CHINA

Chuck Oliver Room 10A3, Yu Jia Building No. 1336 Huashan Rd. Shanghai 200052 China Tel: +86-21 6240-5884 Fax: +86 21 6240-4820 E-mail:coliver@theyorkgroup.com

Regional Spending on Information and Communications Technology
(Data provided by WITSA - www.witsa.org/digitalplanet)

Spending ($millions)

Technology Sectors	China	Hong Kong
Hardware	29,643	2,140
Software	3,900	469
Services	4,565	980
Communications	47,492	10,625
TOTAL ICT Spend	85,600	14,214
Vertical Markets
Agriculture	1,245	1
Manufacturing	37,835	738
Utilities	2,316	163
Construction	1,363	150
Wholesale & Retail	3,825	1,898
Transportation & Communication	3,608	1,255
Finance & Bus. Services	3,953	1,841
Other Services	288	2,282
Government	9,199	1,525
Consumer	20,941	4,360
Software Piracy	92%	52%

China Services

Entering China is much easier than succeeding in this complex market. Many Global 1000 companies have made significant investments in China without achieving the desired results. While this is a market where most companies cannot afford to fail, the challenge for executives based outside China is to understand in detail what is actually happening in this crucial market. Unfortunately, relying on input from local subsidiaries is not always enough. This is why we offer the China Market Audit.

Doing Business in China

1. Have Clear Contract Terms


Everything in China is constantly changing. China’s consistent 8 percent economic growth leads to continuous rapid transformations in the domestic economy. Nothing is fixed. Thus, when entering into a contract with a Chinese partner you must be careful to plan for all reasonable contingencies. Do not attempt to enter into an agreement without sound legal advice. Have your own legal counsel. Pay your lawyer a little to ensure a clear contract; or pay your lawyer a lot more later when you have a dispute. In your contracts, specify exact terms of payment, and performance standards. Set time lines. 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 the legal advice from your Chinese partner. Beware of claims that the 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 they must visit your production facilities in the United States, remember that you cannot guarantee that they will receive a visa. A visa denial 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 from independent sources. Question ALL such claims.

2. Make Certain Your Project is Economically Viable

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, incentives, special considerations, or non-market related sources of income to create a profit. If incentives are offered, they should be used to augment profit, not create it. Make certain your partner has the authority to offer incentives and assure yourself from independent sources that the incentives will actually be paid. Look for examples of companies which have actually received such benefits. Viability may look very different over the short, medium and longer term. Many Chinese partners will insist you look at the longer term potential of the market and sacrifice your profit in the early stages. This is treacherous. Your floor becomes their ceiling. In China, as in any high growth economy, it is difficult to predict the future, so, make sure that you can reach profitability in the foreseeable future and can build a sustainable model forthe medium and longer term.

3. Know Your Partner

Do your "due diligence," and do it well. Make certain that your partner is not a shell subsidiary of a larger company. If they default, do you have the ability to collect from the parent company? Specify this in your contract. Remember that the best contracts are those that do not have to be enforced i.e., both partners have the same motivations. Be sure that your negotiating partner has the authority to make a decision. Establish ground rules at the outset of negotiations, including keeping minutes. Be prepared for protracted negotiations. Make certain your partner is able and willing to do all they say they will do in the contract. Assure yourself that it is in their best interest to perform as agreed. If the project is not “win-win” you can expect that enforcement of your contract will be difficult – regardless of your legal rights. If you have to go to court to enforce your contract, it is already too late. Is it in their interest to assist you to protect your brand and/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 the data on your partner or customer from independent sources. Avoid being "stovepiped" - talking only to those people to whom your partner or buyer directs you. You can lose a lot of money if you make a great deal with the wrong partner.

