Foreign Entrepreneurs in China

This is the second post of the series entitled “A China Joint-Venture Survival Guide” based on Mike Smith´s experiences as his company’s representative in a Chinese joint venture. If you have not read our previous post with the first set of facts and tips you can read it here:
A China Joint-Venture Survival Guide (I).

A Joint Venture Survival Guide (II).(Tips 9-15)

“The Danger Zone”
9. Your Potential Partner is Well Connected … Maybe Good, Maybe Bad
Experience: It is quite common to be taken on the “big tour”, introduced to the city mayor, the bank’s president, and all sorts of top-end contacts. Your partner will put especial effort into making a great impression and showing you how easy doing business in China is going to be if you deal with him.
! Tip: Do not be dazzled by your partner’s connections …They will not necessarily be used for your benefit.
The fact that your partner is well connected is good (you obviously don’t want to end up with a nobody), but it is also a fact that at times those connections are only used for their own benefit.

10. Financial Reports: “I can’t live with or without you”
Financial reports: you need them, if only because when things go wrong you will be the first one fired if you did not order a financial report. But just be aware that reports can easily be falsified, and a lot of relevant information may be missing.
Experience: I will not get into too much detail but let’s say that I have even seen the falsifying process in action. Do not believe everything you read, and be aware that there will be facts/realities that are not reflected in those reports.
! Tip: There are things you will only get the feel for if you base yourself at your potential clients´ workplace. My recommendation would be to place your trusted person (who by the way should be China-knowledgeable and understand what he/she is looking for) at the company´s site . You need to see how the factory works, how many workers there are, their accounting, their stock control ….

11. Tax Planning: “Tax Breaks. Do not believe all you hear”.
While you are negotiating the joint venture you will be promised a lot of benefits. Tax breaks are a common tool to lure you into a location that needs to be developed. A lot of companies start operations in a location partly because they have been offered corporate income tax exemptions or reduced/zero import/export duties. It is also common to find that the day you to try to apply for them, you are told that the central government has changed the regulation and they can no longer grant you the benefits they promised.
Experience: We were promised tax exemptions on all those tools and parts required for our product manufacturing. It did not happen. Not even once.
! Tip: As mentioned in tip number 5 , it is essential to get the support of a good consultancy firm. Your investment should also make sense regardless of the tax exemptions or other promised benefits.

12. Let me guess: your Chinese partner wants to contribute the land to the joint venture.
Experience: The Chinese partner always wants to contribute his own properties to the joint venture. But, can he give you actual proof of the real land value? These are common situations to encounter:
- The real value of the land, does not correspond to what your partner is claiming.
- The audited value presented and paid by your Chinese partner has been (easily) falsified.
- All sorts of excuses to justify the absence of a purchase document stating the real value they paid: “Government does not give invoices. We got a good deal …” . Do not fall for them.
In our case, we got an independent valuation of the land. It was worth 30% less than what our partner claimed.
! Tip: Do not fall for excuses. A land purchase should be properly documented. Beware if is not.
Experience: We wanted to buy land for the JVC. Our Chinese partner finally presented what he deemed was the best possible location and the required size(we felt it was too big). The land value would be considered capital contribution by the partner. He presented an alleged Government document stating the land value. The document had no seal so we suspected something was wrong and requested an independent valuation. The land value estimation was 200,000 € cheaper than the value presented by our partner. Our company´s President trusted the partner so they decided to take his word on this (by that time MD was already suspicious about the partner). The land was purchased, the invoice was never seen. He showed us an ownership title and the land became his capital contribution. Later on I managed to located the real purchase documents and the deal had been sealed at a 400,000€ cheaper prize.

13. Does your land have a license to have a factory built on it?
You need to watch out for this one. Chinese companies often ignore this step. You may find sizeable companies operating (100 employees, tax bureau number, social security …) without the license to legally operate a factory/company on their land. That may not be a problem while you stay together (they will surely have their ways to ensure there are no problems). But in the event of a split you may face one of these two situations:
- You want to sell it but you can’t because there is no licence for the construction done.
- You want to operate it alone, but being a foreign company you will find the government inspection at your doorstep day one. And they will close it due to lack of permits.
! Tip: Make sure you know all the licenses the business needs to operate legally. If your partner claims to have the license for that land already, you need to see it. If licenses are pending have your expert/consultant involved in that matter.

