china business environment oct 2009

Copyright @ 2009 The JLJ Group. All rights reserved.

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

China’s Business Environment

October 22, 2009


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• China at a Glance

• The Chinese Consumer

• The Tier-2 Cities

• Development Zones

• Modes of Entry in China

AGENDA


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China at a Glance

Slightly Smaller Than Europe; Almost Twice the Population

1) GDP - Gross Domestic Product based on current exchange rate, does not take into account purchasing power parity.

~3,100 miles

~2,170 miles

Category Description

Area9.56Mil sq. KM ( Europe: 10.18Mil sq. KM; 28x the size of Finland.)

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

GDP1 (’08) US$ $4.2 Trillion (Europe

GDP / capita US$ (’08) $3,134

Administration

• 656 cities, 48,000 districts

• 22 Provinces (not including Taiwan)

• 2 Special Administrative Regions – Hong Kong, Macau

• 5 Autonomous Regions –Guangxi, Inner Mongolia, Ningxia, Tibet, Xinjiang

• 4 Municipalities – Beijing Chongqing, Shanghai, Tianjin

Language Mandarin Chinese +7 major dialects and 80+ minority languages


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China is Similar to Europe More Than the US…

…with a non-homogeneous market and significant segmentation

• Relatively homogeneous market

• Relatively similar cultural background

• Common language

• Common Law

• Highly segmented market

• Multiple countries and cultures

• Multiple languages

• Predominately Civil Law

• Segmented market

• Regional cultural differences

• Multiple language dialects

• Civil Law


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China by the Numbers

Per Capita GDP Significantly Lower than Developed Countries

14.3

4.84.2 3.8

2.9 2.82.4 1.7 1.6 1.2

0

2

4

6

8

10

12

14

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Real GDP of Top 10 Countries (2008)[US$ Tril]

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


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

China by the Numbers II

Source: JLJ analysis based on multiple sources including the National Bureau of Statistics

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

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

4.2 Tril


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China by the Numbers III

0102030405060708090

100

China Utilized FDI: 1985-2008[US$ B]

92.4 Bil

China is the Second Largest Recipient of FDI

* FDI - Foreign Direct InvestmentSource: National Bureau of Statistics


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The Income Gap

Source: National Bureau of Statics of China

Most FDI and growth concentrated along coastal areasTwo thirds of Tier-2 cities are in coastal area

Legend - Annual Income (US$)

BEIJING

SHANGHAI

BohaiBay Area

Pearl River Delta

Yangtze River Delta

GDP per Capita in 2008


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DOING BUSINESS IN CHINA Overview

• Opportunities in China do exist - country has been opening up, growth rates are impressive, population is getting wealthier, FDI has been pouring in…

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

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

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

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

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

Proper Preparation and Planning are Key


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AGENDA


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The China Consumer

258 283 310 352

680 764 873 1020

0

300

600

900

1,200

1,500

2004 2005 2006 2007

Growth of Consumer Spending, 2004-2007Urban consumption

Rural consumption CAGR*= 14%[US$ B]

Consumer Growth is Being Driven by the Urban Population

*CAGR = Compound Annual Growth RateNote: Exchange Rate: US$ 1 = RMB 6.8; Figures will be updated after

consumer spending statistics of 2008 are published in October 2009Source: JLJ analysis based on figures from National Bureau of Statistics of China


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The China Consumer II

33%

16%11%

11%

8%

8%5% 5% 3%

Consumer Spending by Goods,2007

FoodHousingTransport & communicationEducation & entertainmentClothing & footwearMedicine & healthcareHousehold durable goodsFinancial servicesOther

Almost Half of Consumer Spending is Still on Basic Necessities

*CAGR = Compound Annual Growth RateNote: Exchange Rate: US$ 1 = RMB 6.8; Figures will be updated after

consumer spending statistics of 2008 are published in October 2009Source: JLJ analysis based on figures from National Bureau of Statistics of China


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The China Consumer IIILocalization - The KFC Model

Localization Even More Important in Tier-2 Cities, Which are not as Cosmopolitan

Egg Tarts

Youtiao

KFC – China Menu

Congee


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AGENDA


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Tier-1 vs. Tier-2 Cities

Tier 2 Cities May Offer Greater New Entry and Growth Opportunities

Tier-1 Cities

Tier-2 Cities

• Most expensive cities in China

• Highly saturated markets

• More sophisticated consumers

• Usually lower overall operating costs

• More fragmented and nonexistent markets

• Burgeoning middle class


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Tier 2 Cities15 Tier-2 Cities with ~10% of Total Population…

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

Macro-Economic

Criteria

Tier 1 cities

(3 cities)

Tier 2 cities

(15 cities)

China Total

Population 46 M 133 M 1,328 M

GDP (’08) (US$) 473 B 893 B 4,200B

FDI (’08) (US$)

20 B 57 B 92 B

Source: National Bureau of Statistics (2008); JLJ analysisExchange rate : US $ 1 =RMB 6.83


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Tier-2 Cities IIThe Approach

Often no obvious answers, doing “homework” is needed!!!

