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Written by Mark Hedley

Within China, rapidly changing demographics, rising incomes,increased consumer spending and an increasingly open businessenvironment have all helped to make the Chinese market increasinglyattractive to Western businesses across a variety of industries.Similarly, declining sales in their home markets has forced many USand European companies to relocate China firmly to the centre of theirlong-term global growth strategies.

Breaking into the China market [https://www.b2binternational.com/experience/international-markets/china/ ] successfully can seem likean almost impossible task to foreign companies with limited or noexperience of doing business there. The aim of this white paper is tohighlight some of the key challenges that foreign companies face when

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entering the China market for the first time, and to offer some practicalrecommendations that can be integrated into a company’s Chinamarket entry [https://www.b2binternational.com/research/solutions/moving-into-new-markets/ ] and expansion plans.

With a population that exceeds 1.3 billion people and a land masslarger than the United States, China's sheer size and scale presentschallenges uniquely distinct from any other market (including otherAsian markets such as Japan and South Korea). While it is true thatChina represents a huge potential market for foreign manufacturedgoods and services, it is also the case that understanding where theseopportunities lie and how to access them can be extremely challenging.Whether it be the large Western multinationals with an establishedChina presence or the first-time market entrant with no previous Chinaexperience, foreign companies of all shapes and sizes often find theirChina success stymied through insufficient lack of local understanding.

The first realisation that foreign companies often need to make is thatChina is in no way a uniform and homogenous market. Although Chinais unified in the geo-political sense, socially and economically thepicture is much more disparate and fragmented. Uneven rates ofeconomic growth in different parts of China over recent years haveserved to exacerbate many of the economic and social differences thatalready existed between different provinces. For example, there arehuge variations between different provinces in terms of populationlevels, per capita GDP, average income levels, consumer spendinghabits, education levels, literacy rates, lifestyles and so on. As such, itis certainly no exaggeration to state that rather than representing asingle, unified market, China is actually a collection of individualsub-markets defined by vastly differing demographic, economic andcultural characteristics.

The nature and make-up of markets in different parts of China alsovaries considerably, which means that foreign companies should thinkcarefully about which geographical location offers the best vantagepoint to target the broader China market. In the past, foreignbusinesses have often been drawn to coastal provinces such asZhejiang, Guangdong, Jiangsu and Shanghai, due to higherpopulations and incomes in those areas. In particular, foreigncompanies involved in consumer markets have tended to focus theirattentions on these higher income coastal regions.

Figure 1 - Map of China's 33 Provinces and Administrative Regions


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China Market EntryResearch[https://www.b2binternational.com/research/services/market-entry/china-market-entry/ ]

Province Industry

Shanghai Petrochemicals, chemicals, pharmaceutical,automobile, electronic apparatus, financial

Beijing IT, communications, electronics

Guangzhou Automobiles, electronic appliances, textiles,apparel, toys, petrochemicals, chemicals

Jiangsu Chemicals, textiles, communications,petrochemicals, steel, foods, auto parts,biomedicine

Shenzhen IT, semiconductors, biomedicine,communications, electronics information

Although foreign companies in the b2c sector still remain focused oncoastal cities, business-to-business markets are often far moregeographically scattered. As in many countries, China has activelyencouraged the setting up of industrial clusters in specific cities orregions, and in many cases entire industry supply chains can beconcentrated in a small handful of cities. In many b2b markets, suchclusters can help foreign companies to know where its target customersare, which cities to focus on and even where to base its operations(particularly where local manufacturing will take place). The first step ofany effective China market entry strategy is therefore to identify thegeographical location of the target market(s) and the best specificlocation to target first.

Figure 2 - Selected Cities According to Industrial Orientation


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Zhejiang Light industry, plastics, textiles, apparel, toys,metallurgy, household electrical, furniture,kitchenware

Shandong Agricultural, oil & foodstuffs, pharmaceutical

In recent years, the prevailing wisdom among foreign enterprises hasbeen to focus predominantly on China's Tier 1 cities (i.e. Shanghai,Beijing and Guangzhou) – highly populated areas with a large,middle-class representation and income levels well above the nationalaverage. Tier 1 cities are China's most mature markets in terms ofconsumer behaviour, and are typically the most suitable testing groundfor foreign companies with limited experience in China. Although beingbased in a Tier 1 city may offer the lowest risk point of market entry[https://www.b2binternational.com/research/services/ market-entry/ ] , it will also mean that the company faces higher operationalcosts and more competition.

