Doing Business in China

Five days ago, 22 Smith students entered China knowing very little Chinese, understanding very little about Chinese culture, and half-expecting the cuisine to be General Tso’s Chicken with fortune cookies for dessert. Duck tongue and tripe (a.k.a. beef stomach lining) soon proved us wrong – what a difference a week makes!

General Motors:

Our last day in Shanghai began with a factory tour of General Motors (GM) in Shanghai.
GM, the world’s largest automaker and one of the best known American brands, formed a 50-50 joint venture with Shanghai Automotive Industry Corporation Group to create Shanghai General Motors Co. Ltd (Shanghai GM) in 1997. Today, Shanghai GM has an annual production capacity of 200,000 vehicles and employs 6,000 of 13,000 GM employees in China. As noted here, Smith students enjoyed looking at the newest models.

While there were similarities among the GM plants in the US and China, there were some notable differences. One example is that Shanghai GM produces brands unique to the Chinese market that are not produced in the United States. In addition, the Shanghai plant has capabilities to produce multiple vehicle models on the same production line, while the US plants typically only produce one model per line. One of the primary reasons for this difference in production styles is because GM has a comparatively smaller niche target market and producing multiple models on the same line is more efficient for their needs there.

Shanghai Stock Exchange:

Founded on Nov. 26, 1990, the Shanghai Stock Exchange was the first stock exchange in China and remains one of the most topical institutions in the world today. The group met with Situ Danian, an economist at the Exchange, and received a briefing on many of the current events at the exchange.

The Shanghai Stock Exchange has 153 members, currently all domestic, and the majority primarily from securities firms. The Exchange estimates 39 million investors, and institutional investors hold approximately 22 percent of the equity in the Shanghai market. The market has seen significant gain since 2001 and is getting ready to list one of the most anticipated IPO’s of 2006 – the $10 billion Bank of China deal. The past 10 years have brought about historical highs and represent the emergence of China as a market economy. Most of the companies on the exchange are state-owned-entities, where generally over 2/3 of the shares are not tradeable. A major initiative of the Exchange is its effort to attract more blue-chip listings for the Shanghai Stock Exchange. The Exchange has had a moratorium on IPO’s. Hong Kong has taken advantage of this vulnerability and worked diligently to attract more Chinese companies to list in Hong Kong. Reforms are said to have “gone well” and the IPO’s just resumed yesterday. People are optimistic that these changes will bring Chinese IPO’s back to the Chinese stock exchange.

Situ Danian provided a candid assessment of the Shanghai Stock Exchange’s reform efforts and acknowledged that the Exchange has a long way to go to gain the confidence and respect necessary to be among the world’s leading capital markets. One initial step towards improvement is a recently created “corporate governance board,” which provides companies the opportunity to voluntarily adhere to better corporate governance practices. While this effort is a first step, the board is purely voluntary and will not have the authority or the political grit to create or enforce regulation.

GRACE

Smith students also met with Jim Healy from W.R. Grace and Co. (Grace)
www.grace.com

Grace is a US based specialty chemicals a materials company with a significant presence in China. The company has been in the PRC since 1965 and was among the first Wholly Foreign Owned Enterprises (WFOE) allowed in China – a significant achievement for a company based in Columbia, MD. Despite W.R. Grace and Co. being in Chapter 11 since 2001 as a result of the company’s previous involvement with asbestos, Grace’s operations in China boasts a healthy $70 million in sales turnover per year and growth in China remains a high priority in 2006 and beyond.

Stephen Green – China’s Financial Structure

The last session of our course in China did not disappoint. The class heard from Stephen Green, an economist at Standard Chartered Bank and the author of “China’s Stockmarkets – A Guide to its Progress, Players and Prospects,” a book reviewed by three students on this blog. Mr. Green’s education and professional experience make him one of the premier experts on the Chinese economy, thus hearing his perspective on China’s current financial structure was a great way to conclude our time in China.

Mr. Green spoke at length about China’s banking reform efforts, capital markets and issues related to the exchange rate and currency and offered his own insight about the successes and struggles to date. Green concluded that the general direction is right and the reforms are meaningful, but many obstacles still remain. After a week of various meetings with business leaders in China, Mr. Green’s conclusion seems to be consistent with what we are seeing. It will be interesting to see what the next few years will hold for China’s economy and its impact on the world.

This evening, the class will be celebrating the conclusion of our time together in Shanghai by dining with out Smith counterparts at Barbarosa. As we bloggers plan to be an active part of these festivities, we will have to post the pictures from that event in the near future.

