The Small Fry Take on China

Rosemary D. Gallant

Tips and strategies for
small and medium-
sized companies
looking at the China
market

As China continues to grow, and to implement its World Trade Organization (WTO) commitments, more and more small and medium-sized US companies have sought—and found—opportunities to sell their goods in China. With US exports to China up 18.5 percent in 2001 and an estimated 15 percent in 2002, more US firms than ever before have questions about how to succeed in the China market. The interest is especially strong among small and medium-sized enterprises (SMEs), despite the limited resources these companies can commit. How, then, are they finding out how to enter the China market? A look at 10 small American companies with successful sales efforts in China, together

with information from the US Department of Commerce (DOC), points out some of the key dos and don'ts of doing business in China on a small budget.

The 10 companies—in industries ranging from specialty chemicals, to fire and safety products, to high-end consumer goods—share common concerns. They have learned that, unlike companies in other markets, Chinese companies typically lack a credit history and rely heavily on relationships; that the Chinese legal system is underdeveloped; and that the PRC government has imposed barriers on a broad range of products. Nonetheless, the companies employ the same basic export strategies and tools they use around the globe: They research the market, conduct careful due diligence, identify reliable distributors, and employ prudent payment practices. These companies also monitor the market closely to take advantage of changing opportunities.

Lesson 1: Diverse markets require careful research
Any firm entering the China market must understand China’s diversity—its varying levels of development and regional industrial strengths. From Harbin, Heilongjiang, in China’s Northeast, to subtropical Haikou on Hainan Island, China encompasses diverse topographies, climates, cultures, and peoples. Each region therefore has its own consumer preferences and business needs. Some industries are spread all over the country, some are clustered, and others are heavily concentrated in one area. For example, of the roughly 3,000 personal care product factories in China, 2,700 are located in southern China’s Guangdong Province.

Small US companies typically cannot afford to hire a high-priced market-entry consultant to guide them in China. Instead, they rely on numerous other sources of information on China’s markets. Basic market research is available from DOC, as well as a host of less-expensive private consulting and research companies, and trade groups—like the US-China Business Council, publisher of this magazine. To help US companies follow local markets and make local contacts, DOC maintains offices in six cities in the PRC (Beijing; Chengdu, Sichuan; Guangzhou; Shanghai; Shenyang, Liaoning; and Hong Kong). Similarly, many companies need multiple representatives to cover China.

All of the SMEs interviewed for this article continually supplement their understanding of the market through such sources. And because China’s market is changing rapidly, trade shows and other opportunities that allow companies to make contacts directly with potential customers are also critical to success.

Lesson 2: Find the right partner
SMEs, unlike large multinational corporations, tend to start by exporting to China rather than establishing a large operation on Chinese soil. They need to find a counterpart of counterparts in China to make sales and deliver products for them. Companies can locate distributors or sales agents through a variety of methods, including trade shows and business connections. DOC offers two programs that help companies find representation in the market—the Gold Key Service and the International Partner Search (see www.buyusa.gov). The Gold Key Service can provide instant business relationships, or guanxi, for companies new to China, by setting up customized, prescreened appointments with potential importers, distributors, endusers, or, if desired, government agencies or trade associations. The International Partner Search provides detailed company information on prescreened partners that have expressed interest in the US company's products or services. Both services are effective ways for newcomers to contact interested, qualified agents in China. Companies already in China seeking further representation may consider using either service. One midwestern industrial equipment company used a small and underfunded distributor in China for 10 years. In early 2002, the company traveled to China on a trade mission that included Gold Keys in Beijing

Several successful
companies interviewed
for this article use
independent
distributors that were
either established by
entrepreneurs in China
or are branches of
companies from
Taiwan, Hong Kong, or
Singapore.

and Shanghai. The 15 meetings arranged through the Gold Keys led the US company to sign up four new distributors covering four areas from Dalian, Liaoning, in China's Northeast, to Shanghai along the southeastern coast.