Economic growth and rising incomes in China's Tier 2 cities have madeentering these markets much more attractive to foreign suppliers than itwas in the past. Not only do Tier 2 cities have the advantage of lowerset-up and operating costs, but the increase in consumer spendingpower in these areas is creating a rapid growth in demand for foreignmanufactured goods and products. In particular, cities such asShenzhen, Tianjin, Wuhan, Chongqing, Chengdu, Nanjing, Qingdao,Dalian, Suzhou and Hangzhou all offer strong commercial opportunitiesfor foreign companies across a range of sectors. Over the long term,including Tier 2 and even Tier 3 cities in their strategy can enableforeign companies to gain first-mover advantage in these cities andlead to greater long-term market success.

Whether to set up in more tried and tested locations or to take the riskof setting up in a less developed market is likely to depend on a varietyof different factors, and ultimately this decision will be based on havingthoroughly research the market landscape. For example, it is critical tospend time mapping out the location of customers and suppliers,understanding how distribution channels vary between differentlocations, and fully researching any local regulatory barriers that couldblock market entry in specific regions. Companies planning to set up alocal manufacturing facility will be required to research a broader rangeof factors, such as local manufacturing and transport infrastructure,access to key raw materials, local investment policies, the availabilityand cost of human resources, and a myriad of other factors.

Understanding government policy and regulations is critical to successin Chinese b2b markets. Although China's entry to the WTO in 2001helped to liberalise China's trade environment to some extent, manyindustries remain heavily regulated. There are still a lot of industries


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that remain off-limits to foreign companies, and many industries wheresevere limitations remain in place. For example, China severelyrestricts foreign companies' involvement in the field of petrochemicals,energy and telecommunications sectors. Any foreign company lookingto set up local production in China should first consult the China foreigninvestment catalogue, which divides foreign investment projects into‘encouraged', ‘restricted' and ‘prohibited' categories.

As China's economy develops, it is also accumulating a growingnumber of industry-specific regulations and standards, which bothdomestic and foreign companies should conform to. China now has ahost of different ministries and regulatory organisations withresponsibility for industry regulations and laws. For example, in thehealthcare sector both the Ministry of Health and the State Food andDrug Administration (SFDA) play a role in drawing up and enforcingregulations, while there are also provincial level MOH and SFDAorgans that implement regulations at a local level. In industries withgreater levels of regulation (such as the healthcare and food sectors),foreign companies will need to attempt to unravel the web of complexlaws and regulations, and try to understand which authorities haveprimary responsibility for implementing them.

Regulation is becoming more stringent, as are to efforts ensure thatcompanies actually conform to them. In the wake of the melaminepoisoned milk scandal in 2008, the Chinese authorities have taken atougher line against companies that openly flaunt the food safety law,whilst the SFDA is also tightening regulations on pharmaceuticals andmedical devices to avoid similar events from occurring in the future. Likewise, environmental problems caused by poor environmentalregulatory enforcement and widespread pollution in years gone by haveled to the introduction of much tighter environmental legislation. Foreign companies are now required to go through lengthyenvironmental assessments before gaining permission to producelocally.

Government regulations can very often impact significantly on thetimeline and costs of market entry, and companies are advised toexamine the implications of such regulations prior to committing to themarket. For example, in the medical and pharmaceutical sectors, longproduct or clinical trials may be required, which result in a longer salescycle than may be the case in other countries. It is also worthwhilenoting that just because a product has previously been approved byregulatory authorities in Europe or the US does not automaticallyguarantee that the same product will receive approval in China.

It is critical to spend time researching and understanding the regulatoryenvironment prior to making any decision to enter the market. Havingentered the market, it is equally important to constantly monitor for anychanges to legislation or regulations and how these could affect yourbusiness. Chinese regulatory bodies often operate in a quite opaquemanner, making it difficult to anticipate regulatory changes before theyhappen. A further problem is that China's regulations are often vaguelyworded and open to interpretation, which can be unsettling for foreigncompanies used to a more transparent regulatory environment. Market


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Advantages Disadvantages

WFOE High level ofmanagerial controlCan employ ownpeople withoutrestrictionsGreater flexibilityCan convert RMBprofits into US dollarsGreater level of IPRprotection

Initial set-up costs highLong incubation periodNo access to JVpartner resourcesHigher start-up andoperating costs(registered capital)Some industrylimitationsMinimum number ofstaff requirementTax and repatriation ofprofits challenging

research specialists and legal consultants can help foreign businessesto better understand how China's laws and regulations should beinterpreted.Market Entry Mode

Choosing the right vehicle for entry is one of the most crucial decisionsa business can make when entering China for the first time. Although agrowing number of foreign companies are ‘going it alone' in China, thejoint venture (JV) business model still brings with it many advantagesand can often be seen as a lower-risk strategy than the wholly foreignowned enterprise (WFOE). Equally, while some b2b markets requiresetting up a local Chinese entity, in other markets using localintermediaries or a small representative office may suffice.