14. Building the Factory- Oh Nightmare
This is another potential source of conflict. You will probably trust your partner to lead the factory construction works.
Experience: “…a workshop building would not progress and when I inquired I would get “We have run out of money”. Digging into the contracts details I would find a lot of irregularities like missing contracts, unsigned contracts …”
! Tip: “If your project involves building a factory, I would recommend to budget for 15% to 20% extra cost vs. agreed amounts. Timewise, I would build in an extra 40% as a buffer. Penalties should be included and quantified in your contract. And as mentioned before, always use the China or Hong Kong Arbitration Court”.

15. Check Company Operational Manuals.
Very often there is nothing written on how operations should function. When you land there and try to organise things you do not even know where to start. And what is worse, your Chinese partner is not interested in changing anything as he feels it has been working for him for years before you arrived.
! Tip: The trusted person I advise before to place in your prospective partner´s operation should check out the operational manuals and whether the company works in compliance with them. If there are no manuals in place, you should request them to record their existing processes so that you can discuss them and negotiate before the deal signature.

Coming soon the final post of this series: “A Joint Venture Survival Guide (III)”. More interesting and useful tips to help you navigate a joint venture negotiation.

 Would you like to share your experience with a Chinese joint venture?

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China Law Blog has published a post about foreign companies that try to buy out their Chinese suppliers. Dan Harris makes very enjoyable reading out of a very serious topic. You can read his post entitled here: “Buying A Chinese Company. Why China Deals Don´t Get Done”

This is what you will learn from his article:
Very common practises for Chinese companies are:
-to under report employee wages to the government
-to underpay taxes
-to pay the rent under the table.
Which may be easy to get away with as a Chinese company but not as a WFOE.

So, if you are considering buying out your Chinese supplier, life will be a bit different for you. As a WFOE, your company will probably be wanting to play by the rules (and you better do it because as a foreign company you will be closely scrutinised) and the profits your supplier was making will be imposible to replicate as you will:
-end up paying double the amount your supplier was paying in wages and benefits
-pay all your income taxes
-have to increase booked rental costs

This is the short version. Read the original post here to get really interesting details and some cost estimates.

I will only add that it is indeed widely known that these practises are common. Some of these issues I will also mention in the second part of “A China Joint Venture Survival Guide” that is coming soon (Check my first post on the topic here)

Do you have any stories about buying out a Chinese company?

Joint-Ventures (J-V) in China can go well, and can also go very wrong. When the latter is the case, problems come up from where you less expect them. “Mike Smith” (not his real name) spent two years in rural China supervising his employer’s interest in a Chinese joint venture where they were the majority partner (deal signed before he landed there). His case falls within the second category I’ve mentioned (I would in fact say that all that could go wrong went wrong) but that has given him invaluable lessons on how to ensure things are done right. He has also met on the way a number of joint-ventures facing quite similar challenges to the ones he experienced.

We met to talk about his time representing the foreign partner and I’ve drafted a series entitled “A Joint-Venture Survival Guide” composed of three posts based on his experiences, opinions, tips and comments .

A Joint-Venture Survival Guide (I).(First 8 Facts and 5 Tips)

Some introductory thoughts
1. China is a noble and good society… but when it comes to doing business, the value system changes. Ripping off a foreigner may be seen as a clever thing rather than a bad one.

2. Beijing, Shanghai and Guangzhou are in a universe of their own. Drive just 100 km away into central China and reality changes. It is a hardship environment and corruption is readily encountered.

3. You may have successfully set up joint-ventures and businesses in other countries. Do not assume China is going to be the same. You are lost without an expert if you are going to deal with a local partner.
“My company had successfully set up J-Vs across the world, and nowhere did they face the situations they faced here. They assumed they knew it all, and that was a big mistake”.

“The Essentials”
4. The foundations for your success will be laid before you sign the deal.
Preliminary work is essential, and I cannot stress this enough. Once you have signed you are helpless. And later on, once your million dollars are in China, you will not be able to get them out unless you exit the J-V. There is plenty of room for disaster so make sure you dig into every single hole to figure out where the problems may be.
! Tip: This is the time to get as much information as you need. You need to be able to access all books, information about operational manual, … You may hear the somewhat overused sentence “What is the problem? Don´t you trust me?”. Well it is not about trust, it is about business, and companies that have nothing to hide will share the information with you.

5.Confidentiality and know-how protection will be difficult in a small cities. All the legal issues about this will be judged in the city in which it happens, which means that if you have a company in Shanghai and someone “copies” your product in Ningxia, the legal procedure will be carried out in Ningxia so you will be dealing with all the difficulties of operating in a place that is not a business hub.
! Tip: We are a European SME. If that is also your case you canhave free brief advice from the European Chambers of Commerce. Also a free advice for intellectual property, copy right, etc in China IPR SME Helpdesk.

