China Business Environment Oct 2009

China’s Business Environment

October 22, 2009

Prepared by The JLJ Group – Solutions for China Entry & Growth

Copyright @ 2009 The JLJ Group. All rights reserved.
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1

AGENDA

• China at a Glance
• The Chinese Consumer
• The Tier-2 Cities
• Development Zones
• Modes of Entry in China

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China at a Glance
Category Description

9.56Mil sq. KM ( Europe: 10.18Mil
Area
sq. KM; 28x the size of Finland.)

Population 1.34 B (Europe: 731 Mil; Finland 5
Mil; 1/5 of world’s pop.)

GDP1 (’08) US$ $4.2 Trillion (Europe

GDP / capita US$ (’08) $3,134

• 656 cities, 48,000 districts
• 22 Provinces (not including
Taiwan)
• 2 Special Administrative
Regions – Hong Kong, Macau
Administration
• 5 Autonomous Regions –
~2,170 miles Guangxi, Inner Mongolia,
Ningxia, Tibet, Xinjiang
• 4 Municipalities – Beijing
Chongqing, Shanghai, Tianjin

Language Mandarin Chinese +7 major
dialects and 80+ minority
~3,100 miles languages

Slightly Smaller Than Europe; Almost Twice the Population
1) GDP - Gross Domestic Product based on current
exchange rate, does not take into account purchasing 3
power parity.

China is Similar to Europe More Than the US…
• Relatively homogeneous market
• Relatively similar cultural background
• Common language
• Common Law

• Highly segmented market
• Multiple countries and cultures
• Multiple languages
• Predominately Civil Law
• Segmented market
• Regional cultural differences
• Multiple language dialects
• Civil Law

…with a non-homogeneous market and significant segmentation
4

China by the Numbers
Real GDP of Top 10 Countries (2008)
[US$ Tril]
16
14.3
14

12

10

8

6
4.8
4.2 3.8
4
2.9 2.8
2.4 1.7
2 1.6
1.2

0

GDP / Capita
46,400 38,700 3,100 35,400 44,700 43,700 39,800 12,000 10,000 1,000
US $

Per Capita GDP Significantly Lower than Developed Countries
5

China by the Numbers II

China Real GDP: 1985-2008
[US$ Tril]
4.5 4.2 Tril
4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

Growth has Slowed to 6-8% Since Economic Crisis at the End of 2008

Source: JLJ analysis based on multiple sources Copyright @ 2009 The JLJ Group. All rights reserved.
including the National Bureau of Statistics
6

China by the Numbers III

[US$ B] China Utilized FDI: 1985-2008
100 92.4 Bil
90
80
70
60
50
40
30
20
10
0

China is the Second Largest Recipient of FDI

* FDI - Foreign Direct Investment Copyright @ 2009 The JLJ Group. All rights reserved.
Source: National Bureau of Statistics
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The Income Gap
GDP per Capita in 2008

BEIJING
Bohai
Bay Area

Yangtze River
Delta Legend - Annual Income (US$)
SHANGHAI

Pearl River
Delta

Most FDI and growth concentrated along coastal areas
Two thirds of Tier-2 cities are in coastal area
Source: National Bureau of Statics of China Copyright @ 2009 The JLJ Group. All rights reserved.
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DOING BUSINESS IN CHINA
Overview
• Opportunities in China do exist - country has been opening up, growth rates
are impressive, population is getting wealthier, FDI has been pouring in…

• However, competition is fierce; China market should be approached
gradually, un-emotionally and with realistic expectations

• Long-term vision is a must, quick profits are unlikely – time, money and
effort are necessary

• There is no such a thing as one China market, rather several regional/
provincial/ local markets

• Gaining local knowledge is crucial – adapt your business practices to the
local environment

• Conducting proper due diligence, developing a sound strategy, and legal
framework are key success factors

Proper Preparation and Planning are Key

9

AGENDA


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The China Consumer

Growth of Consumer Spending,
Urban consumption 2004-2007
[US$ B] CAGR*= 14%
Rural consumption
1,500
1,200
900 1020
764 873
600 680
300
258 283 310 352
0
2004 2005 2006 2007

