doing business in china

iift ,INDIA

FINAL REPORT ON BUSINESS PLAN

DOING BUSINESS IN CHINA

UNDER GUIDANCE OF DR. PRABIR KUMAR DASS

5/25/2013

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GROUP III

NAVNEET

PARTHA PRATIM GHOSH

KUMARJIT CHAKRABORTY

DHEERENDAR SRIVASTAVA

ASHOK UPADHYAY

ABHISHEK BOSE

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Index

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DESTINATION CHINA:IS STILL A BUSINESS SENSE TO INVEST IN!China's soaring wages and strengthening currency might blunt the competitive edge of exporters that have seen average pay double since 2007, but it won't stop firms worldwide making a collective $100 billion bet on setting up shop here this year.Although foreign direct investment inflows in 2012 have seen the longest monthly run of year-on-year declines since 2009, hurt by a weak outlook for corporate investment and sagging global trade, FDI should still top $100 billion for the third year running.That would bring China's total since 2007 to about $625 billion, based on data from United Nations agency, UNCTAD, during which time a rally in the yuan currency has sliced 25 percent from exporters' margins.Vietnam, Bangladesh, Indonesia and Thailand combined managed to snag only $141.6 billion in FDI between them from 2007 to 2011, despite being repeatedly touted as the places to which manufacturers fleeing China flock.

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What keeps the money coming to China is a steady shift away from cheap assembly lines to high value-added production and from volatile external demand to the spending power of a new mainstream consumer class that will rise 10-fold between 2010 and 2020.Indeed the decline of low-end manufacturing fits with Beijing's ambition to drive firms up the global value chain to help sustain the wage rises vital to attaining developed economy status and avoiding a "middle income trap" of low wages and stagnating growth.It's so far not threatening to the competitiveness position of China because it's the very low-end of manufacturing sectors that are affectedIn that sense, it's quite consistent with the government's strategy to move up the value chain and improve the industrial structure.Under government guidance on foreign investment issued in December 2011, China aims to lure more FDI in advanced manufacturing, as well as services including logistics, research and development, higher education and vocational training.The government policy no longer encourages FDI in the low-end manufacturing; only firms that are up in the global value chain can make profits.

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WAGE COSTS BITE: IS THIS A REAL THREAT! There is pressure on Foreign business enterprises in China to transform from being cheap labor-driven to innovation-driven.Some factories in the clothing and footwear industries have closed. German sportswear maker Adidas AG (ADSGn.DE) has shut its only directly-owned factory in China, but it still sources goods from local suppliers.Supply chains and relatively sound infrastructure make China a stand-out destination for many foreign investors.A lot of suppliers are in the immediate neighborhood of main industry, which cuts logistics and other costs, reason to be in China is not it’s labor costs.Currently, minimum wages in China range from 870 yuan ($139) per month to 1,500 yuan, according to government data. In Vietnam the minimum wage is around 1.05 million dong ($50).China's foreign direct investment inflows fell 3.45 percent in the first 10 months of 2012 from a year ago, compared with an annual average 9.2 percent rise between 2002 and 2011 that saw investors plough in a cumulative $1.2 trillion.

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That cash has now got to work smarter, since China's manufacturing sector is suffering from overcapacity and investment opportunities will be limited.If we assume China's economy can continue to grow around 6-8 percent in the next decade, China's market is still attractive. But we will see a structural change - more on services sector, consumption, more on industrial upgrading.

STRUCTURAL SHIFT:TRENDS HAPPENING! That shift is already happening, according to official data that shows foreign investment accounted for just over 50 percent of China's total exports in the first nine months of 2012, down from 57 percent in 2007.Meanwhile, the proportion of FDI inflows into China's services sector were $43.7 billion in the first 10 months of 2012 versus the $40.4 billion that went into manufacturing. FDI into services beat manufacturing FDI for the first time in 2011.China's services sector makes up far less than the 60-70 percent of GDP typical in major developed economies, but its 43.3 percent share in 2011 is not far behind the manufacturing sector's 46.6 percent share, according to World Bank data.