Business-to-ConsumerBusiness to Business

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

Business to Consumer

• Each city is a different market, offering different opportunities and barriers

• Many factors to consider: disposable income, openess to foreign concepts, existing competition, local taste & preferences, etc.

• Company-specific research & analysis necessary to develop Tier 2 strategy


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Tier-2 Cities IIIThe Costs of Doing Business

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

0.53 0.57 0.58 0.65 0.67 0.68 0.69 0.71 0.72 0.72 0.74 0.74 0.74 0.75 0.77 0.77 0.78 0.78 0.79 0.80 0.81 0.87 0.92 0.93 1.00

0.000.200.400.600.801.001.20

Labor Costs (2008) - Shanghai as Baseline

0.36 0.43 0.43 0.44 0.44 0.45 0.46 0.49 0.49 0.51 0.51 0.52 0.53 0.53 0.53 0.56 0.58 0.61 0.61 0.62 0.69 0.750.84 0.88

1.00

0.000.200.400.600.801.001.20

Energy Costs (2008) - Shanghai as Baseline


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AGENDA


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Development ZonesHistory

• Implemented by the government to encourage foreign investment in specific industries and to provide incentives to promote investment in underdeveloped areas

• First Zone was established in 1980s; there are approximately 6,000 zones in China

3 of the Major Zones:

• Economic and Technological Development Zone (EDZ)

• High-Tech Industrial Development Zone (HTDZ)

• Free Trade Zone (FTZ)

Other Zones Include: Logistic Parks, Costal Open Economic Zones, Tourist and Holiday Resorts, Taiwanese Investment Zones, Export Processing Zones, Special Economic Zones, Border Open Cities…


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Development Zones IIEconomic and Technological Development Zones (EDZ)

• 54 EDZ’s throughout China predominately in urban areas

• Primarily for Foreign Manufacturing enterprises

• Tax Incentives normally include reduction of EIT rate to 15% for encouraged statuses


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Development Zones IIIFree Trade Zones (FTZ)

• 12 FTZ’s located in China• Established to improve

Import/Export and International Trade

• Intended for assembly / processing of imported goods and export purposes

• Streamlined customs clearance procedures

• Various preferential tax treatments depending upon the FTZ


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AGENDA


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Modes of EntryOverview

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

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

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

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

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


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NATURE OF THE INVESTMENTForeign Investment Catalog

Status of industry/activity

Description Examples

Encouraged • Special incentives possible• Usually high-tech or agriculture industries

• Manufacture of high-performance welding robots

• Operation of nurseries

Permitted

• All activities not mentioned in catalog are permitted

• But may be difficult to get approval for uncommon activities

• All sectors not mentioned in catalog

Restricted• Special approval required – usually JV

partner necessary• Usually are protected sectors

• Production of cigarettes• Operation of oil refineries• Media production

Prohibited• Activities are disallowed• Harms national interests or

environmentally damaging

• Arms manufacturing• Operation of gaming industry

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


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FOREIGN INVESTMENT CATALOGLegal Set up Options

Setup Options DescriptionInvestment Restrictions

Encouraged Permitted Restricted Prohibited

Representative Office (RO)• Liaison office for parent

company

Foreign Invested Enterprises (FIE’s)

Wholly Foreign Owned Enterprise (WFOE)• Service WFOEs• FICE• Manufacturing WFOE•Trading WFOE

• 100% invested and owned by foreign entities

Equity Joint Venture (EJV)• Capital investment from

both foreign and Chinese entities

Cooperative Joint Venture (CJV)

• Partnership between foreign and Chinese entities

Allowed business scope depends on specific sector and type of entity


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Nature of Business

Import/Export Rights

Domestic Distribution

Capital Requirements

Registration Complexity

Service Activities

Rep. Office

Manufacturing WFOE

FICE

Service WFOE

WFOE’s provide greater flexibility for future operations


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Entity Options Analysis Sourcing

Rep. Office

Service WFOE

FICE

Conduct negotiations, QC for Parent company .

