aircraft leasing a portfolio without much synergy between the component parts.
2. If the expected significance of the China market is high, and the bargaining power of the corporation is low, one option is to a give/go along/ally with local government demands. Here, the corporation's top management considers that what counts most is to get a toehold in the China market. In this frame of mind, the corporation is prepared to go a long way in accepting the government's requirements, such as agreeing to a minority share in a joint venture, to transfer technology as soon as possible, and to be satisfied at least early on with government demands.
Take Nike, the US sportswear group, which saw the China of the early 1980s as an ideal platform from which to source manufacture and exports of shoes. Despite low wage levels, it found that the non-labour costs of operating there were nearly one-third higher than in South Korea. Additional costs included the import of expatriates to train, the problems of finding local suppliers, the difficulty of getting staff to appreciate inter-national quality standards, the discovery that the workforce in SOEs had no incentive to improve and unanticipated transport costs. No wonder that Nike more or less accepted the government's terms in shifting its opera-lions to a special economic zone, where free market conditions prevailed.
Otis, the US elevator manufacturer, had a similar experience. Powerful competitors were entering the fast-growth market, and negotiations with the Tianjin authorities for a joint venture were dragging out. So Otis accepted a minority share, gave the joint venture an exclusive right to distribute its products, and agreed to employ the local workforce, maintain the existing pricing system and to accept an export clause all with tongue in cheek.
Not surprisingly, the joint venture got off to a spanking start and then drifted into trouble as the two partners' different agendas came to the fore. The deal was eventually renegotiated at the turn of the 1990s by incorporating the Tianjin operations into a broader China strategy. By then, corporate bar-gaining power was given a big fillip in both Beijing and Washington by organisations such as the US Chamber of Commerce and the US-China Business Council.
3. If the corporation's expected bargaining power is considered high and the expected significance of the China market is rather low, an opportunistic approach may pay dividends. Top management's attitude is: let's see what turns up in China, as long as we don't get sucked into some never-ending project that detracts our scarce managerial resources from their main markets.
This was very much the approach of Jan Froeshaug, the chief executive since 1987 of Egmont, the Danish children's entertainment company. By the early 1990s Egmont, as a Walt Disney, licensor, was responsible for 50 percent of Disney's stories. Froeshaug had been quick to spot the opportunities opening up in central Europe and here was a new opportunity in China. China had about 200m children aged 5-14, with a print size in the five major regions equivalent to the market size of the whole of German-speaking Europe.
The problem was that publishing was out of bounds for foreign investors, and the powerful Ministry of Post and Telecommunications had control over printing and magazine distribution through China's 53.00 post offices. Disney agreed to let Egmont explore the prospect and Froeshaug was duly introduced to an agent, Shoul Eisenberg multi-billionaire Israeli national, escapee from Hitler's Europe, one of Mao Zedong's contacts with the western world and part responsible for the Nixon-Kissinger diplomacy with Beijing in 1971-72.
Froeshaug relates how Eisenberg flew into Frankfurt on a Chinese military plane. With this outsize character as partner, Froeshaug stitched up a workable deal, just in time for the government to announce a ban on other foreign publishers undertaking joint ventures in China. Meanwhile the Children's Fun joint venture, Egmont's China baby, had to learn the hard way that Mickey Mouse and Goofy, the Stone Age was not a hit with Chinese parents and children. Egmont's China operations have done fine but, like many others investors, less well than might have been hoped for.
4. If both the corporation's bargaining power and the market's significance are high, then the corporation can challenge local demands and negotiate favourable concessions with public officials. Take the ease of distribution networks, which the state began to marketise in the early I 990s. The sector was opened up to joint ventures and rules about advertising were eased. Carrefour, the French retail giant, seized the opportunity to build up China's second biggest retail chain in the short space of five years. By 2000, Carrefour could boast 28 outlets in Is cities and a turnover of nearly US$ Iba all the while ignoring Beijing's required say-so to open retail joint ventures. A key to its success is to provide a simple, large store space, offering a large variety of products and low prices. The stores move goods fast, cut tough deals with suppliers, carry minimal stocks and eater to local tastes.
