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A. Distribution
and Sales Channels
B. Selling Factors/Techniques
C. Advertising and Trade Promotion
D. Product Pricing and Customer Service
E. Sales to the Government
F. Intellectual Property Rights (IPR) Protection
G. Professional Services
H. Due Diligence
A. Distribution
and Sales Channels
Trading Companies
Generally, foreign companies are not permitted to directly engage
in trading in China, with the exception of the direct marketing
of a portion of the products manufactured in China, or the establishment
of wholly owned foreign trading companies in some free trade zones
with limited access to markets outside these zones. Distribution
rights may change after WTO accession but not in current trading
activities. Accordingly, U.S. exporters need to use a domestic Chinese
agent for both importing into China and marketing within China.
Only those trading companies authorized by the central government
to handle exports and imports are permitted to sign import and export
contracts. Since the beginning in 1998, some private and collectively-owned
enterprises in the manufacturing sector have been granted this authorization.
Some import/export trading firms extend their scope of business
to represent foreign manufacturers as their distributors, in arrangements
similar to a "manufacturers representative."
With careful
selection, training and constant contact, a U.S. exporter can obtain
good market representation from a Chinese trading company, many
of which are authorized to deal in a wide range of products. Some
of the larger companies have offices in the U.S. and other countries
around the world, as well as a network of offices and affiliates
in China. However, given transportation and communication difficulties
as well as regional peculiarities, most of these trading companies
cannot provide diversified coverage throughout China.
Local agents
In addition to trading companies, China is witnessing an explosion
in local sales agents who handle internal distribution and marketing.
Most of these firms do not have import/export authorization. They
are the next layer down the distribution chain, buying imported
products from those that do. They may be representative offices
of Hong Kong or other foreign trading companies, or domestic Chinese
firms with regional or partial national networks.
Given China's
size and diversity, as well as the lack of agents with wide-reaching
capabilities, it makes sense to engage several agents to cover different
areas, and to be cautious when giving exclusive territories.
China can be
divided roughly into at least five major regions: the South (Guangzhou),
the East (Shanghai), the Central/North (Beijing-Tianjin), West China
and the Northeast.
The U.S. &
Foreign Commercial Service's (USFCS) Agent/Distributor Service (ADS)
program was designed to help U.S. exporters find appropriate sales
agents and representatives in China. This service may be ordered
through any U.S. Department of Commerce district office or U.S.
Export Assistance Center. For a fee of $250, USFCS searches for
potential agents or distributors for your product in a specific
geographical area. Regional ADSs are available from the USFCS offices
in Beijing, Shanghai, Guangzhou, Shenyang, and Chengdu, but nation-wide
searches are not available. An ADS is an excellent way to gauge
interest in your product and begin the process of finding a suitable
representative.
Establishing
a Representative Office
Representative offices are the easiest type of offices for foreign
firms to set up in China, but these offices are limited by Chinese
law to perform "liaison" activities. As such, they cannot
sign sales contracts or directly bill customers or supply parts
and after-sales services for a fee, although most representative
offices perform these activities in the name of their parent companies.
Despite limitations on its scope of business activities, this form
of business has proved very successful for many U.S. companies as
it allows the business to remain foreign-controlled.
China's Company
Law, which has been in effect since July 1, 1994, permits the opening
of branches by foreign companies but, as a policy matter, China
still restricts this entry approach to selected banks, insurance
companies, accounting and law firms. While representative offices
are given a registration certificate, branch offices obtain an actual
operating or business license and can engage in profit-making activities.
Establishing
a representative office gives a company increased control over a
dedicated sales force and permits greater utilization of its specialized
technical expertise. The cost of supporting a modest representative
office ranges from $250,000 to $500,000 per year, depending on its
size and how it is staffed. The largest expenses are rent for office
space and housing, expatriate salaries and benefits.
Establishing
a Chinese Subsidiary
A locally incorporated equity or cooperative joint venture with
one or more Chinese partners, or a wholly foreign-owned enterprise
(WFOE), may be the final step in developing markets for a company's
products. In-country production avoids import restrictions -- including
relatively high tariffs -- and provides U.S. firms with greater
control over both intellectual property and marketing.
