LOOK BEFORE YOU LEAP:
Essential Advice for Doing Business in China
By the U.S. Commercial Service, Beijing
and Rosemary Gallant U.S. Commercial Service

Since adopting market reforms in 1978, China has been among the world's fastest growing economies. This has led to dramatic developments in America's commercial relationship with China. In 1986, total trade between the United States and China was $7.9 billion. By 2003, this total had reached $170 billion, making China the United States' third largest trading partner. Despite a significant trade deficit, U.S. exports to China grew by 66 percent over the past three years as compared to 10 percent decline for the rest of the world. There are significant opportunities for U.S. businesses in China.

A key list of "do's and don'ts" of doing business in China draws from the experience of American companies with successful sales in China, as well as information from the U.S. Department of Commerce.

Diverse Markets Require Careful Research

China is a very diverse market with varying levels of development and regional industrial strengths. From Harbin in China's Northeast, to subtropical Haikou on Hainan Island in the South China Sea, 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 products factories in China, 2,700 are located in the southern province of Guangdong.
Basic market research is available from the U.S. Department of Commerce through http://www.export.gov, as well as a host of private consulting firms, research companies, and trade groups. The commercial sections of the U.S. embassy and consulates in China, in conjunction with the Export Assistance Center of Western PA, can also work with American exporters to provide research on specific topics to understand current market conditions, pricing, and future trends. Lists of local businesses service providers, consultants, and law firms are available through the commercial sections of the U.S. embassy and consulates. The U.S. Department of Commerce maintains offices in Beijing, Chengdu, Guangzhou, Shanghai, Shenyang, and Hong Kong. Similarly, many companies need multiple representatives to cover China.

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 in China should supply company information in Chinese and be prepared to initiate contact in Chinese. Having Chinese-language material prepared and a Chinese speaker or interpreter available makes a great first impression and demonstrates that a company is serious about doing business in China.

Small firms also need to be resourceful about finding affordable Chinese-language expertise. For initial oral communication, a number of companies have 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, successful companies normally invest in developing Chinese-language material about their companies and products. Companies worked with their distributors on the translations, used outside professional firms, or used their U.S. staff to produce business cards, brochures, and other materials. The Commercial Service can help companies find translators.

Find the Right Partner

Small firms typically need to find a counterpart in China to make sales and deliver products for them.

Guidebooks on doing business in China emphasize the importance of personal connections, or guanxi (GWAN-shee). Networking is an aspect of doing business around the world, but it takes on added importance in a society with a complex bureaucracy and a weak legal system. A web of guanxi helps firms navigate China's bureaucractic and distribution challenges.

The importance of relationships is another reason why many small American companies choose to sell through trading companies or local distributors, even if they have offices 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 such offices to sign sales contracts or bill customers directly. As a result, local agents and representatives are crucial.

It is critical that companies make sure that their partners are reliable and that they have the right motivation. Make certain your client or partner is able and willing to do all he says he will do in the contract. Ensure that it is in your partner's best interest to perform as agreed. Is it in his interest to assist you to protect your brand or other intellectual property rights? Be careful that your partner is allowed by law to fulfill the promises in the contract. Check the reliability of information on your partner or customer through using independent sources.

Companies can locate distributors or sales agents through a variety of methods, including trade shows and business connections. The Department of Commerce offers a program that helps companies find representation in the market—the Gold Key Service. Knowledgeable Commerical Service trade specialists research and develop appointments with the contacts you need to do business in China. The Gold Key Service can provide instant business relationships for companies new to China, by setting up tailored appointments with potential importers, distributors, end users, or trade associations. Companies already in China seeking further representation may consider using either service.

One Midwestern industrial equipment company used a small and under-funded distributor in China for 10 years. In early 2002, the company traveled to China on a trade mission that included Beijing and Shanghai. The 15 meetings arranged through the Gold Key Service led the U.S. company to sign up four distributors covering four areas from the northeastern to the southeastern part of China.

Successful companies have also used independent distributors either established by entrepreneurs in China or 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 U.S. 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 the contract.

Have Clear Contract Terms

China's consistent, 8-percent economic growth leads to continual radical transformations in the internal dynamics of the economy. When entering into a contract with a Chinese partner you must be careful. Do not attempt to enter into an agreement without sound legal advice. Have your own legal counsel. In your contracts, specify exact terms of payment and performance standards. Set timelines. Pay careful attention to details, such as initialing pages of contracts and signing properly. Scrupulously follow the contract yourself—or expect to pay a high price. Do not rely on legal advice from your Chinese partner. Beware of claims that Chinese law requires specific covenants in your contract. Verify this with your own counsel. Do not agree to provisions in a contract that are not under your control. For example, if your client or partner wants you to specify in the contract that he must visit your production facilities in the United States, remember that you cannot guarantee that he will receive a visa. This could invalidate your contract. Do not assume that local or provincial officials actually have the authority to give you permits and permissions. Verify their claims of authority through independent sources.

Ensure Project Viability

Profitability of a project or the sale of goods and services should be based on sound economic criteria. Do not rely on promises of subsidies, special considerations, or non-market sources of income to create a profit. If subsidies are offered, they should be used to augment profit, not create it. Make certain your partner has the authority to offer subsidies and verify from independent sources that the subsidies will actually be paid. Look for examples of companies that have actually received such benefits. Viability may look very different over the short, medium- and long term. Many Chinese partners will encourage you to look at the long-term potential of the market and sacrifice profit in the early stages. Doing so may be detrimental to your ultimate success in the market. In China, as in any high-growth economy, it is difficult to predict the long term, so make sure that you can obtain profitability in the short term and sustain that profitability in the medium term.