Public Chinese Firm with a Maryland Presence

Our second day in Hang Zhou started with (more…)

Today, the group met with Yingxi Fu-Tomlinson of the Kay Scholers Asia Practice. Yingxi is a member of the firm’s Shanghai office and concentrates on mergers and acquisitions (M&A).

Yingxi took time from her busy schedule to meet with us and discuss her M&A work in China despite traveling to Hong Kong and Beijing on the previous day.

Yingxi discussed the main differences between M&A and doing business in general in China from that of the United States. The three main distinctions she noted included the role of government, the role of government officials, and the laws and regulations around business.

In the US, the role of government is that of a regulator, referee, and facilitator; while in China the government’s role is more that of a parent overseeing its children (notions of national interest), although it is trying to move to a more US-based model.

The role of government officials in the US are that of public servants, while those in China “face south¨. That is, they sit back and listen to the problems brought before them. If they occupy a high enough position, they are referred to as a parent official.

The laws in the US are created to establish the integrity of political institutions (constitution, etc) and to regulate and balance economic and social interests. In China, there are a limited number of laws to establish political institutions. Rather, the system is based on civil law in which the interpretations of judges are not necessarily precedent setting. A judge in one jurisdiction may rule one way, while another jurisdiction may rule another way and there not nbe a tension between the two.

Yingxi also discussed some myths about doing business in China. Such myths include China as a lawless country, connections are everything, and contracts are useless. As a practitioner of M&A Yingxi rebuffed these myths by stating that China has many business laws (cited examples of advertising regulations during dinner time) and that while connections are important, China is now progressing to the point that any deal must have merit to be considered regardless of connections. She further stated that contracts are not useless but must be structured differently than in the US. She suggested that contracts have economic leverage for both parties so that both parties have an incentive to fulfill the obligations of the contract. She also reiterated the obvious that the contracts should be well understood by both parties and should be as fair as possible.

In the afternoon the MBA group visited the office of BearingPoint office in Shanghai, China. Mr. Afzal Tarar, Managing Director & Greater China Financial Services Leader led a discussion on opportunities for Bearing Point in China.

Mr. Tarar, a graduate from Case Western School of Business started his career as a consultant for Deloitte Consulting in New York, NY. After several years he moved to IBM Business Consulting and had his first assignment in China. Few years later he was finally recruited by Bearing Point and moved on a full-time basis to Shanghai, China.

After working with the big names in consulting, Bearing Point presented Mr. Tarar with a unique opportunity to help the revamp of Bearing Point. In China the firm is also known as the first enterprise risk management financial services consulting company, the second largest financial management and transformation company, and the third largest in business process animation. These strong client perceptions and a supportive senior management team gave Mr. Tarar the energy to take this challenge in China.

The first challenge faced by Tarar was the fact that all consulting companies in China produce negative operating income. His first goal objective was to change this situation for Bearing Point. His initiatives to achieve these goals are: 1. Focus on Strategic Clients, selecting engagements with higher potential of being profitable 2. Recruit, develop, and retain talent; and 3. Rationalize costs, from operational costs to higher consultant time utilization

While Mr. Tarar foresaw a 9 to 12 months for the turnaround the senior management only granted him 3 to 6 months for results. For this demanding timeframe Mr. Tarar focused his initiatives with a selected group of clients that included the China Construction Bank (the most important), the China Agricultural Bank, and the China Industrial Bank, among others.

To face this challenge, Mr. Tarar mentioned that having entered the Chinese market before India gave Bearing Point a first mover advantage, to the point that as of today, the firm is the only foreign consulting company allowed to quote major public consulting projects.

As for the future, Mr. Tarar added that the company will avoid areas that have been commoditized, such as integrating systems, and keep focusing on the Financial Services as the one area with higher potential for growth and profitability.

Our day ended with a journey to Hangzhou, where we checked into the Ramada Inn and had dinner at West Lake.

Meeting with Sage Brennan, Managing Director of Pacific Epoch

Our first presenter Sage Brennan spoke to us today on a wide range of topics from technology and communications to starting a business in China. Pacific Epoch is a business intelligence firm focusing on media, telecommunications and investment opportunities in China. Filling the void of information in the technology sector with a boots on the ground strategy, Pacific Epoch provides customized information to clients, mainly hedge funds and VCs.

One of the challenges in providing independent research in China centers on a general suspicion of answering questions. Companies in China are not enthusiastic to provide market data or trends as would a typical US company selling its story. This requires Pacific Epoch to develop its own market research techniques through polling and surveys. Part of Sage’s job is to sort through which projects best add value to the company and can be used in follow on research. One off projects with no follow on application are not the best way to leverage the assets of their small office.