6. A GOOD consultant/advisor: Priceless.
You need real in-depth expertise to pull this one off successfully:
! Tip: “J-V conflict resolution and dissolution in China is really complicated compared to other countries. Consultant/Advisor companies have an instinct for knowing the real situation”

7.[On consultants] … But find the one suited to your size
“The reality on the ground for SMEs is quite different to that of MNCs. We don’t have their leverage and muscle power and we deal with different issues/situations. It is essential to get on board a very good consultant but I wouldn’t recommend one of the big ones. I think they are better suited for big companies.”
! Tip: MNCs are often interested in high tech, setting up R + D centres, the pharmaceutical industry, medical issues and they will find some decent protection from the Local Government. In the case of SMEs that do business outside big business hubs, protection will be very difficult to guarantee and there will be unimaginable issues unless they hire the right consultant/advisor. And believe me, consultant/advisor big names will not help you to find the back door of your J-V.

8. Sign the right “pre-nup”
You obviously don’t want your relationship to go wrong, but if things happen you need to have put in place the right “break-up” conditions.
! Tip: Always use the Chinese or Hong Kong Arbitration Court. Most companies feel more comfortable with international arbitration, but what do you do when your Chinese partner doesn’t show up or doesn’t comply with the resolution? It needs to be done in China or Hong Kong where the resolution will be mandatory and enforceable.

Coming soon “A Joint-Venture Survival Guide (II)” with more interesting and useful tips to help you navigate a J-V negotiation.

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Christmas is here so in case anybody is looking for books to add to the Christmas wish list, these are a couple of recommendations (both of them really good China business books):

“China Entrepreneur. Voices of Experience from 40 International Business Pioneers” by Juan Antonio Fernandez and Laurie Underwood
Insights and anecdotes based on in-depth interviews to successful expatriate entrepreneurs.

“Business Leadership in China. How to Blend Best Western Practices with Chinese Wisdom” by Frank T. Gallo
Based on interviews and the author´s own China experience, brings a lot of insights on Chinese managerial styles and presents advice on how to blend best western management practices with Chinese wisdom.

FOREIGN ENTREPRENEURS IN CHINA
wishes you Merry Christmas and a Happy 2012
from Shanghai!

Olivia’s Place is a paediatric therapy clinic in Shanghai that offers occupational, physical, and speech therapy as well as educational psychology and learning support services.

Olivia’s Place has also set up a charitable foundation in order to provide access to therapy for families in need of such services.

I have unfortunately needed their paediatric therapy services but was extremely fortunate to find them. And as the three founders, Quynh Chow, Nelson Chow, and Maggie Tai Tucker are foreign entrepreneurs (from the U.S.) in Shanghai, I could not help but devote an article to them. Today I will share with you a bit of their experience, the lessons they’ve learned, some tips for those wanting to follow their example, and a way to contact them in case you wish to help.

The Market Need: A Paediatric Therapy Clinic Where a Multidisciplinary Team Can Work Together to Better Fulfil Their Little Clients’ Needs

Quynh and Nelson Chow had suffered the lack of quality service in their own lives. Their elder daughter, Olivia, has Down Syndrome, so they had to go through the nightmare of running from one clinic to another in order to give her all the therapy she needed. They felt and knew that that was not the type of support they wanted for her, and they decided that, if not available in town, they would make it happen themselves.

That’s how Olivia´s Place started to take shape. They knew what they wanted:

• A Centre where all paediatric therapies are available
• The best therapists
• Standardised assessment tools and protocols
• A multidisciplinary team in-house
• Clean and healthy environment
• Optimised treatment rooms

This may all sound like basics to those of you who know about this topic and can enjoy it back home, but if you live in China and have ever been in need for this type of service, you may have found yourself spending a lot of money on suboptimal services. Moving from one provider to another, as clinics who provide one service don’t provide others, or in less than optimal settings (like a hospital room where nobody cleans the floor your child is crawling on between therapy sessions) and without access to a real assessment (a lot of professionals can do treatment but are not able to do assessment – so will treat your child without first working out what really needs to be done). There is a lot of room for improvement.

8 Business Challenges & Decisions They Faced (or are Facing)

1. Deciding Upon the Right Legal Entity

Olivia’s Place’s founders initially desired to register under a medical clinic and educational license. That would have allowed them to expand their services into other activities like a kindergarten … But they soon discover the number of hassles that would entitle:

- A huge capital requirement

- Receiving regular visits by local authorities (e.g. the Ministry of Health, Ministry of Education).

They ended up registering under health consulting, which has a wide coverage, is health related and perfectly covers the type of activity that currently takes place in their clinic.

