China News & Views 3/05

Deutsche Consult (Asia) Ltd.

Trustees, Administrators, Corporate Services since 1994

Remember China’s Friendship Stores until the early nineties, where foreigners and overseas Chinese could buy a limited variety of imported goodies like light motorbikes, refrigerators, TVs, recorders and appliances? Outside these shops a motley crowd of locals always lay patiently in wait to push bundles of precious cash at any stranger with the privilege to enter those ‘temples of decadence’. Students from overseas in particular were generally eager to -for handsome profit- offer their assistance. Those were the days…

Today’s China could not be more different: “Made in China” TVs, PCs, laptops, fridges, washers, dryers, appliances, toys and tools swamp the world, and at home demand is so saturated that price wars are the order of the day.

Indeed China is even becoming an exporter of increasingly sophisticated machinery, and those who still believe that e.g. all good printing presses come from Heidelberg or Italy, look again: “Almost as good at half the price” the owner of a printing factory here laconically justified his recent decision to henceforth meet any replacement needs with local machines; a convincing point indeed.

So those still thinking of China as a place to clear inventory or dump outdated products, can safely stop reading here: You are beyond redemption!

is the first and foremost question to be pondered with utmost care. And although there is no shortage of self-proclaimed “China experts” touting “market surveys” and the like, the hard truth is that many of them are not worth your salt: Unless someone with sound knowledge of your very line of business, and at least some of your potential customers as well as competitors in China can be found, a simple stroll through cities like Shanghai will probably give you just as good an overview of consumer products on offer.

Manufacturers of machinery often need not look further than to the nearest fair with Chinese exhibitors: Your introduction (ideally through a Chinese interpreter) as someone, who builds machines for their products, and polite queries conc. their own equipment will almost certainly not be rebuffed. As almost all Chinese master the art of networking to perfection, chances are that your new friend will immediately understand, and duly reward your efforts at least with an address or two in China.

Once satisfied that your products will indeed stand a chance in that vast country, the next question already beckons:

China is roughly the size of the United States and geographically as well as culturally at least as diverse. Although most of the 1.3 billion Chinese understand Mandarin, some 500 million have other native tongues: The country’s rich coastal provinces in particular are dominated by Cantonese (approx. 90 mio.), Shanghainese (incl. all dialects 77 mio.) and Fukien (approx. 30 mio.).

Those selling consumer goods are well advised to start off where the money is: In the Pearl River Delta, Shanghai or Beijing. Although the average annual income here too is in the area of just over USD 1,000.-, some 200 million Chinese can already afford significantly more than life’s necessities, and the number of seriously wealthy nouveau-riches is rising fast.

For vendors of industrial machinery this rule of thumb applies: Guangdong and the Pearl River Delta are home to mostly light industries, electronics etc., whereas China’s motor industry (headed by Volkswagen) is further north in and around Shanghai. To the Northeast lies China’s “rust belt”: Mostly state-owned, often run-down industrial plants from the Mao era; also in Heilongjiang province: The country’s accident prone mining industry.

Throughout the ages China’s merchants have always been held in very low esteem. Under Mao they were even reduced to loathed pests and parasites, to be re-educated/eradicated like other “thieves of grain”, namely mice, rats and sparrows (birds suffering Mao’s particular dislike). Another brainchild of his Cultural Revolution was that no man should be another man’s servant; thus effectively banning service as a whole: Waiters, farmhands, shop assistants, even nurses followed the call, “shed their shackles”, denounced their former masters as exploiters (effectively a death sentence) and joined the national frenzy. Not surprisingly, food eventually became scarce, resulting in rationing and bizarre witch-hunts: Here again, everyone trying to trade his way out of misery was the enemy!

Today, some 30 years on, China’s traders, and indeed the country’s service industries, have still not fully recovered from those days: A “quick buck” and “make hey while the sun shines” mentality prevail. After-ales service as indeed any service, unless immediately rewarded, is considered pointless; complaints from customers are to be ignored, met with all sorts of excuses –or disdain.

Luckily, these attitudes too are changing for the better. As of today, however, virtually all sales agents in China, whether receiving commission or a salary, need some degree of guidance; even more so as Chinese buyers are highly appreciative of any rare incident, where they feel properly served, and word of mouth spreads quickly!

Having said that, one should, however, hasten to clarify that You cannot succeed in China without loyal Chinese on your side!