Several successful companies interviewed for this article use independent distributors that were either established by entrepreneurs in China or are branches of companies from Taiwan, Hong Kong, or Singapore. Other companies work through major state-owned trading companies that provide wide geographic coverage. The number of distributors these companies use range from two to 34, but regardless of the number, the US companies screened them as thoroughly as they screen distributors in other markets, requiring business plans, interviews, and background checks before signing them on.

Finding the right partner or distributor and employing prudent payment practices are particularly critical in China, where the judicial process is slow, expensive, and plagued by corruption. Rather than relying on legal safeguards, American companies need to ensure that their Chinese counterparts in any contract have their own motivation for fulfilling, or performing according to, the contract.

Lesson 3: Build strong relationships
Cultural guidebooks on doing business in China emphasize the importance of personal connections. Networking is an aspect of doing business around the world, but it can take on added importance in a society with a complex bureaucracy and a weak legal framework. A web of guanxi helps firms navigate China's bureaucracy and distribution challenges. This is true for large firms but even more so for small firms or their agents or local representatives.

The importance of relationships is another reason why many smaller American companies choose to sell through trading companies or local distributors, even if they have an office in China. Representative offices, the most basic, least-expensive type of foreign commercial presence in China, may only perform "liaison" activities; Chinese law does not allow these offices to sign sales contracts or bill customers directly. But for most small US companies, even establishing a representative office is more than they can afford. As a result, agents and local representatives are crucial.

One small, well-established service supplier with a presence in several far-flung Chinese cities regularly finds itself nurturing relationships with suppliers, staff, local officials, and central authorities. This web of relationships supports the smooth running of its business, helps it solve problems, and gives it access to information. To keep business growing, the company must balance the demands of building and maintaining useful relationships with its more fundamental job—providing excellent healthcare service to patients at a reasonable cost.

Companies that
are serious about
doing business
with China
should supply
information about
their company in
Chinese and be
prepared to
initiate contact in
Chinese.

Lesson 4: Speak the same language
Despite China's commitment to, and success in, developing human resources with good English-language skills, companies that are serious about doing business with China should supply information about their company in Chinese and be prepared to initiate contact in Chinese. Having Chinese-language material prepared and a Chinese speaker or translator available makes a great first impression and demonstrates that a company is serious about doing business in China.

SMEs also need to be resourceful about finding affordable Chinese-language expertise. For initial oral communication, a number of the interviewed companies used Chinese-speaking employees from other parts of the company to help with sales and marketing to China. One business has an individual responsible for placing sales calls to China stay late at the office to introduce the company during business hours in China. Another transferred a Chinese-American from the factory floor to the marketing department to handle Chinese customer accounts. Interestingly, once contact was made in Chinese, several companies indicated that they then conducted routine business in English via e-mail without a problem. Similarly, all of the successful companies interviewed for this article have invested in developing Chinese-language material about their companies and products. Companies either worked with their

distributors on the translations, used outside professional firms, or used their US staff to produce business cards, brochures, and other literature.

Lesson 5: Get paid—on time
One critical difference between China and most other markets is the country's lack of a predictable, systematic approach to credit and receivables management. Indeed, perhaps the number-one risk of doing business in China today is the difficulty of collecting full payment on time. The US Embassy in Beijing probably handles more trade complaints and payment problems than any other US embassy in the world. The embassy's senior commercial officer estimates that he currently has trade complaints worth $4 billion on his desk (see "Keys to Business Success in China"). The experience of one US manufacturer illustrates this problem: The manufacturer established an office in China and made sales of $300,000 in its first year. In the end, nearly one-third of the customers did not pay for deliveries, and the receivables eventually had to be written off.

The lack of objective credit procedures, including data about credit worthiness, makes debt prevention an issue for all companies operating in China—foreign and local, small and large. China is keenly aware of the need to develop credit infrastructure and is attempting to establish credit management tools. For example, in 1999, the People's Bank of China announced the Measure on Bank Credit Registration and Information Management (Trial), designed to implement a national bank credit registration and information management system. In September 2002, State Administration for Industry and Commerce offices in Shenyang, Dalian, and Harbin, along with the Jilin provincial office, were building enterprise credit information websites, but it will be several years until a reliable system is in place nationwide.

