The holding game

Over recent years, many of the biggest foreign investors in China have established holding companies, including the likes of General Electric, Motorola and Siemens. Despite the high costs involved in setting up an office in Beijing, the capital is a natural place for multinationals to locate their China holding companies. The city offers a good infrastructure and a large pool of educated workers, but its unique attraction is the presence of so many government departments, ministries, regulators, foreign embassies and Chinese corporate headquarters. This is essential in developing good relations with key organisations in China.

Moreover, there are plenty of service companies, from accountants and lawyers to advertising agencies and human resource companies, to help firms coordinate the business functions of their multiple investments.

Four years ago, when inward investment was at its highest, the Chinese authorities allowed the creation of holding companies to solve a wide range of problems experienced by foreign joint ventures. The details were contained in tentative regulations promulgated by Moftec on April 4, 1995.

The Swiss-based chemical company Ciba was quick to respond, setting up a holding company to support seven joint ventures with a total investment of US$200m.

"The holding structure brought several benefits," explains Mr. Wilfried Liechert, deputy general manager of Ciba in China. "For instance we can employ our staff directly, without intermediaries. That allows better access to the people and the possibility to adjust our training and our own salary scale. Moreover, as one of the first holding companies to be set up in China, we enjoy a good standing with the authorities, which helps us enormously. We have very good contacts with them and we are much more involved than if we were just a representative office."

The regulations allow big foreign companies with several joint ventures to centralise and share business services, including legal advice, accountancy, personnel training, customer services and purchasing. This helps to save costs and promote a consistency of service. "We keep the overall strategy with the holding company; in order to speak the same language," explains Liechert.

However many firms have been frustrated by the restrictions placed on these holding companies, particularly in the areas of distribution and financial services. Back in 1995, multinationals were hoping that China would relax its restrictions on foreign participation in domestic distribution, a huge bottleneck in the country. They thought future policies could allow them to set up their own distribution networks for selling all their joint venture products, a move which would save costs and boost efficiency.

Disgruntlement has been exacerbated by the continued difficulties of operating in China and the downturn in business conditions brought on by the Asian financial crisis. Chinese government departments have been pondering how to respond to complaints from foreign businesses in areas ranging from a scarcity of domestic credit to a lack of transparency in official regulations.

A representative of Philips China in Shanghai admits that there was general disappointment with the restrictions placed on holding companies. The group started to scale back the scope of its holding company, which oversees 24 Mainland factories with reported sales of US$2bn in 1997, and returned many shared services to its individual businesses.

"This general reorientation had nothing to do with China in particular, but was a consequence of a worldwide rethinking of the Philips model," explains the representative. "For instance, if the business is with the joint venture then the accounting functions should be within it too."

But even for supporters of the structure, there have been setbacks. "Some foreign companies created these holding companies during the mid-1990s without a real objective, besides getting negotiating power," explains Mr. Harmut Schnabel, an analyst at the consulting firm Roland Berger. "They were disappointed by what holding companies could actually do – they could offer certain intermediary services, but they were not allowed to sell products to subsidiaries, to run warehouses or to import. There were also inconveniences – the fact that the business licences were always with the subsidiaries and that they were not allowed to make consolidated balance sheets."

There are now signs that the Ministry of Foreign Trade and Economic Cooperation (Moftec) is trying to improve the business environment. For example, new measures have been introduced to widen the scope of Mainland-based holding companies.

In August the government promulgated a new set or measures expanding the 1995 tentative regulations about holding companies. Welcomed as a ‘revolution' by one international consultant, the regulations allow a substantial opening in the business operations of holding companies. However they do not go as far as allowing them to channel profits earned by one joint venture to another that was starting out or in need of capital.

"There were some benefits we would hope to have," explains Liechert. "One of them is definitely the possibility to use the holding company as an investment vehicle to keep a flow of money running between the joint ventures, so we could provide funds to these units in need of cash. But this is not possible so far, as the Chinese system only allows to set up a financial company and this is costly. So, our expectations have not been fully realised yet but, when it comes, the existing holding company will be the first to get these rights."

The major new area to open up is in transporting goods. Companies can now ask Moftec to issue licences to set up warehouses and distribution networks for the products of their joint ventures. The document opens the door for holding companies to purchase goods in China for export.

"These new measures are a real progress," says Schnabel, "because the holding companies are now allowed to run distribution networks for a whole set of joint ventures. Before, it would have been very costly to set up such a network for every small unit."

These new advantages could lead more foreign companies which currently co-ordinate their joint ventures from representative offices, to reconsider their business structure in China and establish a holding company.