Entry mode often depends on a number of factors, including industrylandscape, the geographical size and scope of the market, whether thecompany plans to manufacture locally or import its products, and thelevel of on-the-ground sales and technical support required bycustomers. Ultimately, when choosing which form is most appropriate,a company should consider each of these factors, along with the overallcosts of setting up a local entity and hiring local employees.

Figure 3 - Foreign Investment Vehicle: Advantages & Disadvantages


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JointVenture(JV)

Mandatory for someindustriesOpportunity to utiliseexisting sales networksand customer baseAccess to partner'sexisting resourcesProduction facilityLower cost base (localmanagement)

Less managerialcontrolFinding a trustworthypartner is criticalChallenging to agreeterms of thepartnershipMay be a longnegotiation periodPotential risk to IPRSuccess may dependon having staff on-the-ground to overseeoperationsPartner likely tonegotiate terms in theirfavour

RepOffice

Quick to set upLow cost (lowoverheads)No registered capitalrequirementGood for marketing,partner auditing andadmin

Unable to tradeStaff employed viathird partyLimits on number ofstaff

Ultimately, the best vehicle for a foreign enterprise entering the marketfor the first time will vary according to the size and scope of anenterprise, along with the specific characteristics of the market it isentering. For example, while WFOEs are often the main modusoperandifor high-tech firms with large IP inventories, companiesspecialising in more commoditised products often find that risk ismitigated by partnering up with a well-established local company.

Whichever market entry mode is chosen, thorough market researchshould precede any final decision on how and when to enter themarket. A growing number of market research companies now haveoperations in China, and the market is becoming easier to researchthan ever before. In addition to the numerous off-the-shelf reportsavailable about the Chinese market, there are now a growing numberof companies offering tailored market research services[https://www.b2binternational.com/research/services/ ] (whether itbe global consultancies and management consultants, government-affiliated agencies or private individuals providing research andconsultancy).

The profusion of English-language publications on China availablethrough the internet makes it relatively easy for Western companies to


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carry out some initial research on the Chinese market. Typically, thisinitial in-house ‘desk research' can help firms to determine whetherfurther, more detailed research is required and can assist with settinggoals for more detailed research later on. An experienced marketresearch company will then build upon this initial foundation ofknowledge with more detailed information collected via Chinese-language desk research and in-depth interviews with leading industryexperts and decision makers. Along with these qualitative techniques,quantitative research can then help with determining more accuratelymarket size, future growth trends, levels of competition, routes tomarket, key customer requirements and so on.

Effective market research is essential to determining the size andnature of the market opportunity [https://www.b2binternational.com/research/services/market-opportunity-research/ ] and acts as abenchmark against which firms are able to measure futureperformance. Good market research can help to identify any potentialroad-blocks to market (competitive, legal or regulatory) and identify anyweaknesses in a company's product or service offering. A thoroughand well executed market research study can help prevent poordecision-making and establish a clear strategy map for the future.

Arguably, the single biggest determinant of a company's ultimatesuccess in China is the quality of staff it employs. Very often, theenterprise type will determine the human resources available, andforeign companies tend to have greater freedom with WFOEs and repoffices than JVs in this respect. The quality of human resourcesavailable will also be closely related to where the company is located,and it is generally the case that the quality of people available is muchhigher in Tier One cities such as Shanghai and Beijing than Tier Twoand Tier Three cities.

Another key decision to be made is whether to employ expatriates insenior management positions or whether to localise these roles. Employing expatriates tends to be seen to offer greater operationalcontrol, although is also more costly in terms of salary packages,relocation costs, insurance and other expenses. Moreover, mostexpatriate managers have a very limited local knowledge of Chinesecultural and business practices, and very seldom have the Chineselanguage skills necessary for dealing with Chinese companies on aday-to-day basis.

A key benefit of hiring a Chinese manager is the local marketknowledge and deeper understanding of Chinese business they bringto the role. Not only are salary and insurance costs lower for localemployees, but Chinese employees very often have existing contacts(‘guanxi') with suppliers, customers and local government authoritiesthat can be fully utilised.

Unfortunately, in many industries the supply of highly skilled localmanagers with industry experience is extremely limited, and employers


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may still be forced to pay a premium to attract the right calibre ofemployees. Equally, staff turnover rates are extremely high in Chinaand retaining quality managers over the long term is challenging. Losing local managers will also risk losing access to their guanxinetworks and local market knowledge.