Sage touched on the business strategies for Pacific Epoch as they grow and expand their product offering. Training and hiring is another challenge of operating in China. Most hires are from local universities and have a passion for technology. Innovation and out of the box thinking was the attribute most difficult to find in China and part of the training challenge going forward. As a provider of information it was refreshing to hear that censorship has not had an impact on their operation except for some minor technical difficulties on their server. In a reversal of sorts, Pacific Epoch’s only problems with intellectual property rights violations occur in the US a result of unauthorized distribution of newsletters and reports.

Always a hit with the crowd was the experience as an ex-pat living and working in China. Sage was able to provide insight into the ways to start working in China through his unique experience. His outlook on tech in China was enthusiastic with many opportunities still available.

Meeting with Altcatel’s Kang Wuping, VP of Human Resources

Alcatel is a leading telecom company based in Paris, France with 57,000 employees across 120 countries. Today we met with Kan Wuping, the VP of Alcatel Shanghai Bell, a subsidiary of Alcatel. Alcatel has a 20-year history in Shanghai and has been in a great position to watch China’s recent the economic development and capitalize on it. In 2002 Alcatel China merged with the state-owned company Shanghai Bell to form Alcatel Shanghai Bell. Alcatel’s recent merger with Lucent has transformed the company from a telecom product company into a full telecom solution provider.

Alcatel Shanghai Bell’s shares are 50% +1 owned by ASB and 50% owned by the Chinese government. This means half of the board of directors are government officials, but it would seem as though the relationship with the government is productive and non-confrontational. ASB’s market is mostly in China but they are also a global hub for Alcatel R&D (earning the most patents of any Alcatel location globally in 2005) and also house one of Alcatel’s four manuracturing facilities (consolidated from 100+ just a few years ago).

Alcatel’s core values are 1) Customer Value, 2) Innovation, 3) Teamwork, and 4) Accountability. Fortunately, Shanghai Bell shared three of the four Alcatel core values when the merger took place, and as a result the merger went smoothly and efficiencies were realized quickly.

ASB takes pride in it’s responsibility to the local community. The company has given back large sums of money to the local community for school, SARS research, and to promote a Green Culture.

The key motivator for ASB employees is career management. For this reason, ASB has focused a tremendous amount of resources on developing rigorous career path programs designed to retain employees, accelerate high potential employees, and build broad experience within the relatively young employees of the company (the average age of an ASB employee is 30). Accreditation programs are a key piece of the career management program at ASB and help measure competencies and justify salary and responsibility increases. ASB’s program management system is one-of-a-kind within Alcatel and Alcatel’s Paris headquarters has realized the value and is considering replicating this kind of system across more of it’s regional offices.

After our discussion with Mr. Wuping, the students went on a tour of Alcatel’s Next Generation Network (NGN) showcase center where video conferencing, IP-based phone systems, and data-voice convergence technologies were demonstrated.

Meeting with Jonathan Heimer
Our first presenter was Mr. Jonathan Heimer from the US Department of Commerce. He spoke about some of the highlights and drawbacks of doing business in China. He started by detailing how large the US government presence is in China (approx 1500 full-time staff) and how much money the country spends to ensure good relations (approx 100 million USD per yr).

He relayed that China is probably the most important country to the US in regard to future business and why it is important for the US to do everything it can to help China become part of the world economy. Some of the more troubling comments he made regarded the sudden nationalistic surge he is sensing from the Chinese people and the anti-foreign vibes that are becoming more prevalent. As well, he went into detail about intellectual property issues, (one of his specialties) and how challenging it is for firms to reconcile this problem when doing business in China. He did say there were signs of improvement but also explained it is a very cyclical process. He talked about the tax code in China and how it affects foreign investment as well as a brief synopsis of transfer pricing issues that affect foreign and domestic business.

Finally, he spoke about the limitations firms have in regard to legal protection but finished by giving statistics regarding how well companies actually do here. The overall message was that although there is great risk involved, by and large, firms that set up operations in China are very profitable. It is simply a very different environment than what one would experience in the US. If firms are willing to accept and work through these issues, they will most likely be successful.

Meeting with professor Zhou DunRen
The second meeting the group had today was with Professor Zhou DunRen. Professor DunRen is a former deputy director, Center for American Studies, Fudan University, Shanghai, and a senior research fellow and deputy director, Shanghai Pudong Institute for US Economy.

He talked about the excellent economic growth that China has been experiencing the last three years. More so the unprecedented GDP growth rate of 9.9% in 2005. This represented the 4th largest growth rate in the world for that year.