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Beijing aims to boost the services sector's relative share of GDP to 47 percent by 2015.Under the banner of "industrial transfers" endorsed by Beijing, provincial officials in the interior have rolled out the red carpet for foreign firms trying to escape higher costs in the more developed coastal areas.Although industrial cities are luring more outside investment, including that from big state-owned firms and private firms, due to its lower wages and land costs, but the cost for industrial transfers is rising as labor resources, land and capital become key constraints.Foxconn Technology Group, the world's largest contract electronics maker, has moved its main operations to such inland provinces as Henan and Shanxi. Its factory in Shanxi alone employs nearly 80,000 people.In the first 10 months of 2012, FDI into China's six central provinces - Henan, Hunan, Hubei, Auhui, Jiangxi and Shanxi - jumped 19.4 percent from a year ago to $7.8 billion, or 8.5 percent of the total, according to official data.FDI into eastern provinces, including Guangdong, Jiangsu, Zhejiang and Shandong, fell 6.1 percent to $76.8 billion. But they got the lion's share 84 percent of FDI, suggesting foreign firms still favor established locations.7 | P a g e

Both trends are happening at the same time, It does seem that companies are weighing the pros and cons. But if everyone does look at China as a potential consumer market, it does make sense to first move>>>

SWOT :A Tentative Analysis on the Strengths and Weaknesses of Both Countries (A general consensus from foreign businessmen’s perspective) China Strengths: market size, access to export market, government incentives, favorable cost structure and infrastructure, etc. Weaknesses: poor English skills, a lack of managerial talent, rigid formalism, etc. India

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Strengths: a sizable pool of educated workers, management talent, cultural affinity, regulatory environment, etc. Weaknesses: slow-moving government, dismal infrastructure, etc.PRODUCT ADVANTAGE : INDIA TO CHINA

Electrostatic Precipitators, Large scale frequency convertors, Agro machines, Medicines (pharma), Medical Equipment, IT Training R & D Designing

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PHARMACEUTICAL INDUSTRY VALUE CHAINThe pharmaceutical industry value chain production link is relatively simple, and is divided into (i) raw medicine production and (ii)prepared medicine production. We can judge the position of the Chinese pharmaceutical industry in international specialization according to Trade Competitive Index (TC Index)(of Chinese raw medicine and prepared medicine).

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If we calculate the Trade Competitive Index (TC Index)(2004-2008) for China and India’s raw and prepared medicine. We can see that China and India both have a certain degree of overall competitiveness in the pharmaceutical industry, but the origin of the competitiveness differs greatly. The Chinese TC index is very high for raw medicine, showing that China has absolute comparative advantage in raw medicine production; while India is located at a relatively low position. In prepared medicine, China is located at a low position and the TC index has a falling trend; while India has a remarkable advantage. Thus we can infer that since 2004, in the global pharmaceutical value chain production link, China is mainly specialized in raw medicine, while India is specialized in prepared medicine.As described above, in the nonproprietary medicine field, raw medicine production has a weak connection with the core link of the value chain – the R&D link – while prepared medicine production has a closer connection. Thus, raw medicine production is the lowest end link in the nonproprietary medicine value chain, while R&D and production of prepared medicines are at the relatively high end. 11 | P a g e

So we can conclude that China’s international specialization within the nonproprietary medicine chain is at the lowest end of “smile curve,” while India is located at the relatively high end.India’s growing trade deficit is a cause of concern and, to address this, India is seeking greater market access in China for products in which India has a competitive advantage. Greater market access is being sought in pharmaceuticals, engineering goods, agriculture & IT/ITES. There are also opportunities in jewelry, banking, auto components, and green technologies.