The role of
the Chinese partner in the success or failure of a joint venture
cannot be over-emphasized. A good Chinese partner will have the
connections to help smooth over red tape and obstructive bureaucrats;
a bad partner, on the other hand, can make even the most promising
venture fail. Common investor complaints concern conflicts of interest
(e.g., the partner setting up competing businesses), bureaucracy
and violations of confidentiality. American companies should bear
in mind that joint ventures are time-consuming and resource-demanding,
and will involve constant and prudent monitoring of critical areas
such as finance, personnel and basic operations in order for them
to be a success.
Some companies
prefer to establish a wholly foreign-owned enterprise (WFOE, often
pronounced "woofy") rather than a joint venture, with
a view to retaining greater management control, due to concerns
over intellectual property rights (IPR) protection, desire for simplicity,
or for other reasons of corporate policy. The law on WFOEs requires
that they either provide advanced technology or be primarily export-oriented,
and restricts or prohibits them in a number of service and public
utility sectors. However, an increasing number of U.S. companies
find WFOEs, which now account for roughly 20% of all foreign-invested
enterprises (FIEs), to be a viable entry vehicle to the China market,
taking much less time and money to set up than a joint venture (see
Chapter IV).
Licensing
Technology transfer is another initial market entry approach used
by many companies. It offers short-term profits but runs the risk
of creating long-term competitors. Due to this concern, as well
as intellectual property considerations and the lower technical
level prevailing in the China market, some firms attempt to license
older technology, promising higher-level access at some future date
or in the context of a future joint venture arrangement.
Licensing contracts
must be approved by and registered with the Ministry of Foreign
Trade and Economic Cooperation (MOFTEC). A tax of 10-20% (depending
on the technology involved and the existing applicable bilateral
tax treaty) is withheld on royalty payments (see section F of this
chapter).
Franchising
China has no laws as yet which specifically address franchising,
but many foreign companies are beginning to establish multiple retail
outlets under a variety of creative arrangements, including some
which for all practical purposes function like franchises. Virtually
all of the foreign companies who operate multiple-outlet retail
venues in China either manage the retail operations themselves with
Chinese partners (typically establishing a different partner in
each major city) or sell to a master franchisee which then leases
out and oversees several franchise territories within the territory.
Within three years of WTO accession, restrictions on equity share,
number of outlets and geographical area are to be eliminated.
Direct selling
Major U.S. direct selling companies entered the China market in
the early- to mid-1990's, when China's legal and regulatory framework
for this industry was not very clear. Direct selling was quickly
modeled after by domestic Chinese companies, some of whom abused
this legitimate format of doing business and operated scams to rip
off consumers and evade taxes. In early 1998, the Chinese government
started implementing a series of strict controls over this industry,
culminating in the re-licensing of all direct selling companies.
Although a few major U.S direct selling companies were re-issued
the business license, restrictions are severe and requirements many,
resulting in difficult business environment. The U.S direct selling
industry is working pro-actively with various Chinese government
departments and agencies, as part of an overall effort toward China's
WTO accession, to construct a fairer business climate in this industry.
E-commerce
The Chinese government has adopted an open attitude towards the
advent of electronic commerce in China. Interest among both Chinese
and international businesses focuses on investing and on establishing
vertical integration and sales channels on-line. Investment is risky,
however, due to the lack of clearly defined regulatory powers over
the industry, an effective Chinese certificate authentication system,
secure and reliable on-line settlement system, and an efficient
physical delivery system. Many U.S. IT sector companies have been
actively engaged in jointly developing these systems in China, and
WTO accession will increase the speed of these developments.
B. Selling
Factors/Techniques
Relationships
Personal relationships in business are critical. The Chinese feel
more comfortable dealing with "old friends," and it is
important for exporters, importers, and investors to establish and
maintain close relationships with their Chinese counterparts and
relevant government agencies. It is equally important that American
exporters encourage strong personal relationships between their
Chinese agents or distributors and the buyers and end-users. A web
of strong personal relationships will help ensure smoother development
of business in China.
Foreign Currency
Chinese companies are not permitted to retain foreign exchange.