The lack of credit infrastructure makes determining creditworthiness challenging—but not impossible. Companies need to spend the time and money to analyze customers' and partners' creditworthiness or minimize the exposure to the risk of nonpayment. DOC's International Company Profile service can help companies understand the background of potential customers or business partners by providing reports on individual Chinese companies. DOC in China subcontracts with Kroll Associates, an American investigative service firm, for parts of these reports. Commercial Service staff members provide additional information about the relative strength of the firm in its market and the firm's reliability.

In another example, a small US firm that provides specialized training for the financial services industry in China recently ran into trouble when it attempted to save money by foregoing due diligence, relying instead on a personal referral. The first training session it organized with its local partner was well attended, but success soon gave way to a trade complaint. A company representative stressed, "When I say the Chinese company took advantage of us, I mean it in the full extent." In this case, the partner collected $10,000 in registration fees but refused to share

One critical
difference between
China and most
other markets is
the country's lack
of a predictable,
systematic
approach to credit
and receivables
management

information on the number of paid participants. The representative continued, "When it came time for [the partner] to pay us the money agreed upon she reneged. She paid me $1,000 cash and promised to pay 50 percent via wire. We will lose 90 percent of what we agreed to." Given the vast need for financial services training in China, the US company decided to plow ahead despite this experience, but with a more cautious strategy.

This small service provider subsequently found success—packed training sessions and full payment for its services—by establishing a relationship with a domestic Chinese insurer. The US company found that locating a reputable partner through extensive research and requiring third-party confirmation of information could help avoid further trade disputes.

To minimize risk,
companies just
entering the market
can protect themselves
by not selling on credit.
Exporters frequently
require full payment in
advance from their
distributors or
customers.

To minimize risk, companies just entering the market can protect themselves by not selling on credit. Exporters frequently require full payment in advance from their distributors or customers. One credit manager has his multinational corporate clients in China pay his company directly, via bank transfer. For local Chinese buyers, the American company requires payments from its distributor before releasing shipments.

The local distributor is responsible for collecting payment from the endusers that placed orders. Two US consumer products companies made their first significant sales to China this year, in both cases to retail companies. The two US companies obtained full payment prior to shipment, allowing them to gauge consumer interest in their products while limiting their risk.

A midwestern company makes regular sales to China using a DOC catalogue Commercial News USA, again requiring all payment in advance. Longer-term or more substantial success will no doubt require greater flexibility on payments, but at least these companies have not been burned in their first experience in China.

Article continued below

Keys to Business Success in China
CBR Assistant Editor Paula M. Miller recently spoke with Thomas Lee Boam, PhD, minister counselor for Commercial Affairs, US Embassy, Beijing, about how US companies can use the services of the US Department of Commerce (DOC) to break into the China market

CBR: What is the role of the US DOC in Beijing? Do you serve small and medium-sized companies only?
Boam: Our mandate is to assist small and medium-sized businesses in our US DOC offices throughout the world. That said, we find that all US businesses in China need our help, so we respond to all inquiries.
CBR: What percentage of US companies doing business with China use your service? How many US companies do you help on average?
Boam: We don't have exact statistics on this kind of information but we were involved in approximately 200 trade missions last year and assisted several thousand firms. DOC sees as many CEOs of big companies as small ones?every type of company asks for help. In China, we had $3.7 billion in success stories last year—this is the highest of any of the countries in which we operate. Last year, total exports from the United States to China were over $23 billion. We were involved with nearly 15 percent of total sales to China.
Fifteen years ago, the US embassy in Beijing probably saw over 90 percent of businesspeople who came to China. At that time, embassy help was almost a necessity to establish business with China. Today, we see less than 50 percent of businesspeople who conduct operations with China. This percentage is still far greater than in the average European country, but it is lower than in countries like Vietnam.
CBR: What are the most common problems US businesses encounter in China?
Boam: The most common problem is a failure to conduct proper due diligence and risk analysis before doing business in China. Business executives sometimes get overexcited when they think about conducting business with more than 1.3 billion people and become careless. We have approximately $4 billion in trade complaints in our office, including many that could have been avoided if the American business executives had prepared properly. About 75 percent of the cases we see are self-inflicted wounds—the US company did not do anything wrong or illegal, but they did not prepare well. For example, it's not difficult to find out if your business is allowed to have joint ownership under Chinese law. We have seen numerous cases in which companies will depend on their Chinese partner to tell them the law, without doing their own homework, or hiring competent legal counsel, and this can lead to serious errors. Other key problems involve contract difficulties and intellectual property (IP) right abuses.
CBR: How do the needs of smaller companies compare with the needs of larger companies?
Boam: Smaller companies generally need greater assistance—especially in determining if there is a market at all in China for their products or services, and how this market will be regulated and controlled. Larger companies generally have greater resources to evaluate the market and create entry strategies. For the smaller companies, our offices can often replace much of the work that the large companies can assign to internal staff, through our services [see www.usembassy-china.org.cn].
Smaller companies also tend to be more careful than larger companies—this may be because a mistake to a small company could put them out of business while larger companies generally have a little more room for error.
CBR: What is the easiest sector for US businesses to enter in China? What is the hardest?
Boam: Several years ago Gordon Wu, a Hong Kong industrialist, told me the secret of doing business in China. He said, “Sell the Chinese things that they need.” This sounds basic, but this advice solves many problems—of course it is ineffective to try to sell people things they don’t need or want. The most successful businesses will be those that cause an increase of wealth in China and growth in China’s economy. For example, selling products or services in infrastructure, industry, energy, mining, chemical, and medical