There are other reasons, though, for Carrefour's success. An intangible Carrefour asset is the managerial savvy acquired in its home market in France, and then across Europe. Europe is, in many ways, like China, composed of quite separate provinces and governed loosely by a distant emperor. Knowing the local barons, and winning their support, is essential to success. Thus, while its arch rival Wal-Mart stuck to Beijing's rules and to the Guangdong markets, Carrefour managers raced around China cutting deals with city governments, promising local jobs and tax revenues. They had done much the same in expanding around Europe.
An additional advantage for Carrefour is that China is a huge France: both countries pride themselves on their cuisine, both are convinced that they are the center of the world, both love mandarinates and both know that rules are there to be bent. When, in 2001, Beijing opened an investigation into the lack of central approval for Carrefour outlets, Carrefour had already built up an extensive constituency across the country. It also put the opening of 10 new stores on hold, just to hint at the cost of a negative decision. Given that there were 270 other foreign-financed retail outlets watching, Carrefour was given the nod.
Avon, the US direct-selling corporation, had a rather different experience. Like Carrefour, Avon found lobbying in Beijing unrewarding, and headed for the provinces. Guangdong authorities were receptive, and the company began to roll-out its plans for door-to-door sales. Others soon followed Avon's example, so that by 1997 there were about 2,300 direct-selling firms in China, employing up to 20m people and generating a sales volume of US$2bn. But the State Council issued a blanket ban in April 1999. All door-to-door sales operations were ordered to convert to standard retail distribution or go out of business.
One reason for the crackdown was to flush out the get-rich-quick artists. But the main reason to stop door-to door sales operations was political: officials did not like the rituals used to arouse enthusiasm at marketing meetings. They were too much like religious revivalist movements. Avon had to concede, and swiftly altered its business model to turn
its supply stores into retail outlets. The motto is that foreign investors ?must know when the central government is in earnest, and when it is less so. Beijing is definitely in earnest about stamping out opposition movements, before they can organise.
The takeaway for businesses entering China is that there has been a learning process about how to enter the market. This holds for both corporations and public officials. There are plenty of examples, of course, where firms that are fresh to China, and public officials with limited expedience about dealing with foreigners, have to learn the hard way all over again.
But it is equally true that the Nike and Otis stories recounted here are more typical of the 1980s, and Egmont's is typical of the early I 990s. Shoul Eisenberg's skills as a go-between were rooted in the old planning system, still being vigorously championed by the Ministry of Posts and Telecommunications at the time of Egmont's entry. Since then, Eisenberg has passed on, and the ministry has transmogrified into the Ministry of
Electronic Industries. Carrefour's and Avon's stories could occur at the turn of the century, because that is when the party-state was learning how to sort out its policies regarding the marketisation of the wholesale and retail sectors. In future, foreign corporations can chose from a range of options on how to enter the China market, whereas 20 years ago they would have had to proceed sequentially and slowly.
Even so, a few rules of thumb still hold for the future: be clear about -your own objectives and those of your Chinese partners; don't tailor your strategy to government demands; control is best exercised by a majority stake but, failing that, considerable influence can be exerted by exploiting the leverage derived from the provision of know-how, technology etc; being in there for the long term does not mean running a loss-making operation indefinitely; develop good antennae to help you learn about China's changing environment; remember the government in China is not a monolith, and relations have to be cultivated at all levels of the state. Not least, remember that the best partner, as the Chinese saying goes, is one who shares the same dreams but not the same bed.
This is an edited extract from China, the Race to Market, written by Professor Jonathan Story and published by Financial Times Prentice Hall, US$27.50. The book is available from www.amazon.com and www.business-minds.com. Jonathan Story is professor of international political economy at INSEAD, in France.