Whether hiring staff, investing in a joint venture or appointing a localdistributor, carrying out due diligence is also an indispensable activitywhen setting up in China for the first time. The key objective of duediligence is ultimately to verify the trustworthiness of partners andemployees, and to flag up any skeletons in the cupboard beforeproceeding with any sizeable investment. Although some basic duediligence can be carried out in-house, nowadays there are alsonumerous legal and risk assessment consultants with offices in Chinathat provide business intelligence, individual background checks, andrisk analysis consultancy.

IPR infringement is commonplace in China, and any company enteringthe market for the first time should work under the assumption that itstechnology will be compromised at some point. With this in mind, it isgenerally recommended that foreign companies, and particularly thosewith large IP inventories, consult with lawyers and IPR specialists toformulate an IPR strategy for the China market.

There is no one-size-fits-all IP protection strategy for China, andtypically an effective IPR strategy mix will employ a number of differenttools. One might include a mixture of various legal, practical andtechnical measures designed to prevent infringement and ensure legalrights are enforced in the event of an infringement.

Figure 4 - China IPR Strategy

China has a "first-to-file" patent system, which means that it is possible


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for local Chinese companies to register another company's patentseven though it is not the original inventor of a technology. Also, thereare time limitations on registering patents in China, and so companiesthat registered their patents outside China more than 12 monthspreviously are usually unable to register their patents locally in China. Another important consideration is whether registering a patent couldactually serve to disclose key technical information that could otherwisebe protected through employee non-disclosure agreements (NDAs) andother practical measures.

China also has a "first-to-file" trademark system, which means that aforeign company's legitimate brand and logo cannot be used if thesetrademarks have already been registered by a local Chinese company. Any company seriously considering entering the Chinese market in thefuture should register its trademarks with the China Trademark Officeas soon as possible. Registering a trademark across a number ofdifferent categories may also be necessary for companies keen to deterpotential infringers. Likewise, new market entrants should ensure thatall trademarks are registered both in English and Chinese, and that anyinternet domain names are properly registered.

Beyond these legal measures, there are a number of practicalmeasures that foreign companies can adopt to protect their IPR. Forexample, carrying out thorough due diligence on prospective partnersand company employees, signing NDAs with partners and employees,and constantly monitoring the market for infringements are key practicalsteps a company, having already entered the market, can take toprevent its IPR from being compromised. Equally, actively pursuinglegal proceedings against any IP infringers should act as a deterrent toother potential infringers and will alert the authorities to future IPRinfringements.

Making that first step into the China market is an intimidating step formost companies in the b2b arena, with an almost endless series ofpotential pitfalls to be negotiated. Although there are often manyobstacles in the way of achieving success in China, the rewards ofsuccessfully navigating this difficult course are also immense.

Thankfully, as China's economy continues to grow and become moreopen to foreign companies, the rewards increasingly outweigh thechallenges of doing business in China. While the old adage "In Chinaeverything is possible, but nothing is easy" still rings true for manyforeign companies when doing business in China, the extent of thisdifficulty seems to decline further with every passing year.

China is a country that is constantly changing and its markets areevolving more rapidly than almost anywhere on earth. As such, there isno one-size-fits-all approach by which foreign companies shouldapproach the China market. Each company's China strategy is likely tobe informed by any number of different factors – from industry sector,product type, company size and culture, through to long-term business


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Dos Dont's

Do some initial backgroundresearchCarry out extensive marketresearch before entering themarketSegment the market (bygeography, income andcustomer habits)Determine the best entryvehicle according to resultsof researchDetermine the best routes tomarket and channel partnersConsult with legal experts tocreate an IPR strategy forChinaRegister trademarks inChina prior to market entryCarry out due diligence onprospective partners andemployees

Rely on hearsay orthird-hand marketinformation from ChinesepartnersAssume that similar marketconditions apply throughoutChinaInvest in a local presenceprior to researching themarket thoroughlyChoose partners oremployees without properdue diligenceAssume that IP rights areautomatically protectedunder Chinese law

Readers of this white paper also viewed:

Marketing and Selling to Chinese Businesses [/publications/chinese-marketing-selling/ ]

Business-to-Business Market Research in China [/publications/market-research-china/ ]

Market Sizing In China [/publications/china-market-sizing/ ]

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This white paper has attempted to illustrate some of the fundamentalconsiderations that any company must take when approaching theChina market for the first time. Although these steps may lead to verydifferent conclusions for different companies, they can help companiesto properly determine an appropriate strategy for China. We finish witha brief summary of the ‘Dos and Don'ts' that any foreign companyapproaching the China market for the first time should take intoconsideration.


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