or medical-diagnostic sectors can be very profitable. Things that improve quality of life and economic viability in China are among the best markets.
    Foreign companies run into problems when China already has substantial sources of domestic production and supply of the products the US company wants to export or produce. For example, sales of agriculture and food products are difficult—since China is self-sufficient in food, consumers can buy domestically. In addition, tariffs are still relatively high.
CBR: What are your top three recommendations for small and medium-sized companies that want to get started in China?
Boam: The first priority is market research. There needs to be a market for the product. By this I mean there must be both demand and desire. Demand and desire are two different things, and companies wanting to do business in China often confuse the two. People need to have money in order to buy products, so “demand” is desire with disposable income associated with it. In 2001, the per capita GDP in China was about $900. There are approximately 800 million people living on less than $1 per day. This means China is not an appropriate market for many items, and while there is plenty of desire to buy the products, there is not a lot of demand.
    The second recommendation is to make sure that you write a good contract. Companies must be careful when writing the contract. They must conduct due diligence, confirm the viability of the partner—make sure the Chinese partner will be able to perform—make certain they will be paid. Contract negotiations are very different in China from the United States, and American companies that are not prepared for this may find themselves saddled with bad deals. Good legal counsel is a must.
    The third recommendation is to protect your IP. Companies need an IP protection plan as part of their strategy for doing business in China. It costs money to protect your IP rights. There are laws in China to protect you against theft of your intellectual property, but this does not mean you can relax. There are laws against bank robbery in the United States, but banks still take actions to protect themselves. It is no different in China.
CBR: How do you think China’s entry into the World Trade Organization (WTO) will ultimately affect US businesses?
Boam: It has been one year since China’s accession to the WTO [December 11, 2001]. I’d say, “It’s been the best of times and it’s been the worst of times.” The PRC government has done better than we expected in many ways: tariffs have dropped, quotas have gone down, and some of these reductions are a year ahead of schedule. However, in other areas China is lagging behind. For example, certain areas in agriculture, some tariff-rate quotas, standards, Customs inspection procedure difficulties, etc. are not progressing as quickly as we would like.
    Overall, I’d give China good marks—but this means some things were done very well and some very poorly. If I were to give China one grade it would be a “B-.” The “B-” would be a combination of As and Ds with little down the middle.
    Recently I’ve seen encouraging signs. There seems to be a new willingness to carry out negotiations and work on tough spots—a new level of cooperation. We hope this is a sign of things to come, since both China and the United States have a lot to gain from China’s full compliance with WTO. This issue gets an enormous amount of attention from a variety of American institutions, and I think we are on the right road. We will continue to monitor China’s accession, provide assistance and training, and when necessary, point out areas in which we have disagreements. We think the Chinese also see that WTO compliance is in their best interest, or they would not have signed the agreement, so we will continue to work with them at all levels.