Avoid Prohibited Agreements

Creating viable contracts and agreements is challenging in any business transaction. However, given an unfamiliar business environment, many companies can be unwitting victims of illegal agreements. Be familiar with the overarching rules governing agreements at all levels of jurisdiction. U.S. companies often enter into agreements in China with promises from local officials that central government rules will not be enforced in the provinces. Indeed, often they are not. Problems arise when these rules are suddenly applied—sometimes retroactively—leaving a company with little recourse. You must be ready to follow all WTO-compliant regulations. Seriously question any agreement in which you are told you can ignore or avoid these rules. Also, make sure that your managers know all relevant U.S. laws such as the U.S. Foreign Corrupt Practices Act. You should be aware that China is also cracking down on corruption. You do not want your business to be associated with corrupt officials or illegal practices. Be aware of Bureau of Industry and Security regulations on the transfer of dual-use technology to China. U.S. law prohibits transfer of some sensitive technologies without a license.

Practice Problem Prevention

In addition to creating pro forma balance sheets, spend some time at the beginning of a project to create possible scenarios if things go wrong. Try to anticipate possible problem areas. Create a practical strategy to deal with potential problems. Set milestones in the project for performance. Have an escape strategy for each stage of the project, even if you do not plan to use it. In China, personal relationships are very important, and sometimes partners may not be completely truthful about potential problems if they feel the problems may have a negative impact on a personal relationship. Chinese partners may also be under pressure from government or party bureaucrats (as well as business associates) to compromise ethical standards. When problems arise, you should have excellent contacts among officials at the local, provincial, and central government to manage the issues.

Perform Thorough Risk Analysis

Be realistic about how much risk you are willing to accept in your business venture. Make sure you use reliable sources for this assessment. Use more than news media sources or your immediate partners to evaluate the market. Do not have a corporate risk analysis policy for China that is different than you would have for any other country. If a project is too risky, do not do it—even though it is in China. The majority of American companies currently in trouble in China did not perform thorough risk analysis.

Expect Fierce Competition and Pricing Pressure

Recent economic analysis suggests that there is a significant surplus in industrial markets. There are strong competitive pressures. Chinese brands are strong and gaining market share in many sectors. In many Chinese markets there is a constant downward trend on prices. Chinese competitors, particularly those from the state-owned sector, often enjoy very low costs of capital. Thus, they can enter markets quickly, and they can expect to receive strong encouragement from the government for their efforts. The Chinese government makes no secret of its support for state-owned enterprises. Foreign companies should not expect a level playing field.

Ensuring Payment

Pay careful attention to how you get paid, when you get paid, and in which currency. If you want to be paid in U.S. dollars, be certain you are able to convert profits. Be advised that not all companies have rights to provide payment in foreign currency, and payment may be arranged through a "window company." Inquiring about a company's payment process shoud be an important part of screening for partners. Use letters of credit and other financial instruments to protect yourself. If you do not want to use a letter of credit, require your partner to make advance payment. Remember that Chinese companies usually do not use terms that allow unsecured payments after delivery of goods. For example, payment terms of "30 percent letter of credit, 70 percent payment, 120 days after delivery" would not be customary in China. For most large projects, terms of "70 percent advance payment, 30 percent letter of credit" would not be unusual. Never agree to unsecured payments after delivery.

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 primary risk of doing business in China today is the difficulty of collecting full payment on time.

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 exposure to the risk of nonpayment. The Commerce Department's International Company Profile service can help companies understand the background of potential customers or business partners by providing reports on individual Chinese companies. The Commercial Service 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.

A small U.S. firm that provides specialized training for the financial services industry in China 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 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 U.S. 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 U.S. 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. 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 end users that placed orders. Two U.S. consumer products companies recently made their first significant sales to China, in both cases to retail companies. The two U.S. companies obtained full payment prior to shipment, allowing them to gauge consumer interest in their products while limiting their risk.

Protecting Intellectual Property Rights

Time and again, companies are strongly warned about the problems of protecting their intellectual property rights in China. If you have a successful product or brand name, most likely you will be a target for intellectual property pirates. The U.S. embassy in China, under the leadership of Ambassador Clark T. Randt, has been working with U.S. companies to educate the Chinese government and help it strengthen and enforce relevant laws. In trying to help small and medium-sized U.S. companies, the embassy has devised an IPR toolkit. This toolkit was created to help companies understand the scope of the IPR problem in China, educate them on how to best protect their rights, and give them an action plan for what to do once they discover their goods, designs, logos, software, packaging, and so on have been illegally copied and sold. To access the IPR toolkit, check out http://www.usembassy-china.org.cn/ipr.

Look Before You Leap

Companies must be persistent in their efforts but flexible in their strategies to take advantage of the changing landscape. When they need help, U.S. companies should use available services, from the Department of Commerce as well as from the many professional law, accounting, marketing, translation, and other firms. One good starting place is the Commercial Service China Web site, http://www.buyusa.gov/china/en. Small firms can use the site to find information on Commercial Service China services, Beijing 2008 Olympic updates, and industry highlights.

The U.S. Department of Commerce, as well as other business-oriented organizations, is prepared to serve the interests of American companies and assist with market research, locating suitable and reliable partners, or providing feedback on the viability of a business plan.

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, firms can position themselves to profit from China's growth in the years to come.