He explained that the base in China is low, meaning that things are cheap and ordinary people can afford things. He talked about how the social-political context in China is unique and how Pudong as a special economic zone has grown in the past few years, with over 4000 skyscrapers (buildings higher than 18 floors) has dominated the Shanghai skyline. Two main factors have primarily driven and sustained this high growth, namely the increase in FDI (foreign direct investment) and foreign trade.

China has been experiencing a lot of fundamental institutional changes that have helped it grow – a mixture of Maoist and Marxist ideas have helped shape the country from what was a traditional Maoist socialism to what is now being called preliminary stage socialism. The majority of this influx of FDI is coming from the ethnic Chinese, Hong Kong, Taiwan, and Singapore. Hong Kong however is the largest investor by far.

Sixty percent of China’s GDP is concentrated in a 200 kilometer strip along the country’s eastern coastline, thus the country is looking to spread this wealth into the western part of the country as time moves into the future. He talked about the banking sector as well. Currently, China has about 1 trillion USD in reserves and is looking for investment opportunities so the money could be put to good use. The Chinese banks however are in desperate need of foreign managers to control the management of their banks.

Shanghai Urban Planning Museum
The Shanghai Urban Planning Museum is an awesome experience that should not be missed on a trip to Shanghai. You can tell that Shanghai is a modern city just by touring the city. Believe it or not, Shanghai has built more than 4000 skyscrapers since 1990. However, the Urban Planning Museum provides an interactive historical perspective, as well as a taste of Shanghai in 2020. A sculpture composed of several distinctive Shanghai skyline buildings greets.

However, the real highlight is on the third floor: a huge scale model with plastic models indicating structures that are yet to be built. As one of the largest urban planning models, it is truly awe inspiring.

Behind the huge scale model is a Virtual Tour that takes you on a ten minute fly through of Shanghai and its surround structures.

The fourth floor provides visitors a peek at future structures supporting transportation (Pudong International Airport), and deep and shallow water shipping logistics.

In the near future, Shanghai will have the world’s largest shipping port just north of the city.

The government is in the process of planning for a small city with the approximate population of one million to support the port.

Below the building are restaurants and outlets fashioned in the style of the 1930s. The walk way connects to a shopping mall and metro station.

Mega Bite
We ate lunch at a modern Chinese food court in Raffles Center. Each meal cost about 24 RMB (approximately $3 USD).

Meeting with Scott Kilbourn
We also met with Scott Kilbourn, a partner at RTKL. The company, with approximately 1,000 employees is one of the 10 largest architectural companies, worldwide. Its China office is comprised of approximately 35 local employees, hired from the top three architectural schools. Its major projects include the Shanghai Science and Technology Museum, the Beijing Film Museum and the China Science Museum, located in Beijing. RTKL China has also created the North Bund master plan for Shanghai.

The master plan focuses on living, office and retail space that is connected to public transportation and built on a human scale.

RTKL’s challenges in China have included hiring and retaining talented staff, safeguarding intellectual property, and collecting payment for services rendered. It has met these obstacles and has operated as a profitable company for several years. In order to retain staff, it offers rapid advancement and salary increases to its employees. IP is more difficult to protect, but the company has tried to stay a step ahead of its competitors. Finally, it has developed a mandatory retainer and a graduated payment structure to protect against collection problems.

Meeting with Linda Liu
We ended our first day in Shanghai with Linda Liu, Director of Oxford and Associates Property Consultants. OAPC is a full real estate services provider in Shanghai, with offerings including residential & leasing/sales, investment consulting, market research, and mortgage services.

Ms. Liu briefed the class on the evolution of the real estate market in Shanghai (and PRC as a whole) from 2000 through 2006.

OAPC was established in 2000, around the same time the PRC first allowed mortgage borrowing by its citizens. Ms. Liu noted the astronomical appreciation of property value in the Shanghai area since that time, with price appreciation over the 6-year span commonly between 300% and 500% (and yes, the potential for a bubble burst is a large concern here, as well). She theorized that the emergence of a sizable middle class (loosely defined as household incomes between $600 and $2,500 per month) coupled with the lack of other credible investment vehicles in PRC today (stock, bond markets) are primary reasons for the drive towards real estate investing by the general public. Interestingly, the government sets the mortgage rates offered by all lenders, so the banks are forced to compete primarily on service as opposed to rates.

Dinner at Yu Yuan Gardens
Despite the bazzar of the Yu Gardens (fun to wander among the shops and haggle over prices)being a bit of a tourist trap, we had great dinner at a traditional chinese restaurant, which over looks the Huxingting Teahouse.

The building was built in 1784 by cotton merchants and became a tea house in the late 19th century. We dined with the likes of Bill and Hillary Clinton, Margaret Thatcher, and Queen Elizabeht II, whose pictures were on the wall from their visits.