Lesson 6: Consider investing on the ground
After setting up a distribution function, the next step for most companies is establishing a direct market presence. In the past, this meant establishing a joint venture, partly because Chinese law restricted wholly foreign-owned enterprises (WFOEs) to those providing advanced technology or those that were primarily export oriented. Joint ventures also promised to provide the foreign company with guanxi. But as China has liberalized its laws on foreign investment and allowed the establishment of more WFOEs, an increasing number of US companies have found the WFOE to be a viable way to enter the China market, since it takes much less time and money to set up than a joint venture. In 2000, for the first time, WFOE registrations exceeded joint ventures. By 2001, WFOEs accounted for 60 percent of new projects. (China still prohibits WFOEs in a number of sectors, including insurance and telecommunications services, and other sectors it deems sensitive.)

Two small northeastern US ompanies recently took advantage of this new opportunity. The first one has been aggressively exploring the China market for six years. The company originally tried to work with a local partner to distribute and install its products, but found that even with the US side maintaining 60 percent ownership of the venture, the local partner always wanted to be in charge. Eventually the US company decided to establish its own facility, but negotiating with potential partners had cost it a year. In early 2002, the company set up a stocking facility in a centrally located free-trade zone. The facility, a $300,000 investment, not only allows the US company to ship large quantities of product to China, but it also provides customer and technical support and a training facility. The free-trade zone operation now handles customers' calls, which used to come to the factory's New England headquarters. The company's independent distributors in China also benefit because product education is done in-country for much less than it costs to bring customers to the United States. The US company's presence in the free-trade zone authorizes it to convert renminbi (RMB) to US dollars to repatriate profits and allows the company to bill in local currency (RMB). This has given the company access to many more customers.

The leadership of another small company, a safety device manufacturer, decided about five years ago to manufacture in China. In 1994, the company had established an office in China, which was very successful in developing sales, until two significant problems arose. First, one-third of the customers did not pay. Second, local Chinese companies noted their success and started making knockoffs of their products and selling them for half the price the American company was charging. Eventually the company closed the sales office but wanted to pursue local manufacturing to match the cost basis of the knockoffs and to control payment collection better. The US company reviewed six potential manufacturing companies before finally finding a small plant, located in a coastal province, that the company bought and now operates as a WFOE. After just one year of operation, the factory has already turned a profit. The US manager stated that the company's willingness to wait for just the right fit was critical to its ultimate success.

Lesson 7: Look before you leap
Despite many anecdotal successes, China is still a medium-sized export market for US firms—a market larger than France but smaller than South Korea. Companies must be persistent in their efforts but flexible in their strategies to take advantage of the changing landscape. And when they need help, US companies should use available services, from DOC as well as from the many professional law, accounting, marketing, translation, and other firms. One good starting place is the Commercial Service China website, www.buyusa.gov/china/en. SMEs can use the recently revamped site to find information on Commercial Service China services, Beijing 2008 Olympic updates, and industry highlights.

China is a rapidly changing market that requires a great deal of caution and patience. Companies should test the water carefully before jumping in. With proper preparation, however, even the most wary SMEs can position themselves to profit from China’s growth in the years to come.

China is still a
medium-sized
export market for
US firms—a market
larger than France
but smaller than
South Korea.

Rosemary D. Gallant
is a commercial officer at the US Department of Commerce’s Export Assistance Center in Middletown, Connecticut. She has worked for 11 years for the US and Foreign Commercial Service in Shanghai, Hong Kong, and the American Institute in Taiwan. She joined the China office of the Commerce Department in 1988.

The author would like to thank Thomas Lee Boam, PhD, and Julie Carducci for their contributions to this article. Boam is minister counselor for Commercial Affairs, US Embassy, Beijing, and Carducci is an international trade specialist in the Chicago Export Assistance Center of the US Department of Commerce, who served four years as a commercial officer in the US Embassy, Beijing.

The China Business Review, Volume 30, Number 1, January-February 2003

Last Updated: 11-Feb-2003