2. Local vs. Foreign Company

A lot of foreign entrepreneurs go through this decision process. And you often get warning signs about the dangers of fully relying on your local partner (e.g., if things go wrong, you may find yourself at a disadvantage when you claim your rights).

Olivia’s Place’s is registered as a local business. The registered owner of Olivia’s Place does not get involved in the day-to-day management of the clinic. He leaves that up to the founders to do. He is someone who the founders truly trust. This has allowed the clinic to be set up with a lower capital requirement.

And as they simply put it: “we are not in this for the money”. They want this for their daughter and for other families in the same situation. Quynh has been volunteering for no salary while the clinic reaches financial stability, and Nelson has another job, which actually brought them to Shanghai.

3. Recruiting the Right Staff

Olivia’s therapists hail from all over the world. They have expertise and experience from the United States, Great Britain, Chile, Germany, and Taiwan, just to name a few. Some have dual degrees in education as well as in therapy.

Quynh Chow tells me “It is not easy to recruit the type of highly committed professionals we are looking for. Still we feel fortunate because we have been able to attract people who realise we are giving back a lot to the community. They see it and help us.”

4. Bringing the Clinic to Full Utilisation

Parents are quite reluctant to bring their children during school hours. That means that the clinic is fully booked from about 2:30 – 3:00 p.m. onwards, and on Saturdays, but goes quiet the remaining time.

There is also a seasonal factor. Clients simply leave the country for weeks during the summer holiday.

5. Reconciling the Desire for Affordable High Quality Therapy with the High Costs Involved

Olivia’s Place has always aspired to provide “the highest quality services at affordable prices and to be able to subsidise families in need, too”.

This aspiration caused them initially to have “too optimistic business projections”. Quynh tells me “Our budget did not account for the long summer months when none to low activity would hit us. Plus, staff are highly qualified and a scarce resource in town [hence expensive]. Equipment is pricey too. We initially mispriced our services and dragged along the situation for months till we finally decided to increase fees so that we could ensure survival. Our fees are still lower than other providers but the type of service we provide is nonetheless cheap”.

6. Building a Reputation

“It takes time to get a reputation. In our initial days, we struggled to arrange meetings to introduce ourselves and our project. Some schools would not even meet us to talk about our services. Thanks to our work since we opened the clinic, this situation has changed now. We are already collaborating with schools and sending our therapist to their campuses to provide therapy, either in the classroom or as pull-out sessions. Most of the therapy sessions involve table-task activities and do not need large spaces or specialized equipment. For those children who do need our equipment, we asked the parents to bring them into the clinic as the therapy would then be most effective.”

And in order to continue building a solid reputation, they have also brought on board a person responsible for the marketing side of the business.

7. Having the Right Location for a Scattered Clientele

“No matter where you place your clinic, you always hear parents “complaining” about how far we are”. Shanghai is a huge city, and expats, whom at this stage represent eighyty percent of the clients, are spread all over the city. The clinic is located in the middle of town.

8. Getting the Right Equipment in China

Olivia’s Place prides itself on having the highest quality standards. This applies not just to their recruitment standards but also to the equipment utilised in the clinic. This proved to be also a bit of a challenge because, although labelled as “Made in China”, a lot of the equipment needs to be imported as it is not sold here. Olivia’s Places currently imports most of the equipment from the United States.

9. Setting Up a Foundation… and Making the Donations Happen

Quynh and Nelson set up a foundation, donating US$10,000 themselves, in order to expand the clinic services to families in need that could not afford them. The foundation has ensured that eight families get access to Olivia’s Place services, either through free assessments or at low fees. A reviewing committee comprising of three doctors reviews the cases and decides who gets the funding based on a series of criteria like who is going to benefit more from the therapy. Now they have seventeen families on the list awaiting consideration and could do with more funding.

This post is especially dear to me, as I really admire the efforts (personal and financial) Quynh and Nelson are doing to offer a much needed community service and to help those who can’t afford it.

If you want to know more about them, you can visit their website:
www.oliviasplace.org

And if you wish to support them, please email contact@oliviasplace.org. Someone will respond to your inquiry within 48 hours.

Share this article with people who may find it useful/interesting!:

This is the third post in collaboration with Angela López Molina, corporate lawyer at DS AVOCATS in Shanghai. You may read our previous posts on Retail in China in the following links:
- Retail in China (I): Choosing your Business Model (Distributor/ Agent/ Franchise)

- Retail in China (II): Choosing your Business Model (Corner/ Shop / Internet)

Retail in China (III): 10 Expert Tips to Help a Successful Set Up

Before we start operating retail activities in China, there are a few things we should know as they may affect our business success.