Foreigners, even where they have lived in the country for years and speak the language fluently, will still be perceived and referred to as “foreign devils”; an everyday expression, which says it all. Little better fare overseas Chinese, born and bred abroad, often on assignment for US companies: Referred to as “bananas” (inside white, outside yellow) they too stand no chance of being let into that all-important web of relations, bribes, tricks and lies, which locals are born into and use with enviable ease. China’s notoriously corrupt but sheer almighty customs officials are just one case in point: Their strict immunity to any sort of reasoning or reason swiftly mellows, when relatives or friends put in a word -and a due gift of course.

On a similar note, China’s Compulsory Certification or CCC system http://www.ccc-mark.com/china-compulsory-certification.htm, which subjects 19 categories of goods with 132 subgroups from appliances to latex to testing and certification, is, at least where the process becomes sticky, also best left to local mediation.

Foreigners desirous of having their own foothold in China were formerly confined to opening representative offices, which where severely restricted by law and barred from doing business.

This has now changed dramatically, however, as, since December 2004, non-PRC nationals are permitted to incorporate, wholly own and operate full fledged trading companies! The incorporation process seems bearable by Chinese standards and should take 3 to 4 months only. Even minimum capital requirements are outright lenient: USD 36,000.- for retailers, USD 60,000.- for trading companies engaging in wholesale.

Here too, a Hong Kong incorporated parent company which fully owns the trading subsidiary in China is usually the best and easiest structure (see http://deutsche-consult.com/cserv_eng.html ).

Payment under “Letter of Credit” or (less safe) “Documents against Shipment” are common terms and widely accepted even by China’s big conglomerates of international repute. A few potential pitfalls, however, are very common and noteworthy:

To begin with, even well-known Chinese companies with ample international exposure can be surprisingly lax, when it comes to drafting and signing contracts. In our capacity as trustees acting for the seller, we are, therefore, quite frequently left with the thankless task of explaining to buyers e.g. why some standard text geared to the import of iron ore, grain or other commodities shipped in bulk, is rather ill suited for the purchase of sophisticated machinery.

Although eventually accepting suggested amendments, the Chinese side is then often puzzled by the “fuss” we make, as from their perspective the L/C terms are all that matters.

Generalising of course, it may be fair to say that for many Chinese a written contract is about as binding as a letter of intent elsewhere: Whenever circumstances change or expectations/speculations do not materialise, the disadvantaged party will deem it an unalienable right to renegotiate and, where the other side does not have the courtesy of being duly flexible, eventually renege.

In doing so he has little to fear from China’s courts; even less so, where his “victim” is a foreigner: Judges (in remote areas still today sometimes old soldiers or party veterans of limited literacy) tend to see themselves as protectors of their own against foreign exploitation; none are independent, all poorly paid, and their rulings often unenforceable. In almost half of the cases debtors simply disappear or close shop, only to reopen the same a few days later under some new name.

Not long ago in Guangzhou, some debtor with influence even had the visiting bailiff beaten half dead by members of the local militia –and got away with it!

From what one hears, ICC arbitration rulings from overseas (often Paris or Geneva) fare even worse: The enforcement rate here standing well below 50 per cent.

For vendors this means that they cannot fully rely on a “firm” order from Chinese buyers before holding the relevant L/C in hand. Where a purchase is about made-to-order products, which cannot easily be sold elsewhere, they are strongly advised to insist that at least a substantial part of the agreed price be paid up-front.

But even the L/C itself can contain clauses, which defeat its very purpose as an instrument to secure payment. One is so common that it shall be mentioned here:

Where an L/C stipulates that “the Bill of Lading or Airway Bill be made to the order of the buyer”, any vendor doing so runs a big risk, as the shipper, forwarder or airline will then release the goods directly to the buyer. In the event that the documents submitted under the L/C are not conform to its requirements (as is frequently the case), the bank will rightly refuse payment; -and so will the lucky buyer, who now enjoys the goods for free!

Where we come across such clauses, we usually just ignore them and simply have the Bill of Lading made to the order of the L/C opening bank: The shipper will then only release the goods to the buyer with that bank’s consent, for which it is fully liable.