China’s pharmaceutical industry is poised for significant growth due to an aging population and burgeoning middle class with more money in hand. Foreign players currently account for 10 to 20 percent of overall sales in the industry, depending on the types of medicines and ventures included in the count.The country is poised to become the world’s third-largest prescription drug market in 2011, according to a report by pharmaceutical intelligence service IMS Health, and the value added output of China’s pharmaceutical industry as whole increased 14.9

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percent year on year in 2009, according to statistics released by the Ministry of Industry and Information Technology.China-India trade in pharmaceutical products hit a bilateral trade volume of US$60 billion in 2010, up 2,000 percent in 10 years. Greater bilateral trade activity, particularly between API producers in India and pharmaceutical drug manufacturers in China, is expected to push the global pharmaceutical market to US$1.1 trillion by 2014. To strengthen information sharing between India and China and produce competitively priced active pharmaceutical ingredients and pharmaceutical drugs for the global market, a memorandum of understanding (MOU) was signed between the Indian Drug Manufacturers’ Association and the China Pharmaceutical Industry Association in January 2011.Remaining challenges in the industry include

(i) intellectual property rights protection,(ii) visibility for drug approval procedures,(iii) effective governmental incentives,(iv) corporate support for drug research

and

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(v) equal treatment of local and foreign firms.

Pharmaceutical distribution market in ChinaThe US$44 billion pharmaceutical distribution market in China continues to face several key challenges. In a country with a huge rural population (700-800 million) lacking in key infrastructure and logistical expertise, it is difficult to ensure that drugs are delivered to patients in a timely, safe and cost effective manner. While the government is taking steps to meet these challenges, a distribution network composed largely of thousands of small, local distributors has made it difficult for regulators to monitor products and manufacturers to track their goods and ensure reliable delivery to retailers. However, a combination of government guidance, market forces and foreign involvement are helping China to slowly improve its pharmaceutical distribution system.China’s distribution chain is three tiered. Most multinationals distribute pharmaceuticals through national and provincial wholesalers, which then sell the drugs through hospitals, clinics and pharmacies, which then sell to patients. Up to 80%

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of all Western-style drugs are thought to be distributed through hospitals and clinics, whilst the remaining 20% are distributed through pharmacies Figure 3: China Distribution Channels OverviewHistorically, the wholesaler network was a state-owned distribution system that focused on provincial and local networks, with few links to other regional markets. However, as China began its transformation toward a market economy in the 1980s, the demand for pharmaceutical products increased dramatically, and the distribution system began to decentralise. A surge in the number of distributors created a competitive environment of local operators competing for smaller shares of the market. Of the over 7,000 distributors in China, 80% are considered small and the top 3 distributors account for only 20% of the market.Thus far, many of these small, local distributors have lacked both the scale to automate and the logistical expertise of distributors in developed countries. In addition, this lack of scale has meant that manufacturers seeking to distribute their products on a national basis need to bring in multiple distributors to help their products reach

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the retailer. One current challenge is the lack of a comprehensive product tracking system set up between the various distributors. Consequently, product traceability is hard to guarantee, and when problems arise, product recalls can be extremely difficult to manage. The complexity of the supply chain has also left it vulnerable to the entry of counterfeit products, a substantial threat to the pharmaceutical industry. The need to use multiple distributors can also risk interruption of the cold chain and negatively affect product quality.In the meantime, regulatory changes and the need for scale have led to consolidation in the distribution sector, while international pressure has led to more government oversight. On the regulatory front, China’s 2001 accession to the World Trade Organisation (WTO) prompted some improvements, and the Chinese government has issued compliance mandates to meet Good Supply Practices (GSP) standards in an attempt to rid the industry of players who engage in questionable practices. The need for firms to reach critical mass in order to survive deteriorating profit margins (which are nonetheless higher than US

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profit margins) is also driving the recent wave of consolidation. The average gross profit of China’s drug distribution companies is around 8%, while net profits have declined to about 0.5%.80. Some pharmaceutical distributors that started to operate at a loss have chosen to change their business models and become product agents instead, generating revenue through commissions and discounts from manufacturers. This drive for scale coupled with increased government regulation have more than halved the number of drug distributors from 16,000 to around 7,000.Foreign firms are also beginning to have their effect on China’s pharmaceutical distribution system. Since 2003, in compliance with WTO agreements, China has slowly opened its borders to foreign drug distributors. A year later, the government further unleashed the limit on the proportion of capital contribution of the foreign investors, unless the same investor opens more than 30 retail outlets accumulatively within China, whereby the proportion of such is capped at 49%.82 Thus far, several have entered the market.