1. Register brands /patents as soon as you decide to enter the market
Chinese distributors often “believe” they have the right to register the brands they are marketing. This is the reason why we recommend brand or patent registration as soon as a company starts considering doing business in China, and definitely before they start contacting potential distributors. Although it is a lengthy process (at times it may take up to 2 years) the application grants priority to the first applicant. Intellectual and industrial property protection may not be easy in China, but enforcement has been improving lately.

2.- Choose carefully your brand’s Chinese name… and register it
The brand’s Chinese name should not just be a phonetic rendition of the original brand, it should also be adequate to the image we want our products to communicate. Some distributors may refuse to market our products unless they have a suitable Chinese name.

3.- Become familiar with Chinese negotiation tactics
Chinese negotiation style is quite different from the Western style to which we are so used. When negotiating a contract in China, you will often encounter situations like this (just to mention a few):
* your Chinese partner tries to re-negotiate points that have already been agreed upon

* you see yourself interacting with a number of negotiators and you are not too clear who is the real decision-maker

* a company representative is flying into China to sign an agreement and the Chinese party waits until the last day to raise important issues, so as to get them solved to their advantage (they are the masters of the “time factor”).

All this can easily generate frustration and uneasiness, but understanding the Chinese negotiation tactics will help you be better prepared.  We can’t give a “negotiation course” in two lines, but we can advise the following:
3.1) Expect long negotiations (and renegotiations) – so make allowance for delays in your timelines.
3.2) Try to keep your cool.
3.3) Try to assess who is the decision maker.
3.4) Evaluate how much information you need to release (Information is Power: the other party should not be clear about your constraints or when you are reaching your final deadline …)
3.5) Brief your organisation back home about “the Chinese way” so that they are ready in case any contingencies arise.

4.- Get adequate / sufficient information about your potential distributor or partner
Get a financial report about your potential partner, so that you can verify who they really are, what are all their business lines, whether they can become competition to your business, if they have the required business licences, what their experience is … And it is always advisable to visit their offices, warehouses and/or factories (do not rely on a website, which may contain false information).

5.- Don’t rely 100% on the Chinese partner to follow all the administrative processes/steps
Often companies delegate all the administrative, legal or tax procedures to the Chinese partner. It is important not to blindly trust that all procedures and licences are in place, to avoid later surprises like product being stopped at customs, fines, tax issues, etc. …

6.- Ensure your potential partner’s alignment with your business mission
Companies need to ensure the Chinese partner or distributor understands and shares your business vision and objectives, so that all efforts are focused on achievement rather than re-discussing everything all over again.

7.- Customize your product to local demand
Before we hit the market, we should research consumer reaction to our products. A lot of international brands have adapted their products to better suit the Chinese consumer and guarantee success (e.g. MacDonalds has customised menus for its franchises around the world).

8.- Set the right price point &be conservative about it
The Chinese consumer is very price sensitive and will not pay a premium price unless there is a clear selling point / advantage (quality, brand image …). We tend to recommend avoiding very premium price points in initial stages (unless very clearly justified), to devise loyalty programs (discount cards, VIP promotions …) and to invest in marketing.

9.- Watch out for the internet response
China has the highest number of cybernauts in the world, and they are also extremely engaged in forums, blogs and other internet social networks. This also includes those forums where products and brands go under scrutiny / review. Companies should ensure that the internet is part of their marketing strategy, as a mistake in their brand positioning may affect their reputation / business.

10.- Include location as a factor in your overall China strategy
Another decision that companies need to make is where to locate their retail businesses: tier 1 cities like Shanghai, Beijing or Guangzhou, or tier 2 and 3 cities. Companies like Nike or Adidas started marketing their products in Shanghai and Beijing and have now progressed into tier 2 cities. Other brands have followed the opposite strategy, for example the Chinese brand “Peak” started by capturing the smallest municipalities and has been adding market share through medium range products.

Another example would be the Chinese brand Eno. They follow different strategies in tier 1 and 2 cities. Their objective in tier 1 cities is to improve / build brand image, while they make money in tier 2 cities where costs are lower. Quoting Eno’s founder, Renee Hartman, “look pretty in tier 1 cities, make money in tiers 2 and 3”. Their products, designed for a young urban consumer, have succeeded in that market segment and the company was selected “most innovative”company in China” by Fast Company Magazine.

Would you like to add your tips?

If you are considering to set up a Wholly Foreign Owned Entity (WFOE) in China, the China Law Blog has just published a very good post that takes you through the basic steps that you will need to follow to form this type of entity.

I think this is a good post to recommend because a lot of foreign entrepreneurs choose to form a WFOE to stablish their presence in China. WFOEs allow you to keep full control and ownership of the operation and it also makes IP protection easier -hence it has become the preferred vehicle to enter this market.