In business deals with Chinese companies, U.S. companies have been
asked to keep a portion of the Chinese companies hard currency earnings
in foreign bank accounts to avoid reporting and turning it over
to the foreign exchange control authorities. As part of an effort
to clamp down on corruption and tighten foreign exchange control,
the Chinese government is coming down hard on such practices.
In contrast,
FIEs are permitted to retain foreign exchange contributed to or
earned by the enterprise. On December 1, 1996, China made its currency
convertible on the current trade account. However, foreign exchange
balancing requirements remain in effect in other Chinese laws and
regulations and in joint-venture contractual arrangements.
Chinese companies
are, however, able to purchase the foreign currency necessary for
authorized imports and foreign-currency obligations such as licensing
fees, royalties, and loans by authorized entities.
C. Advertising
and Trade Promotion
Advertising
Advertising is an effective way to create product awareness among
potential consumers in China. Channels for mass advertising include
publications, radio, television, billboard displays, internet, and
sports sponsorship.
China's retail
boom and increasing competition among retailers is making China's
advertising industry grow even faster than the economy as whole.
According to China's National Advertising Association (under the
State Administration for Industry and Commerce, or SAIC), over-all
advertising spending reached $ 7.5 billion in 1999, a 15.4 percent
growth over 1998's volume. China has about 64,000 advertising businesses,
including more than 500 foreign joint ventures. Foreign advertising
firms are limited to taking an equity stake of up to 51 percent
in joint venture enterprises. All of the major international advertising
firms are present in China.
Television advertising
takes the largest single portion of the Chinese advertising market.
China's regular television viewing population is 84 percent of China's
1.2 billion people. Major articles sold on television include toiletries,
foodstuffs, pharmaceuticals, liquor, and home electronics. Television
stations in big markets (Beijing, Guangzhou, Shanghai) require advertisers
to book and pay for specific spots two to ten months in advance.
Now that China
is in the midst of a consumer revolution, foreign products, complete
with advanced marketing, advertising and research techniques, are
leading the way. Brand awareness is increasingly important and sophisticated
advertising is beginning to play a crucial role in charming the
Chinese consumer. Foreign products are expected to continue making
inroads despite 1999 regulations calling for more control over customer
surveys that help foreign firms enhance their marketing effectiveness.
China's 1995
Advertising Law contains guiding principles that set broad requirements.
For example, one of the requirements is that advertising should
"safeguard the dignity and interests of the State." Comparison
advertising is not allowed, nor is the use of superlatives. Chinese
restrictions within the advertising sector include requirements
for the verification of safety and hygiene from the relevant ministries
that monitor various consumer products. Censorship standards vary
considerably throughout China.
MOFTEC and SAIC
are the primary regulatory organizations for the advertising sector,
but many other organizations, such as the Ministry of Culture and
the State Administration of Radio, Film and Television, play an
active role in controlling what ends up in print or on television.
Trade Shows
and Missions
Hundreds of exhibitions are now held annually in China. Most are
sponsored or co-sponsored by government agencies, professional societies,
or the China Council for the Promotion of International Trade (CCPIT).
Shows are also organized by U.S., Hong Kong, and state trade departments,
and other professional show organizers. Show participation costs
are sometimes high and may only reach a local audience so companies
are advised to scrutinize which shows to participate in. A list
of trade shows that are screened by the U.S. Department of Commerce
are listed in the appendix.
Electronic Commerce
and the Internet
The rapid growth of the internet raises interest in using "e-commerce"
in China. Though China remains a developing country, the ambitious
use of high technology has made inroads with the growth of governmental
and business-to-business forms of e-commerce. Government at all
levels seeks to use technology to inform the public about laws,
deal with customs and simplify procedures, and businesses are beginning
to conduct bidding, process sales and handle contacts on-line. In
addition, direct marketing and sales-on-line have begun despite
the lack of credit card usage and distribution difficulties. Beijing
and Shanghai SAICs have begun a licensing process to create a "reasonable
and reliable market." In May 2000, nearly 30 internet companies
were awarded licenses to sell online advertising.
D. Product
Pricing and Customer Service
Most Chinese
consumers are sensitive to price and will usually choose the less
expensive product unless they can be swayed by better after-sales
service or clearly better product quality. For larger purchases,
attractive financing that lowers the effective price is offered
by Japanese, European and other foreign governments' companies and
may make some U.S. products less competitive.