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In 2004, the first modern pharmaceutical logistics center was built by the Beijing Pharmaceutical Group Co., Ltd., using foreign-bought advanced logistics equipment and technologies. Following this trend, similar logistics centers are now being established in several major cities across China. However, there are areas in which foreign firms dominate. For example, in 2007, global giant World Courier launched a cold chain logistics network in China to provide pharmaceuticals to 36 major cities with access to temperature controlled and clinical trial shipments. In building the nascent logistics industry, the Chinese government has been actively encouraging local development through financial support to major distributors.

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The preferential drug pricing policies for innovative drugs, another healthcare reform topic, will stimulate investment in R&D activities and the success of these drugs. With the expansion of China’s economy, one of the key objectives on the central government’s agenda is to shape the country from a world factory into a world R&D base. The new tax regulations providing tax incentives are set out to encourage research and development activities in China. Tighter control on drug distribution profit margins will accelerate the consolidation of the pharmaceutical distribution sector and offer significant opportunities for leading pharmaceutical distributors or foreign investors. A move to separate drug prescription and dispensation will trigger a rise in the number of retail pharmacies, which will impact the drug distribution landscape as well. This segregation in prescription and dispensation will also support a reduction and hopefully the eradication of the practice of giving kickbacks to healthcare practitioners in the near future.

BUSINESS MODEL: STAKE HOLDING & INVESTING IN R & D

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The business model of the pharmaceutical industry is changing globally. In the future, it is of strategic and tactical importance that the industry moves toward a more collaborative model that encompasses a network of other healthcare stakeholders such as regulators, research institutes, academia, technology providers and outsourcing. Against this manufacturing organisations are sectors that are backdrop, contract research organisations and growing fast in China and double-digit growth is expected to continue in the coming years. The Chinese pharmaceutical market is consolidating, with a high number of deals both by foreign and domestic players, due to an appetite (albeit reduced by the current worldwide economic downturn) for domestic IPOs. The amount of investment from foreign (pharmaceutical) players continues to grow and is starting to venture into areas outside of manufacturing, such as R&D, distribution and retail pharmacies. Even though intellectual property protection remains a concern for those outsourcing in China, continuous improvements are being made that will stimulate foreign investment in R&D activities in China.

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Source : tradecommissioner.com

CHOICE OF BUSINESS ENTITY : WFOEWholly foreign-owned enterprise (WFOE)A WFOE organised as a limited liability company is generally a desirable investment vehicle for foreign investors provided the investment regulations do notrequire the participation of a Chinese partner. The limited liability company offers foreign investors sole control ofthe business operations and avoids lengthy negotiations with a Chinese partner, as in the case of an EJV or CJV.According to China’s Company Law, the minimum capital requirement to establish a WFOE is CNY 30,000, although the actual capital requirement

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should be commensurate with the proposed business plan and substantiated by projections(normally, five years) in the feasibility report contained in the company formation application. Capital may be contributed in cash or in-kind. In-kind capital contributions are subject to valuation in China. At least 30% of the registered capital should be in cash and in-kind capital (i.e. industrial property, machinery, technology) should not exceed 70% of the registered capital of the enterprise. When capital is contributed in installments, the first installment must be not less than 15% of the registered capital or the minimum capital requirement, and must be deliveredWithin three months from the date the business license is issued. The deadline for completing the contribution is normally two years from the date the business license is issued. The company is required to arrange for capital verification by a CPA firm in China and apply for an updated business license after each capital contribution. A WFOE must establish a board of directors or a managing director for management structure. For required to have an independent supervisor (similar to

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non-executive director in western countries).A detailed management structure must be set out in the articles of association (including the duties and limits of authority of the legal representative, chief accountant, general manager and supervisor). The articles of association must specify procedures for termination and liquidation and for amending the articles.A WFOE is required to appropriate 10% of its annual after-tax profits for its statutory general reserve fund account until the account balance reaches 50% of the company's registered capital. Hence, the distributable profits of the WFOE may initially be lower than any other business entity in China, whose board may decide not to contribute to such a reserve.

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Appendices: Appendix-I

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