Bellow you can read a recap of the China Law Blog recommendations and steps (you can read the complete post here, and if you still don´t subscribe to their blog I highly recommend you to do it):

1. Make sure your business is legal for foreigners.

2. Provide the required documentation: proof of the company being a duly formed and validly existing corporation or Limited Liability company in its home country.

3. Investor Documents Needed:

a) articles of incorporation or equivalent

b) business license, both national and local

c) certificate of status or a notarized copy of the Corporate Register for the investor or similar document

d) bank letter attesting to the account status of the investor company

e) description of the investor’s business activities (in Chinese)

4. Consider forming a Special Purpose Company to own the WFOE. It is common to form a Hong Kong company for this purpose and there are often tax benefits.

5. Secure Chinese Government approval.(and they remind you that in China, approval of the project by the relevant government authority is an integral part of the company registration process and you risk not being able to register if the project is not approved) . 

6. Documents to be submitted in order to achieve Chinese Government approval:

a) articles of association (which will determine issues like stablishing directors, local management, local address, special rules on scope of authority of local managers, company address, and registered capital)…
Note from Foreign Entrepreneurs in China: you need to devote special care to this part. The articles of association are one of the most important set of documents you will be preparing. The articles of association include articles like “business scope” which needs to truly reflect any type fo activity you are planning, as you will not be able to operate out of its limits.

b) feasibility study (in Chinese).

c) a lease. ( an agreement for all required leases must be provided)

7. Other documents that you will be requested: proposed personnel salary and benefit budget. And any other documentation required for the specific business proposed.

8. Approval process: 2-5 months for governmental approval, depending on the location of the project and its size and scope.

And just to finalize this post I will remind you what most entrepreneurs tell me in their interviews: “Get good advisors”. The people who help you navigate the set up of your company in China can make a huge difference.

More recommended reading: Take a look to our post entitled “Setting Up a Representative Office in China: 10 Steps and some Practical Tips”. Although it was produced with R.O.s in mind, it still provides very good tips that apply to other type of entities.

This week I´ve read an article at McKinsey Quarterly entitled “China´s confident consumers” written by Yuval Atsmon and Max Magni, principals at McKinsey Shanghai and Honk Kong respectlively. Their article is based on McKinsey´s report 2011 Annual Chinese Consumer Study. It focuses on three findings in the report:

1. Chinese consumer´s confidence rises. Chinese consumer´s confidence in their financial future rises compared to 2010 (58% expected their incomes to rise next year vs. 39% in 2010)

2. Chinese consumer…not that loyal. Although they place high value in brands as they guarantee quality, safety and reliability, that does not seem to translate into loyalty. The number of brands in their “repertoire” keeps rising.

3. Growth drivers: first-time buyers lose importance. First time buyers used to be the main growth driver ten years ago. Currently it is not the case for mature categories and developed areas but it is still an important driver for less mature categories, big ticket items or less developed geographical areas.

Read their full article here.

This is the second post about Retail in China in collaboration with Angela López Molina, corporate lawyer at DS AVOCATS in Shanghai. If you have not read our previous article entitled “Retail in China (I): Choosing your Business Model (Distributor/ Agent/ Franchise)” you can read it here.

This new post  will lay down some facts and tips to help you assess what business structure works best for you in China, completing our previous post with information about corners, shops and internet retail.

3. CORNER
This is an individually tailored mini-shop whereby the company rents a small space in a mall. The rent has often a fixed element (based on the number of sq. m. occupied) and a variable part (that is a percentage of the sales made).

a)Laws and Regulations
- You don’t need to establish a company in China to start your business through a corner – you may do it through a local agent.
- Your agent needs to have the so-called “Tax Payer General Status”  (1).
- The term of these contracts is usually from 6 months to 1 year.
- Renewal is subject to sales targets being met.

b) Advantages
It is a small investment; it allows making the products known, understanding the potential client profile and checking consumers’ reaction.

c) Tips
-Tip #1 You should be aware that many malls impose restrictive conditions in terms of the brand (e.g.it must be a reputable international brand).
-Tip #2 The tenant must ensure a minimum profit in the first months.
-Tip #3. Often the contract (which is usually short term) may be terminated unilaterally by the landlord.