Foreign companies
are normally not permitted to directly provide after-sales service
and customer support for their products sold into China. Foreign
Invested Companies (FIEs) can provide such services on products
that they manufacture in-country. Foreign firms sometimes engage
authorized Chinese entities to provide service, often on a contractual
basis, or to establish service centers jointly that can provide
both spare parts and after-sales service. American companies complain
that such arrangements give them inadequate control over the quality
of customer service and result in the loss of customer confidence.
Some companies opt to provide regular servicing from bases outside
of China, such as Hong Kong.
E. Sales
to the Government
In 1999, new
regulations controlling government procurement were issued by the
Chinese State Development Planning Commission (SDPC). While ostensibly
making the system more transparent and open, it also centralizes
the procedure much more. In the past, government procurement was
conducted through state-owned/controlled companies affiliated with
a particular ministry. Since these entities will remain the main
end-users of the purchases, their participation in the process will
probably continue.
China's government
procurement practices have often not been consistent with open and
competitive bidding and, for the most part, non-transparent. It
is unclear at this point how the new regulations will streamline
a system that previously was subject to at least one, and usually
several, approvals from governments at various levels. While tenders
for projects funded by international organizations are usually openly
announced, most government procurement is by invitation only. Competition
is by direct negotiation rather than by competitive bid but that
is supposed to change under the new regulations. Goods and vendors
for large projects that are covered in the annual state plan have
been frequently designated during the planning process. All information,
from solicitation to award, remains secret and is known only to
those companies involved or to officials in the planning and industrial
ministries.
Direct sales
to the Chinese military are also a possibility. While restrictions
on this type of business exist both in the United States and in
China, U.S. manufacturers have successfully sold a wide variety
of products to the Chinese military through the General Logistics
Department of the People's Liberation Army (PLA).
F. Intellectual
Property Rights (IPR) Protection
The U.S. and
China signed an IPR Memorandum Of Understanding (MOU) in 1992, pursuant
to which China improved its laws governing IPR protection over the
following two years and joined the Berne Copyright and Geneva Phonograms
Conventions. The March 1995 extension of the IPR MOU sets out a
plan for enforcing IPR and grants market access to certain products.
In 1998, in an effort to improve IPR coordination and enforcement,
China established a new organization, the State Intellectual Property
Office (SIPO). As envisioned, SIPO will eventually have authority
over the Patent Office, the Trademark Office, and the National Copyright
Administration. At present, however, SIPO only controls the Patent
Office, with which it is co-located. The Trademark Office falls
under the authority of the State Administration of Industry and
Commerce, while the National Copyright Administration is controlled
by the State Printing and Publishing Administration.
Enforcement
Large-scale violations of intellectual property rights in China,
including counterfeiting and smuggling, often overwhelm enforcement
efforts. In recent years, China has had considerable success in
closing down factories that produced illegal optical disks (CDs,
VCDs, and CD-ROMs) computer software products ¨C only to see an increase
in such products smuggled across its borders. The authorities have
also conducted thousands of raids at both the manufacturing and
the retail level, resulting in the confiscation of counterfeit or
smuggled products. In 1999, the State Council issued a decree admonishing
government agencies to purchase only legal computer software.
At the same
time, in 1998, in reaction to continuing IPR violations, over twenty
U.S. companies in China formed a coalition to draw the attention
of Chinese and U.S. Government authorities to the counterfeiting
problem, and to propose ways of strengthening enforcement. These
companies estimate their annual losses due to counterfeiting at
over $1 billion. Severely limited market access for products such
as foreign movies and computer software provides an additional incentive
for smugglers and counterfeiters. Foreign companies have devoted
considerable on-the-ground resources to combating IPR violations,
with mixed results. In early 2000, a coalition of these companies
did gain recognition from Chinese authorities as an official organization
to protect their products.
