china newcomer opportunities
DESCRIPTION
Emerging China market opportunities.China\\’s 12 5yr plan.Key Success Factors in China.Case studies highlighting pitfalls.TRANSCRIPT
The Dbriefs China Issues series presents:
Doing business in China:
opportunities for newcomers
Clarence Kwan, Managing Partner, U.S. Chinese Services Group, Deloitte LLP
Warren Clark, Partner, Deloitte & Touche LLP
Shelley Chia, Partner, Deloitte & Touche LLP
October 14, 2010
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Agenda
• Emerging market opportunities
• Key success factors for doing business in today’s
China
• Case studies of typical market entry pitfalls in China
Copyright © 2010 Deloitte Development LLC. All rights reserved.
What is your company’s China investment plan over the
next 6 to12 months?
• Pursue new investments in China
• No new investments in China
• Scale-back investments in China
• Pull out of China
• Don’t know/not applicable
Poll question #1
Emerging market opportunities: new industries and services
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Sources: PRC National Bureau of Statistics, IMF, U.S. Bureau of Economic Analysis
$0
$1
$2
$3
$4
$5
US
$ t
rill
ion
s
China’s nominal GDP growth
(1978-2009)
China’s rapid economic ascent
From 1978 through 2009, China’s average annual GDP growth
rate was 9.8% - 3x the global average
$0
$200
$400
$600
$800
$1,000
$1,200 Exports (US$B)
(1980–2009)
Launch of China’s Open Door Policy
China joins WTO
Deng Xiaoping’s ―Journey South‖
1
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U.S. investors have grown with China
After investing US$64 billion through 2008 (7.5% of China’s cumulative total
FDI) U.S. investors continued to favor China in 2009
4.4
4.9
5.4
4.23.9
3.1 32.6
2.9
3.6
0
1
2
3
4
5
6
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
U.S. FDI into China last year was US$3.6 billion — a 24% increase
over 2008 despite the economic crisis and the best showing since 2004
Flow of U.S. FDI in China
(2000–2009)U.S.$ billion
Sources: PRC Ministry of Commerce
2
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U.S. SMEs are finding success
Despite less time on the ground than larger U.S. investors, many U.S. SMEs
reported profitable China operations during 2009.
How can this success be replicated, especially with more uncertainty ahead?
SMEs Large companies
> 20 yrs.
10-20 yrs.
6-9 yrs.
2-5 yrs.
< 2 yrs.
SMEs Large companies
Large loss
Break even, small lossProfitable
Very profitable
Source: American Chamber of Commerce 2010 White Paper – survey of 388 U.S. companies with investments in China
SMEs = Small and medium-sized businesses, defined as those with fewer than 500 employees
Profitability of China operations (2009)Length of time in China
3
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To create (and preserve) value in China, successful foreign
investors:
1. Seek to understand China’s business environment and anticipate
the direction of change
2. Adapt their strategy, structure, people and processes to the China
environment
Navigating risk in a land of opportunity
4
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• A shift to a more sustainable development model
– Lessen dependence on exports by spurring domestic demand
– Promote service sector as an engine for job creation alongside
manufacturing
– Strive for “inclusive growth” (包容性增长) – spreading benefits more
evenly across urban-rural, provincial and regional divides
– Green, green, green
• Respond to the Chinese people’s desire to see China
achieve global standing commensurate with its growing
economic leadership
What does China’s leadership want for China?