4. SHOP LEASE
This could probably be, from a financial perspective, your riskier option. The main advantage, though, is the full control you have on your operation.

a) Laws & Regulations
- Shop equals Branch: So, for every shop that you open, you need to register a branch  (it takes 1-2 months if branches are on the same city and 3 months when it is in a new city)
- Contract Length: 3-5 years

b) Advantages
- Not subject to specific sales targets being achieved. You pay a rent and a deposit

c) Tips on how to negotiate a shop lease
-Tip #1 Understand who is renting the space to you (i.e. the owner or a lessee) – you might be renting the space from a person who is not actually the landlord (but, for example, a tenant who is trying to sub-lease the premises). In such case, if the tenant does not manage to renew the contract with the landlord, you may be forced to leave the shop, after having invested in decoration, marketing, etc. You should therefore always ask the supposed landlord for his/her certificate of ownership of the premises.
-Tip #2. Understand what is the legal use of such premises (e.g. residential, commercial, etc.). In the certificate of ownership, you will be able to check what is the use of such premises. Please note that if the premises do not have a commercial use and, for example, they have a residential use instead, you are not supposed to locate a shop in such place- the authorities would deny the registration of this shop as a branch or as the registered office of a company. Furthermore, if you have an inspection, you will be exposed to sanctions.
-Tip #3. Try to negotiate renewal conditions in the initial lease contract (e.g. a maximum percentage rise per year) so that you don’t see a big hike in rental cost when the renewal time arrives
- Tip #4.If your shop will be in a mall that is currently under construction, we advise you to sign a letter of intention first and to negotiate the lease once the mall has the required licene.

5. INTERNET SALES
a) Recent history
Joint Ventures and WFOEs have been allowed (theoretically) to engage in retail activity through the internet since 2004. The reality has been quite different though. Central MOFCOM had to approve these activities and approvals have either been put on hold or suspended.

Foreign companies used to navigate this difficulty in two ways:
- Avoiding setting up in China: but there are a number of hassles (logistics, currency exchange …)
- Partnering with a local broker

b) Update on Law & Regulations
This type of retail activity has now seen some encouraging signs. MOFCOM issued on 19 August 2010 the ”Circular on Several Issues Concerning the Approval and Administration of Foreign Investment in Sales via the Internet and Automatic Vending Machines”. The main changes that this circular represents are:

1. For established FIEs:
Internet sales are regarded as an extension of an FIE’s regular sales activities and can be conducted without any need to obtain additional approvals.
2. For Companies trading only through the internet:
Applications for the establishment of an FIE specialising in Internet sales are to be submitted for approval to the appropriate provincial-level agency under MOFCOM instead of central MOFCOM, which has two positive implications:
i) speeds up the approval process, and
ii) promotes competition among  regional administrations to capture foreign investment.
3. Some requirements on-line businesses should meet:
i) Display its business license in a prominent position on its website home page or on the website where it conducts sales activities.
ii) Establish a comprehensive system for the return or replacement of goods.
iii) Strictly protect consumers’ personal privacy.
iv) Abide by China’s consumer laws and regulations.

Would you like to share your retail experiences?

(1) Small scale taxpayer – ordinary taxpayer

When can a company apply for qualification of VAT ordinary taxpayer?
A trading company (wholesale or retail) after its setting-up, having achieved an annual turnover of no less than RMB 800,000.

According to a circular promulgated by the State Administration of Taxation, effective as of 20 March 2010, a trading company having not obtained an annual turnover of 800 000RMB may also apply for the qualification of ordinary taxpayer if it cumulatively satisfies the two following conditions:
a) It has a fixed place of operation.
b) It can establish accounting books in accordance with the Chinese regulations on accounting, and possesses legal and valid accounting vouchers, and can present exact accounting tax documents.

Update: This series has now been completed. All the links shown bellow.

* Retail in China(I): Choosing your Business Model (Distributor, Agent, Franchise)
* Retail in China (II): Choosing your Business Model (Corner, Shop Lease, Internet)
* Retail in China (III): 10 Expert Tips to Help a Succesful Set Up

Has the Chinese retail boom lured you to consider this market for your products? You are not alone. The rapid growth of the Chinese middle class is increasing this market’s attractiveness. AmCham 2010-2011 China Business Report shows Retail performs highest in all indicators analyzed in their survey (Success, Confidence, Welcoming).

I had been wanting to write a series about retailing in China so when I met Angela López Molina, corporate lawyer at DS AVOCATS in Shanghai, I thought she would be the right expert to contribute to a series of articles on the topic.