Consumer Growth is Being Driven by the Urban Population
*CAGR = Compound Annual Growth Rate Copyright @ 2009 The JLJ Group. All rights reserved.
Note: Exchange Rate: US$ 1 = RMB 6.8; Figures will be updated after
consumer spending statistics of 2008 are published in October 2009 11
Source: JLJ analysis based on figures from National Bureau of Statistics
of China

The China Consumer II
Consumer Spending by Goods,
2007

5% 3% Food
5% 33%
8% Housing
Transport & communication
8% Education & entertainment
Clothing & footwear
Medicine & healthcare
Household durable goods
11%
Financial services
16% Other
11%

Almost Half of Consumer Spending is Still on Basic Necessities
*CAGR = Compound Annual Growth Rate Copyright @ 2009 The JLJ Group. All rights reserved.
Note: Exchange Rate: US$ 1 = RMB 6.8; Figures will be updated after
consumer spending statistics of 2008 are published in October 2009 12
Source: JLJ analysis based on figures from National Bureau of Statistics
of China

The China Consumer III
Localization - The KFC Model

KFC – China Menu

Youtiao

Congee
Egg Tarts
Localization Even More Important in Tier-2 Cities, Which are not as Cosmopolitan
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AGENDA


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Tier-1 vs. Tier-2 Cities

• Most expensive cities in China
Tier-1 Cities • Highly saturated markets
• More sophisticated consumers

• Usually lower overall operating costs
Tier-2 Cities • More fragmented and nonexistent markets
• Burgeoning middle class

Tier 2 Cities May Offer Greater New Entry and Growth Opportunities
15

Tier 2 Cities
15 Tier-2 Cities with ~10% of Total Population…

Macro- Tier 1 Tier 2
China
Economic cities cities
Total
Criteria (3 cities) (15 cities)

Population 46 M 133 M 1,328 M

GDP (’08)
473 B 893 B 4,200B
(US$)
FDI (’08)
20 B 57 B 92 B
(US$)

Teir-2 Cities receive nearly 62% of China’s total FDI inflow

Source: National Bureau of Statistics (2008); JLJ analysis Copyright @ 2009 The JLJ Group. All rights reserved.
Exchange rate : US $ 1 =RMB 6.83 16

Tier-2 Cities II
The Approach
• Each city is a different market, offering different
opportunities and barriers
• Many factors to consider: disposable income, openess
Business to to foreign concepts, existing competition, local taste &
Consumer preferences, etc.
• Company-specific research & analysis necessary
to develop Tier 2 strategy

• Location analysis
• Type of industry and size of investment
Business-to-Consumer
Business to Business • Customer & supplier analysis / logistics
• Operating costs
• Possible special policies or preferential treatment

Often no obvious answers, doing “homework” is needed!!!
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Tier-2 Cities III
The Costs of Doing Business
Labor Costs (2008) - Shanghai as Baseline
1.20
1.00
0.93
1.00 0.87 0.92
0.77 0.77 0.78 0.78 0.79 0.80 0.81
0.71 0.72 0.72 0.74 0.74 0.74 0.75
0.80 0.65 0.67 0.68 0.69
0.60 0.53 0.57 0.58

0.40
0.20
0.00

Energy Costs (2008) - Shanghai as Baseline
1.20
1.00
1.00 0.84 0.88
0.75
0.80 0.69
0.58 0.61 0.61 0.62
0.51 0.51 0.52 0.53 0.53 0.53 0.56
0.60 0.43 0.43 0.44 0.44 0.45 0.46 0.49 0.49
0.36
0.40
0.20
0.00

Source: Compensation survey of ChinaHR.com,
Literature research; Booz & Company analysis 18