5
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• Consensus-building – Harness the Five-Year Planning (FYP)
Cycle to build consensus around a sustainable growth path
• Targeted industrial policy – Revitalize old strategic sectors
while spurring the competitiveness of Chinese enterprises in
new ones
• Accelerated urbanization – Shift residential patterns to
improve access to employment and social services
• Recalibrated role in the global economy – Inbound FDI more
carefully vetted for alignment with balanced growth goals;
outbound FDI encouraged
How will Chinese leaders try to get there?A few examples
6
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Consensus - buildingChina’s 12th Five Year Plan takes form
Drafting
March 2011
Final approval at 4th
Plenary session of 11th
NPC
2009 20112010
Research
October 15-18, 2010
Review and approval of draft at 5th
Plenary Session of 17th the CCP
Central Committee
Review & approval
Implementation
October
2008
2nd National
Economic
Census
launched
March 2010
Premier Wen
submitted guidelines
to 3rd Plenary
Session of the 11th
NPC for approval,
allowing drafting to
move to next phase
November 2009
NDRC announced
that drafting of the
12th FYP is under
way, drawing on input
from across China
Early 2010
NDRC submitted
guidelines for
State Council
approval
November 2008
Planning division of NDRC
released draft outline of 12th
FYP
7
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12th FYP Policy Thrust Potential 12th FYP Targets
Accelerated urbanization Increase national urbanization rate from 47% to 52%
by 2015
Create an energy-efficient, low-carbon society 2015 interim goal to China’s public pledge to reduce
carbon intensity by 40-45% from 2005 levels by 2020
Reduce income disparities through regional
integration & specialization
Increase urbanization rate of Central China from
40% to 48%; reduce energy intensity of Central
China’s economy by 25% from 2008 levels by 2015
Extend social safety net Universal basic healthcare coverage by 2020
Lessen reliance on global markets for growth;
achieve economic rebalancing
Increase domestic consumption to 50% of GDP from
36% now
What we expect to see emerge this week
Consideration of the 12th FYP is the sole agenda item for this week’s four-
day annual meeting of China’s party leadership (Oct. 15-18)
Source: State Council, NDRC, Chinese media, ACMR
8
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• Alternative Energy
• Biotechnology
• Information Technology
• High-end Equipment Manufacturing
• Advanced Materials
• Alternative Fuel Cars
• Environmental Protection
Targeted industrial policySeven new strategic sectors unveiled in September 2010
Detailed industry support plans - similar to the 2009 revitalization
plans for 10 old strategic sectors - are expected before January 1st
9
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Meeting the challenge of faster urbanization
•Although cities account for just 3% of global surface area and 51% of the world’s
population, they consume 75% of energy and emit 80% of greenhouse gases
•China has 622 million urban residents today but is still just 47% urban - plans to
urbanize an additional 280 million Chinese by 2030 will place tremendous strains
on sustainability
Sources: Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat, World Population Prospects: The 2009 Revision
and World Urbanization Prospects: The 2009 Revision, Chinese Academy of Social Sciences, China Daily
0
10
20
30
40
50
60
70
80
90
100
1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030
Pe
rce
nta
ge
Urb
an
(%
)
Year U.S. China Global Average
47%
51%
82%
Urbanization rates (1975-2030)
10
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“Inclusive growth” – narrowing regional disparities
Sources: National Bureau of Statistics, MOFCOM and local trade & investment promotion agencies
―Rejuvenate the Northeast‖
(October 2003)
―Go Inland‖
(September 2006)
Heilongjiang
Jilin
Liaoning
Hebei
BeijingTianjin
Inner
Mongolia
Shandong
Zhejiang
Fujian
Guangxi
Hainan
HunanJiangxi
AnhuiHubei
Henan
Guizhou
Yunnan
SichuanChongqing
Gansu
Ningxia
Shaanxi
Shanxi
Qinghai
Xinjiang
Tibet
Jiangsu
Shanghai
Guangdong―Go West‖
(September 1999)
―Open Up and Reform‖
(December 1978)
2008 East Northeast Central West
Population (m) and
as % of total
480
(37%)
109
(8%)
355
(27%)
365
(28%)
GDP (US$B) (% of
total)
2,555
(54%)
406
(9%)
909
(19%)
838
(18%)
Average Per
Capita GDP (US$)
5,908 3,665 2,551 2,405
FDI inflows
(US$B), and as %
of total*
86.2
(70%)
12.0
(10%)
16.5
(13%)
7.9
(6%)
The 12th FYP is expected to strongly emphasize regional development
11
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Has your company begun to look at the implications of
the 12th Five Year Plan for its future plans to invest in
China?
• Yes
• No
• No, but we intend to
• Not applicable
Poll question #2
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Recalibrated role in the global economyChina as a major source of capital
Sources: PRC Ministry of Commerce (MOFCOM), NBS, State Administration of Foreign Exchange (SAFE)
0
10
20
30
40
50
60
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
US$ billions
Overseas FDI in financial sector Overseas FDI in non-financial sectors
Chinese outbound
FDI flows
(2002-2010)
(Jan.-May)
US$60 billion
projected
By the end of 2009, China's cumulative overseas investment had exceeded US$230 billion, up from just US$28 billion at the end of 2000
12
Copyright © 2010 Deloitte Development LLC. All rights reserved.
How will you leverage China’s future development
to achieve your business objectives?
• Where does your product/service fit in the 5-year
plan?
• Are you in one of the seven new strategic sectors?