We will divide this topic into the following 3 posts:
Retail in China (I): Choosing your Business Model (Distributor/ Agent/ Franchise)
Retail in China (II): Choosing your Business Model (Corner/ Shop / Internet)
Retail in China (III): 10 Expert Tips to Help a Successful Set Up

(*Update: this series has now been completed. Links provided at the end of this article)

And today we will kick off with “Retail in China (I): Choosing your Business Model” 

1. DISTRIBUTORS & AGENTS:
Selling your products through distributors or agents is the “easiest” way to penetrate the Chinese market. It does not require a high investment and it allows assessment of the Chinese consumer’s reaction to your product.
It is not free of risks, though, as you may find yourself in the middle of a chaotic distribution network that is difficult to control.

a) Distributor vs Agent: Different Roles/Responsibilities
- Distributors buy and sell the products; their profit is the difference.
- Agents act in the name and on behalf of the foreign investor; they receive commissions on sales.
- Degree of trust: The agent generally enjoys a higher degree of independence and is able to change certain conditions without the explicit consent of the principal.

b) Tips on how to deal with agents/distributors in China
- Tip #1. Licences: Ensure your distributor/agent has the required licences to retail your products.
- Tip #2.  Exclusivity: Try to reduce the exclusivity territory (you may attach a map to the contract). Generally, exclusivity for all China is a bad idea.
- Tip #3. Establish sales targets and regulate your rights in case they are not met (e.g. termination or end of exclusivity).
- Tip #4. Commissions: describe clearly the calculation basis for commissions in the agency agreement.
- Tip #5.  IP Rights: Define the use of IP rights, promotion and publicity materials. Do not grant property on IP rights; grant instead a licence of use.
- Tip #6.  Termination: Reasons for termination are a key issue in distribution/agency contracts. Do not forget to regulate the consequences of such termination (e.g establish sale of stock to third parties / to the foreign investor, destroy / return the promotion materials, etc.).
- Tip #7. It is quite common for entrepreneurs and SMEs to initially “test the waters” with a distributor or an agent, and once they understand the market better and how their product works, they take it to the next level.

2. FRANCHISE:
a) Franchisors: Laws & Regulations
Under applicable laws and regulations, there are certain conditions imposed on franchisors in China:
- Legal form: Having a commercial company in China (JV or WFOE) or abroad. Individuals cannot establish a franchise in China.
- Previous experience: Having at least 2 own shops operated directly by the franchisor (in China or abroad), for  more than one year.
- Business model: Having a business model and the ability to render assistance and give instructions to the franchisee, as well as technical support, training and other services.
- IP rights: Having a trademark, patent or know-how (suggestion: register your IP in China).
- Registration of confidential business information: For every signed contract, franchisors must register with the competent authorities highly detailed (and usually confidential) information, such as: original franchise contract, marketing plan, franchisee manual, etc.

b) Franchisees: Some things you should know about their rights
Your Chinese franchisee has some rights that you should be well aware of:
- Your franchisee has the right to unilaterally terminate the contract without paying an indemnity if:
1) the franchisee claims that the information supplied is incomplete or untrue.
2) after a “reflection period” the franchisee decides to back out.

c) Tips on how to deal with your potential franchisee
- Tip #1. Make the franchisee sign a receipt acknowledging that the information received is complete.
- Tip #2. Clearly define in the contract how long this “reflection period” will last and try to make it as short as possible (i.e. within 1 day from the execution of the franchise contract).
- Tip #3. Enter a non-disclosure agreement (“NDA”), as you will be sharing all your business information.

d) China Franchise: Main issues
- Lack of payment by the franchisee is common; there is not a real franchise culture in China.
- Lack of confidentiality.
- Difficulty in controlling brand image.
- Legal uncertainty due to:
a) franchisee’s right to unilaterally terminate the contract.
b) reclassification risk: if, in order to avoid the disadvantages, the franchisor has established a distribution network that works as a franchise in practice, authorities may reclassify the legal relationship and impose a penalty (RMB10,000 to RMB500,000).

e) Recommendation
- If possible, enter the market initially managing your own stores, so that you can fully understand the market before you start granting franchises.

f) Conclusion
For obvious reasons, the franchise regime is very restrictive for franchisors and inevitably favours franchisees. As a result, some companies establish a distribution network that works de facto as a franchise. As we have pointed out, there is a risk of reclassification into franchise and the consequent sanction. In addition, in the new draft of the Catalogue for Foreign Investment (which regulates which are the encouraged, permitted, restricted and prohibited activities to be carried out by foreigners in China), the franchising business is now encouraged, which make us think that in the future the regime will be less restrictive and more favourable for foreign investors.

Would you like to share your retail experience?

Update: This series has now been completed. All the links shown bellow.

* Retail in China(I): Choosing your Business Model (Distributor, Agent, Franchise)
* Retail in China (II): Choosing your Business Model (Corner, Shop Lease, Internet)
* Retail in China (III): 10 Expert Tips to Help a Succesful Set Up