AGENDA


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Development Zones
History

• Implemented by the government to encourage foreign investment in
specific industries and to provide incentives to promote investment
in underdeveloped areas
• First Zone was established in 1980s; there are approximately 6,000
zones in China
3 of the Major Zones:
• Economic and Technological Development Zone (EDZ)
• High-Tech Industrial Development Zone (HTDZ)
• Free Trade Zone (FTZ)
Other Zones Include: Logistic Parks, Costal Open Economic Zones,
Tourist and Holiday Resorts, Taiwanese Investment Zones, Export
Processing Zones, Special Economic Zones, Border Open Cities…

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Development Zones II
Economic and Technological Development Zones (EDZ)

• 54 EDZ’s throughout China
predominately in urban
areas
• Primarily for Foreign
Manufacturing enterprises
• Tax Incentives normally
include reduction of EIT rate
to 15% for encouraged
statuses

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Development Zones III
Free Trade Zones (FTZ)

• 12 FTZ’s located in China
• Established to improve
Import/Export and
International Trade
• Intended for assembly /
processing of imported
goods and export purposes
• Streamlined customs
clearance procedures
• Various preferential tax
treatments depending upon
the FTZ

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AGENDA


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Modes of Entry
Overview

• Business setup process difficult for foreign companies to navigate due to
complex bureaucracy and regulations - laws & regulations constantly changing

• Regional differences may exist; national regulations may differ from local
applications

• There are three main legal setup options in China – Rep. office, WFOE and JV,
with different capital requirements and business scopes

• No one solution for all companies; solution depends on specific company’s
business and objectives for China

• When deciding on the optimal legal entity, look for advice and assistance from
professional service providers – getting it right from the start is key

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NATURE OF THE INVESTMENT
Foreign Investment Catalog

Status of
Description Examples
industry/activity

• Manufacture of high-performance welding
• Special incentives possible
Encouraged robots
• Usually high-tech or agriculture industries
• Operation of nurseries

• All activities not mentioned in catalog are
permitted
Permitted • All sectors not mentioned in catalog
• But may be difficult to get approval for
uncommon activities

• Special approval required – usually JV • Production of cigarettes
Restricted partner necessary • Operation of oil refineries
• Usually are protected sectors • Media production
• Activities are disallowed
• Arms manufacturing
Prohibited • Harms national interests or
• Operation of gaming industry
environmentally damaging

When considering setting up in China, first step is to check the catalog

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FOREIGN INVESTMENT CATALOG
Legal Set up Options

Investment Restrictions
Setup Options Description
Encouraged Permitted Restricted Prohibited

• Liaison office for parent
Representative Office (RO)
company

Foreign Invested Enterprises (FIE’s)

Wholly Foreign Owned
Enterprise (WFOE)
• Service WFOEs • 100% invested and owned
• FICE by foreign entities
• Manufacturing WFOE
•Trading WFOE

• Capital investment from
Equity Joint Venture (EJV) both foreign and Chinese
entities

Cooperative Joint Venture • Partnership between foreign
(CJV) and Chinese entities

Allowed business scope depends on specific sector and type of entity

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Nature of Business

Import/Export Domestic Service Capital Registration
Rights Distribution Activities Requirements Complexity

Rep. Office

Service WFOE

Manufacturing
WFOE

FICE

WFOE’s provide greater flexibility for future operations

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Entity Options Analysis
Sourcing

• Simplifies tax exposure (~8.8% on
expenditures), registration complexity, & initial
Conduct negotiations, QC for Parent investment
company .
Rep. Office • Heavy reliance upon 3rd party agents to
facilitate trade
• May cause additional tax exposure if effective
Legal Gray Illegal management is within China
• Not scalable

• Allows more sophisticated means of tax
Provide sourcing consulting services optimization
Service exclusively to Parent Company • Heavy reliance upon 3rd party agents to
WFOE facilitate trade
Legal Gray Illegal management is within China
• Not scalable

• Allows for the flexibility to bring more of the
supply chain in-house
Source from within China then sell to • Platform for future domestic distribution
FICE Customer direct
• More sophisticated tax optimization
• Allows more flexibility for future expansion of
business scope and scalability
Legal Gray Illegal • Greater administrative costs/overhead
• May cause tax complications if used as a
captive business model