4. Know the Rules

Beware of offers to bend them in your favor. American companies have often entered into agreements 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 regulations are suddenly applied - sometimes retroactively - leaving the company with little recourse. You must be ready to obey all Chinese laws and regulations, even if you initially can successfully avoid them. Seriously question any agreement where you are told you can ignore or avoid the law. Also, make sure that your managers (or agents and distributors) know all relevant American laws such as the U.S. Foreign Corrupt Practices Act (FCPA). 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. Many American companies have reported that their Chinese partners respect their requirement to be in compliance with the FCPA and do not expect American companies to pay bribes. Also, be aware of U.S. Bureau of Industry and Security (BIS) regulations on the transfer of dual use technology to China. American law prohibits transfer of some sensitive technologies without a license. For more information on BIS regulations, please check http://www.bis.doc.gov/.


5. Search for Problems Before They Materialize

In addition to creating pro forma balance sheets, spend some time at the beginning of a project to create scenarios of what you will do if things go wrong. Try to anticipate possible problem areas. If you can't find any, you are not looking hard enough. Create a strategy to deal with potential problems. Know your limits on losses as well. Be sure to limit your exposure. Set milestones in the project for performance. Have an escape strategy for each stage of the project, even though you do not plan to use it. In China, personal relationships are very important and sometimes partners may not be completely truthful about problems or potential problems if they feel it may have a negative impact on the 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 level governments to manage the issue.


6. Do a 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 have been caught up in "Chinaeuphoria" and have not performed a thorough risk analysis, assuming that China is, somehow, different. When it comes to taking undue risk, it is not.

7. Mind the Store

Projects and sales in China require constant attention and clear lines of communication. Do not assume they will run themselves. There is often a gap between perceptions of the individuals managing your product or project and headquarters in the United States. U.S. based managers must visit often to evaluate the situation on the ground. Developing and nurturing personal relationships are important. Be prepared to provide good training and technical assistance to assure product and management quality. Keep an eye on the company’s account books, or if licensing, on the licensee’s account books. Neglect of oversight can result in compromised product quality and lead to a struggle for management control as well as possible unethical activity. When things go wrong, you cannot rely on the court to offer a clear or consistent legal settlement in a manner that would be consistent with U.S. practice and or other parts of the developed world.

8. Expect Virulent Competition, Pricing Pressure

Recent economic analysis suggests that over 80 percent of China’s industrial markets are in oversupply. There are terrible competitive pressures. Chinese brands are strong and getting stronger 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 a very low cost 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 (SOEs). Foreign companies should not expect a level playing field. Rather, the field is downward sloping for SOEs. It is level for private Chinese companies. The field is upward sloping for all foreign firms.

9. Get Paid

A contract with an insolvent partner or customer is worthless. Pay careful attention to how you get paid, when you get paid, and in which currency. Check with legal counsel to determine the specific payment terms that are customary for a certain type of transaction. If you want to be paid in U.S. dollars, be certain you are able to convert profits and remit funds. Use letters of credit with international banks, 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 the product. For example, payment terms of "30%letter of credit, 70% payment 120 days after delivery," would not be customary in China. For most large projects, terms of "70% advance payment, 30% letter of credit," would be common. Offering payment after delivery tells your partner that you do not know how business is done in China and makes you look easy to deceive. NEVER agree to unsecured payments after delivery.

10. Watch Your Intellectual Property Rights

It has been said that, in China, if a product or service can profitably be copied; it will be. Also, foreign IPR holders (whether they are in the China market or not) suffer enormous losses to Chinese pirates in the China market and, increasingly, in third country markets. It behooves all traders and investors to take aggressive measures to minimize their potential IPR vulnerability in the market. For trademarks, at you must file with the State Administration of Industry and Commerce to receive protection. You should also notify Customs. For patents, you must file with the State Intellectual Property Organization (SIPO) to receive protection. At a minimum, it is advisable to register copyrights in China, even though you may theoretically receive protection under the Berne Convention. Confirm this with your legal counsel, as the copyright treatment across industries is not identical. You should also notify customs. Taking the above procedural steps is insufficient. You must also closely monitor the markets on a constant basis. Monitoring and enforcement in China require considerable expense. IPR infringing goods also flooding out of China to all regions of the world and therefore vigilance in third countries is also strongly advised. Many foreign companies have lost their IPR with the active connivance of employees of their partner. To the extent possible, make sure that your partner’s interests and yours are fully aligned.