Provide sourcing consulting services exclusively to Parent Company

Source from within China then sell to Customer direct

• Allows more sophisticated means of tax optimization

• Heavy reliance upon 3rd party agents to facilitate trade

• May cause additional tax exposure if effective management is within China

• Not scalable

• Simplifies tax exposure (~8.8% on expenditures), registration complexity, & initial investment

• Heavy reliance upon 3rd party agents to facilitate trade


• Not scalable

• Allows for the flexibility to bring more of the supply chain in-house

• Platform for future domestic distribution• More sophisticated tax optimization • Allows more flexibility for future expansion of

business scope and scalability• Greater administrative costs/overhead• May cause tax complications if used as a

captive business model

Legal Gray Illegal

Legal Gray Illegal

Legal Gray Illegal


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Entity Options Analysis Services

Rep. Office

Service WFOE

Conduct services through local office while all invoicing is conducted offshore.

Provide services and invoicing directly to local & International clients

• Allows more sophisticated means of tax optimization

• Direct hire of local employees• Substantial presence within China with ability

to issue Fapiao• Option to establish branch office to expand

presence• May require higher upfront costs and greater

overhead • May cause tax complications if used as a

captive business model

• Simplifies tax exposure (~8.8% on expenditures), registration complexity, & initial investment

• Not a substantial presence in the market; may deter potential clients


• Must setup a separate RO to expand presence

Legal Gray Illegal

Legal Gray Illegal


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Capital RequirementsInjection Methods

Total Investment

Less than 3 million

Registered Capital

No less than 70% of total investment, with a minimum of 3,700

Between 3 and 10 million

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

Between 10 and 30 million

No less than 50% of total investment with a minimum of 2.1 million if total investment is below 4.2 million

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

• Complete injection within 6 months

-or-• Capital contributed in

installments: 20% within first 3 months with the remaining injected within 2 years

Currency: US Dollars


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Capital RequirementsInvestment Ratio Examples

Equity (70%) Debt (30%)

Registered Capital

Total Investment

Example 2

Equity (100%)

Registered Capital

Total Investment

Example 1

Shareholder loans are an alternative means of profit repatriation


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Business Registration ProcessWFOECompany’s Chinese Name Approval

Approval to Establish Company

Registration of Business License

Stage I: Licensing

Filing and Carving Seals*

Foreign Exchange Approval

Open RMB & Foreign Currency Bank Accounts

Capital Verification

Statistics Bureau Registration†

Enterprise Code Certification**

Registration with Tax Bureau

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

Stage II: Post-

Licensing

Update Business License

Stage III: Post-Capital

Injection


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China by the Numbers

Source: National Bureau of Statistics

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

FDI By Investment VehicleWFOE EJV CJV


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A Few Last Points…

• China is not a mystical land of dragons and forbidden citiesThe Chinese have many of the same desires and needs as all of us

It is possible to understand China and the Chinese in the context of your business, but…

• There is no such thing as the “China Expert”The more that you know about China the more questions you will have

Even the Chinese cannot grasp, in its entirety, the socioeconomic changes that are occurring within their own country

• Cultural differences should not preclude standard business practicesChinese hospitality is often mistaken for commitment to a mutually understood business objective; do not let this undermine proper legal contracts

Investing in market research, regulatory compliance and due diligence will increase your chances of developing sustainable business model

• Foreign Invested Enterprises should not behave like locally owned companiesForeign firms are scrutinized more closely and held to stricter standards

Train your staff to understand the difference


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THANK YOU FOR YOUR ATTENTION!The JLJ Group

SHANGHAI OFFICESuite 603-605Oriental Center699 Nanjing West Road Shanghai, 200041 ChinaTel: +86 21 5211 0068Fax:+86 21 5211 0069

BEIJING OFFICESuite 1008, Tower B, Building 3, 22 International Art Plaza / Pingod North32 Baiziwan Road, Chaoyang DistrictBeijing, 100022 ChinaTel: +86 10 5876 9437Fax:+86 10 5876 9467

BOSTON OFFICE162 Chapel StreetNewton, MA 02458, USATel: +1 857 636 2596

Email: [email protected]

Web site:www.jljgroup.com

Shanghai

Beijing

mailto: [email protected]

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