Enforcement
options
The Chinese government agencies most often involved in enforcement
actions are the Quality and Technical Supervision Bureau (TSB) and
the State Administration of Industry and Commerce (SAIC). U.S. companies
have also reported success in registering trademarks, patents and
copyrights with the Customs General Administration, which can then
confiscate infringing products. The Trademark Office and the National
Copyright Administration also can take action in cases involving
trademark and copyright infringement. In addition, China's court
system can be utilized to enforce IP rights. In fact, China has
established special IPR chambers in the Supreme Court and in many
Intermediate Courts, whose judges have had special training in IPR
protection. Compared with the administrative agencies (such as the
SAIC and the TSB), which reportedly sometimes conduct raids within
hours of receipt of a complaint, the court system is relatively
slow.
Patents
Under China's patent law enacted in 1984, domestic and foreign patent
applications have increased steadily. Patent protection was extended
in January 1993 to pharmaceutical and chemical products, as well
as processes; the period of protection was lengthened to 20 years.
The amendments also provide the patent-holder the right of importation
and expand the scope of patent infringement to include unauthorized
sale or importation of products manufactured with the use of patented
processes. Under the provisions of the MOU, China extends transitional
administrative protection to some U.S. pharmaceutical and agrochemical
products for up to seven-and-a-half years. A revised patent law
is now under review.
China acceded
to the patent cooperation treaty on January 1, 1994, and will perform
international patent searches and preliminary examinations of patent
applications. Under the patent law, foreign parties must utilize
the services of a registered Chinese agent to submit the patent
application. Preparation of the application may be done by foreign
attorneys or the Chinese agent.
Copyrights
In March 1992, China established bilateral copyright relations with
the U.S. and in October 1992 acceded to both the Berne Convention
and the Universal Copyright Convention. China also joined the Geneva
Phonogram Convention in April 1993. Following accession to the Berne
Convention, China explicitly recognized computer software as a literary
work and extended protection to computer programs for 50 years without
mandatory registration requirements.
Trademarks
Although problems remain with enforcement, China's trademark regime
basically conforms to world standards. In October 1989, China joined
the Madrid Pact for protection of trademarks; the latter grants
reciprocal trademark registration to member countries. China amended
its trademark regime in February 1993 to add special regulations
for criminal prosecution for trademark infringement.
Legal framework
China is revising its copyright, trademark and patent laws to meet
the requirements of TRIPS and WTO accession. The revised patent
law is closest to completion, and the copyright and trademark laws
are also likely to be revised.
China has a
"first-to-register" system that requires no evidence of
prior use or ownership, leaving registration of popular foreign
marks open to anyone. The Unfair Competition Law extends IPR protection
to trade dress. Under the trademark law, foreign parties must utilize
the services of registered Chinese agents to submit the trademark
application. Preparation of the application may be done by foreign
attorneys or the Chinese agent.
Trade secrets
In September 1993, the Chinese government adopted the Law Against
Unfair Competition. This law defines unfair competition to include
conduct that infringes the "lawful rights" of another
business operator, including acts that violate "commercial
secrets" rights. Commercial secrets which can bring economic
benefits to the authorized users and which are protected by taking
appropriate security measures are defined to include technical and
operational information not available to the public. Sanctions under
the law include civil remedies such as damages, administrative sanctions
such as fines, and criminal penalties for "serious violations."
China is further obligated to protect trade secrets under the Paris
Convention for the Protection of Industrial Property, to which it
is a signatory.
Regulation of
Technology Licensing
Technology transfer by foreign companies is governed by 1985 regulations
on technology import contracts, which include contract-licensing
patents, trademarks, know-how or trade secrets; contracts for technical
services; and other technology import contracts. Contracts transferring
intellectual property as part of the foreign equity contribution
to FIEs are generally regulated by laws concerning foreign investment.
Technology licensing contracts must be approved by MOFTEC or its
provincial commissions.
Some of the
issues of particular concern to U.S. companies include:
* The licensor cannot require confidentiality beyond the duration
of the contract, except where the supplier provides improvements
to the technology, and most technology contracts are not to extend
beyond 10 years;
* The licensor cannot restrict sales channels or impose unreasonable
restrictions on the export of products produced with the licensed
technology; and
* Special approval is required for extended confidentiality, export
restrictions, and preferential treatment for payment of royalty
tax.