– If not obvious, could you at least support these sectors?
• Will you invest in an “encouraged” region?
• Will you collaborate with a Chinese company to
expand your global footprint?
– Leverage partner’s local knowledge, financial strength, R&D
capabilities, and distribution network to expand market
coverage
– Relationship goes both ways
Align China’s objectives with yoursShare the same bed, and the same dreams
13
Success factors and examples of typical market entry failures into China
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Poll question #3
Which of the following best describes the likely mode of
entry for your next investment in China?
• Wholly-owned greenfield/organic entry
• Minority stake acquisition
• Majority state acquisition
• Other forms of strategic alliance (joint venture etc)
• Not applicable
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Deal-making in China - creating lasting value
• At what point should we walk away from a deal?
• What is an acceptable price to both parties?
• How should the deal be structured?
• Does the deal present a compliance risk?
• How can the acquisition be integrated in to the global organization?
Five Questions Companies Should Ask
14
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Potential deal breakersWar stories from our colleagues on the ground in China
• Lack of integrity on the part of target’s
management
• Disagreements over management
control
• Inability to establish clear title to assets
• Diverging expectations over price
• Conflicting stakeholder obligations
At what point should we
walk away from a deal?
• What is an acceptable
price to both parties?
• How should the deal be
structured?
• Does the deal present a
compliance risk?
• How can the acquisition
be integrated in to the
global organization?
• Case: A U.S. manufacturer acquiring an operation in Southeast
China realized that the target’s managing director had been making
large payments to a “non-existent” overseas consultant
– It was revealed that the “consultant’s” offshore account belonged to the
managing director
15
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Pricing considerations War stories from our colleagues on the ground in China
• Availability of basic financial information
• Conflicting valuation
procedures/methodologies
• Contingent/hidden liabilities
• Redundancies and non-core assets
• Sustainability of sales
• At what point should we
walk away from a deal?
What is an acceptable price
to both parties?
• How should the deal be
structured?
• Does the deal present a
compliance risk?
• How can the acquisition be
integrated in to the global
organization?
• Case: A European chemical company seeking to acquire a privately-
owned manufacturer in China found that no social security payments
had been made for its 3,000-strong sales support staff. This would
have potentially resulted in huge un-accrued liabilities for the acquirer.
16
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Structuring and compliance considerations War stories from our colleagues on the ground in China
Remember the “3 Cs” of Deal Structuring
Contain: Insulate the investment from hidden or
contingent liabilities associated with previous
operations or from potential liabilities created
during the transaction itself
Comply: Ensure that the terms of the deal and
subsequent operations are in compliance with
pertinent regulations from the outset, both in China
and in the home country
Compete: Create a sustainable business model
that minimizes the net global tax position and
maximizes the flexibility of cross-border capital
deployment
• At what point should we
walk away from a deal?
• What is an acceptable
price to both parties?
How should the deal be
structured?
Does the deal present a
compliance risk?
• How can the acquisition
be integrated in to the
global organization?
17
Copyright © 2010 Deloitte Development LLC. All rights reserved.
• Failure to detect legacy liabilities and adjust structuring
accordingly
• Failure to uncover improper related-party transactions
• Assuming unnecessary risk in a seller’s market
• Over-reliance on personal relationships
• Failure to assess the consequences of offshore payments
Common containment mistakes War stories from our colleagues on the ground in China
• Case: A U.S. firm purchasing a majority stake in a Chinese
consulting company was pleased with the three years of financial
data presented by the seller, but due diligence advisers found the
virtually flawless financial statements suspicious and recommended
searching further in the past
– It was revealed that the seller had enhanced the most recent accounts
and buried significant unpaid taxes in the preceding years
– The buyer avoided the tax liability by executing an asset deal rather than
an equity deal
18
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Common compliance mistakes War stories from our colleagues on the ground in China
• Following common business practices without a full understanding of
their legal basis
• Failure to recognize the potential for inconsistent regulatory
interpretation between local and state-level officials
• Failure to anticipate and adapt to changes in the regulatory
environment
• Ignoring industry-specific regulations
• Violation of foreign exchange rules
• Misunderstanding of circumstances under which a license can or
cannot be transferred
• Case: A Canadian enterprise sought to acquire the exploration rights
from a gold and platinum mining facility in southwest China
– After making payment, the buyer was informed by the central government that
the exploration rights were non-transferable
– The buyer was forced to invest an additional US$8 million to set up a joint
venture with the Chinese company
19
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Common competitive positioning mistakes War stories from our colleagues on the ground in China
• Failure to use an offshore intermediate holding company or
forming one in a sub-optimal jurisdiction
• Giving insufficient consideration to exit strategies
• Using legal entities that are incompatible with the business model
• Failure to capture specific tax incentives
• Failure to correctly estimate the long-term capital needs of the
China operation
• Inability to repatriate cash in excess of dividend capacity
Case: A U.S. firm acquired a contract manufacturing facility in Shenzhen to
do final product assembly for export
– The company’s structure was intended to minimize the Chinese tax burden but
they were precluded from selling directly in to the Chinese market
– As local demand products grew, the firm sought to sell domestically but to do so
they had to export and re-import its products, incurring customs and shipping
costs, thus making their prices uncompetitive vis-à-vis local Chinese competitors
20
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Poll question #4
Which of the following issues strikes you as the most
significant challenge to pursuing a deal in China?