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Entity Options Analysis
Services

• Simplifies tax exposure (~8.8% on
Conduct services through local office expenditures), registration complexity, & initial
while all invoicing is conducted offshore. investment
Rep. Office
• Not a substantial presence in the market; may
deter potential clients
Legal Gray Illegal
management is within China
• Must setup a separate RO to expand presence

• Allows more sophisticated means of tax
optimization
• Direct hire of local employees
Provide services and invoicing directly to • Substantial presence within China with ability
Service local & International clients to issue Fapiao
WFOE • Option to establish branch office to expand
presence
Legal Gray Illegal • May require higher upfront costs and greater
overhead
• May cause tax complications if used as a
captive business model

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Capital Requirements
Injection Methods

Total Investment Registered Capital

No less than 70% of total • Complete injection within 6
Less than 3 million investment, with a
months
minimum of 3,700
-or-
• Capital contributed in
No less than 50% of total installments: 20% within
investment with a first 3 months with the
Between 3 and 10 million minimum of 2.1 million if remaining injected within 2
total investment is below years
4.2 million
Currency: US Dollars

No less than 40% of total
investment with a
Between 10 and 30 million minimum of 5 million if
total investment is below
12.5 million

No less than 1/3 of total
Between 30 and 36 million investment with a
minimum of 12 million

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Capital Requirements
Investment Ratio Examples

Example 1

Registered Capital

Equity (100%)

Total Investment

Example 2

Registered Capital

Equity (70%) Debt (30%)

Total Investment

Shareholder loans are an alternative means of profit repatriation

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Business Registration Process
WFOE
Company’s Chinese Name Approval

Stage I:
Licensing Approval to Establish Company

Registration of Business License

Filing and Carving Seals* Enterprise Code Certification**

Foreign Exchange Approval Registration with Tax Bureau
Stage II:
Post-
Licensing

Statistics Bureau Registration†

Open RMB & Foreign Currency Bank Accounts

Stage III: Capital Verification
Post-Capital
Injection
Update Business License

*Official company stamps required for many business and banking transactions in China
** Equivalent to a personal identification number for the licensed company
•† This process can be completed at any stage following foreign exchange approval and registration with the tax
bureau
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China by the Numbers

FDI By Investment Vehicle
WFOE EJV CJV
35,000

30,000

25,000

20,000

15,000

10,000

5,000

0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: National Bureau of Statistics 33

A Few Last Points…

• China is not a mystical land of dragons and forbidden cities
The Chinese have many of the same desires and needs as all of us
It is possible to understand China and the Chinese in the context of your business, but…

• There is no such thing as the “China Expert”
The more that you know about China the more questions you will have
Even the Chinese cannot grasp, in its entirety, the socioeconomic changes that are occurring
within their own country

• Cultural differences should not preclude standard business practices
Chinese hospitality is often mistaken for commitment to a mutually understood business
objective; do not let this undermine proper legal contracts
Investing in market research, regulatory compliance and due diligence will increase your
chances of developing sustainable business model

• Foreign Invested Enterprises should not behave like locally owned companies
Foreign firms are scrutinized more closely and held to stricter standards
Train your staff to understand the difference

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THANK YOU FOR YOUR ATTENTION!
The JLJ Group

SHANGHAI OFFICE Shanghai
Suite 603-605
Oriental Center
699 Nanjing West Road
Shanghai, 200041 China
Tel: +86 21 5211 0068
Fax:+86 21 5211 0069

BEIJING OFFICE
Suite 1008, Tower B, Building 3,
22 International Art Plaza / Pingod North
32 Baiziwan Road, Chaoyang District
Beijing, 100022 China
Tel: +86 10 5876 9437
Fax:+86 10 5876 9467
Beijing

BOSTON OFFICE
162 Chapel Street
Newton, MA 02458, USA
Tel: +1 857 636 2596

Email: info@jljgroup.com

Web site:www.jljgroup.com

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China Business Environment Oct 2009

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