G. Professional
Services
The system for
regulation of foreign commercial activity in China is difficult
to navigate and non-transparent. Companies new to market are strongly
encouraged to retain professional services to structure commercial
transactions. Establishing a wholly foreign owned subsidiary, joint
venture, or representative office requires compliance with complex
contract approval requirements, business registration requirements,
taxation regulations and statutes, and labor regulations. Many foreign
banks, accountants, attorneys, and consultants have established
offices in China and are familiar with Chinese requirements. Some
Chinese professional service providers also have substantial experience
serving foreign clients.
Accountants
Chinese law requires representative offices and foreign invested
enterprises to engage the services of accountants registered in
China to prepare officials submission of annual financial statements
and other specified financial documents. Therefore, only Chinese
accountants and joint venture accounting firms may provide these
services. All the Big Five accounting firms (KPMG Peat Marwick,
Pricewaterhouse Coopers, Deloitte Touche Tohmatsu, Ernst & Young,
and Arthur Andersen) have established offices in China and provide
services ranging from providing advice on taxation matters and preparation
of investment feasibility studies, to setting up accounting systems
that are in compliance with Chinese law. Among accounting firm clients,
multinationals are shifting their focus from market entry strategies
to business operation efficiency. During the past six years, their
market share has grown from 2% to 30%.
Attorneys
During the past eight years, many U.S. and international law firms
have received approval to register in China as a foreign law firm.
Prior to l992, most foreign law firms were registered as consulting
firms. More than one hundred foreign law firms currently operate
in China, of which nearly thirty are based primarily in the United
States. Foreign law firms registered in China are restricted to
advising clients on legal matters pertaining to the jurisdiction
where they are licensed and general international business practices.
Although a foreign lawyer may not offer a legal opinion, clients
can obtain assistance with structuring transactions, drafting contracts,
and resolving disputes. Only attorneys licensed in China may appear
in court and provide legal advice on Chinese legal matters. Foreign
law firms are allowed to open only one office in China and are not
allowed to employ Chinese lawyers in that firm. Foreign lawyers
are not permitted to qualify to practice law in China and are not
allowed to form a joint venture with Chinese lawyers
Management Consultants
Foreign companies new to the Chinese market typically engage the
services of local consultants to develop market entry strategies,
conduct due diligence investigations, and identify potential investment
partners, sales agents and customers. More than 100,000 companies
are active in the Chinese consulting industry, of which 65% are
foreign firms that generate 85% of consulting industry revenue.
Licensed and unlicensed firms compete in the market, and the regulatory
environment for this services sector is unclear. Only four foreign
consulting firms have received a consulting firm license ¨C BCG,
Arthur Andersen, China Consulting Association, and the Lei-Da Group
of Hong Kong.
Advertising
Approximately 64,000 advertising firms exist in China, of which
500 are foreign invested enterprises. Foreign advertising firms
are limited to a 51% maximum equity stake. The major international
advertising firms have established a presence in China. Companies
new to market can gain valuable advice from top-notch advertising
firms on how to effectively craft an effective advertising strategy
that is responsive to Chinese consumer preferences and cultural
differences. Advertising is strictly regulated in China, and penalties
for violation of the law through misleading advertisements, unauthorized
use of national symbols, or other prohibited forms of advertising
are subject to fines of 100,000 RMB ($12,500).
Commercial Service
posts in China maintain lists of U.S. law, accounting, and consulting
firms with offices in China, as well as lists of Chinese firms that
the Commercial Office or its customers have had favorable dealings.
H. Due Diligence
Undertaking
a due diligence investigation prior to engaging in a trade or investment
transaction can minimize risk of encountering commercial disputes.
The primary causes of commercial disputes between Chinese and American
companies concern breach of contractual payment obligations, irregularities
in accounting practices, financial mismanagement, undisclosed debt,
and struggle for control within joint ventures. These problems can
be minimized by investigating the financial standing and reputation
of local companies before signing contracts with them. Both U.S.
and Chinese firms with offices in China conduct due diligence investigations;
the former include Dun & Bradstreet, Kroll Associates, and Pinkerton
Consulting Services. The fees charged by these companies may be
considered a useful investment to ensure that the local customer
or partner is financially sound and reliable. The U.S. Foreign Commercial
Service's International Company Profile (ICP) is not offered in
China at this time.
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