• Lack of transparency
• Legacy liabilities
• Management/Control issues
• Difficulty agreeing on price, including the valuation
method
• Regulatory/licensing issues
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Potential deal-breakers
• Lack of integrity on the part of target’s management
• Disagreements over management control
• Inability to establish clear title to assets
• Diverging expectations over price
• Conflicting stakeholder obligations
Pricing considerations
• Availability of basic financial information
• Conflicting valuation procedures/methodologies
• Contingent/hidden liabilities
• Redundancies and non-core assets
• Sustainability of sales
Deal-making in China - creating lasting valuePeople issues dominate the list of transaction headaches
21
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Putting people first - before the dealUnderstand the stakeholder environment
1. Find out not only
who can make the
deal but who can
break it.
In China, these
individuals can be both
inside and outside the
company.
2. Learn everything
you can about the
stakeholders in
advance.
Lack of management
integrity is one of the
most frequent deal-
breakers in China.
3. Secure a firm
mandate from your
top management,
including clear
“go/no go” decision
points.
This will help you to
negotiate with
confidence in China’s
unpredictable and less
than transparent M&A
environment.
At what point should we
walk away from a deal?
What is an acceptable price
to both parties?
• How should the deal be
structured?
• Does the deal present a
compliance risk?
• How can the acquisition be
integrated in to the global
organization?
跨
国
经
营
以
人
为
本
22
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Putting people first - during the dealEstablish trusting relationships
4. Negotiating in China
is not just about
getting the best deal
possible but also
building lasting
relationships.
Strong-arm tactics can
be effective but should
be applied judiciously.
5. Trust takes time but
once you have it,
nothing moves a
deal forward faster.
If they trust you, you will
get the information
needed to support your
decisions.
6. You do not need to
be Chinese to get
what you want in
China.
Be creative – Look for
occasions where acting
like an American
advances your cause.
7. Better to
communicate too
much than too little.
But more importantly,
make sure you can trust
your translator.
0
• At what point should we
walk away from a deal?
• What is an acceptable price
to both parties?
How should the deal be
structured?
Does the deal present a
compliance risk?
• How can the acquisition be
integrated in to the global
organization?
跨
国
经
营
以
人
为
本
23
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Putting people first after the dealTransform relationships into lasting China value
8.Signing the
contract is often
just the beginning
of real negotiations
in China.
Use the relationships
you have established to
protect your China
value.
9.Loyalties in China
are more often to
individuals than to
companies.
The best way to retain
critical employees,
customers and
suppliers is to retain
key leaders.
10.Anything is
possible in China,
but nothing is easy.
Without the right
people, nothing is
possible.
• At what point should we
walk away from a deal?
• What is an acceptable price
to both parties?
• How should the deal be
structured?
• Does the deal present a
compliance risk?
How can the acquisition be
integrated in to the global
organization?
跨
国
经
营
以
人
为
本
24
Question and Answer
Join us on November 11 at 11 AM ET as our China Issues series presents:
China Tax and Regulatory Update
Copyright © 2010 Deloitte Development LLC. All rights reserved.
Contact info
Shelley Chia
+1 213 688 3232
Warren Clark
+1 215 246 2503
Clarence Kwan
+1 212 436 5470
Copyright © 2010 Deloitte Development LLC. All rights reserved.
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This presentation contains general information only and is based on the experiences and
research of Deloitte practitioners. Deloitte is not, by means of this presentation, rendering
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Copyright © 2010 Deloitte Development LLC. All rights reserved.
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