The big advantage: Where the bank named in the Bill of Lading finds inconsistencies in the L/C documents, it may only refuse payment if it is still in possession of the goods and holds them at the vendor’s disposal! In practice any buyer genuinely wanting/needing the merchandise, will then swiftly authorize his bank to accept those flaws in the documentation, whereupon the vendor receives his money minus a small discrepancy fee, and all happily part ways.

As mentioned earlier, “Cash against Documents” may be a viable alternative to L/C terms, where the vendor is prepared to face the following risk: Rather than taking up the Bill of Lading and thus the goods, some buyers (not only in China!) have made it their habit to go back to the seller, demanding a better price. Where the merchandise is already shipped and upon arrival at its destination stiff warehousing charges loom, a sufficiently ruthless buyer then clearly has the vendor cornered, although the latter, unless a total dimwit, will only fall for this one once.

Exporters quite frequently –and somewhat routinely- demand that Chinese L/Cs opened in their favour be confirmed by a bank in their home country. Where the buyer accepts the relevant extra expense, all is well and good. Where he does not, however, it may be safe for the vendor to relent:

China’s banking system is certainly burdened with stellar amounts of bad loans, mainly used to drip feed moribund state-owned enterprises, with most, if not all of that money effectively lost! Anyone hinting at an imminent collapse of the country’s financial system (and few do!) would, however, conveniently forget that China’s banks are state owned too, that the central government has enough other things on its platter not to want a banking crises, and that it is armed with a handsome war chest of some USD 600 billion in foreign reserves alone; more than enough to extinguish any fire.

If someone told you that, to get a glass of milk, you have to buy the cow, he would be considered a joker at best. The same, of course, holds true for all those looking to China. Here too the simple logic applies that one should only spend money if and when one needs to: Many an ill fated foreign investment in the country could have been avoided, if the owner had only kept the money in his pocket and concentrated on sales instead.

On the other hand China’s availability of ample cheap and relatively skilled labour is certainly a draw, and in time, a well planned move into local manufacturing can be the logical “next step”.

As to Chinese consumer sentiment, the perception of everything foreign as being a status symbol is somewhat fading. Often however, –and above all where it comes to cosmetics, canned food, baby food etc.- foreign products enjoy greater trust; and in view of frequent scandals over e.g. locally made fake milk powder, tainted baby food, rotten meat plus highly toxic chemicals in Chinese sausages etc., etc. -and resulting loss of life, buyers certainly have a point.

Sellers of such “sensitive” items in particular may have to carefully consider this before localising production.

In any event, however, when investing in China, it is highly advisable to do so via Hong Kong: The latter is much more than just a tax haven and “Gateway to China” with the world’s biggest container terminal and one of its busiest airports, both handling over one third of the PRC’s foreign trade: This, our role as China’s through-port and cargo handler may, and over time will, be replaced by the country’s own facilities. Just look at London’s or New York’s docks today.

More importantly, our new emperors in Beijing (not unlike Hong Kong’s former British colonial rulers) want to keep us so busy with making money that we have no time for politics. To this end, they see our role as that of a financial and service centre at least for the Pearl River Delta, a powerhouse of 40 million people, generating 36 per cent of the entire country’s exports, a BIP of USD 271 billion in 2001 (probably well over 300 bln. now), and China’s highest annual per capita income of USD 3,800.-.

The few “Made in Hong Kong” products that we still make, are exempt from Chinese import duty, and Hong Kong’s accountants, solicitors, doctors etc. can relatively easily obtain licenses to practice across the border.

And Beijing’s favours keep on coming: Hong Kong is now the only place outside the PRC, where banks open Renminbi accounts, and buyers can pay with Renminbi cash or Renminbi credit cards.

It is a sad reality that local officials, mayors, judges etc. (even more so those in rural areas) quite often see themselves above the law and foreigners in their fiefdom as little more than welcome sources for personal gain. At least in the Pearl River Delta, they are, however, likely to think twice before blatantly extorting money from a Hong Kong company. Hong Kong is close by, and Beijing’s special attention to its wellbeing widely known.

As companies here are easily incorporated, just as easy to maintain, and, properly structured, cost little (http://deutsche-consult.com/cserv_eng.html), this “protection” alone may make the exercise worthwhile.

The above information is given to the best of our knowledge but without warranty for its correctness. Copying and/or redistribution (or parts thereof) without any liability for us are welcome and complimentary, where they quote the authors: Deutsche Consult (Asia) Ltd., Hong Kong; http://deutsche-consult.com

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