Market Entry Strategies into China for Australian Companies

AdvisoryTransaction Services Strategy GroupMarket Entry Strategiesinto China for AustralianCompanies*connectedthinking•

Market Entry Strategies into Chinafor Australian Companies• Business opportunities in China• Business issues and challenges• China market entry strategies• How PwC can helpTransaction Services Strategy GroupPricewaterhouseCoopers

Business opportunities in ChinaChina is now one of the largest and fastest growingeconomies and markets in the worldUSChinaJapanIndiaGermanyFranceUKItalyBrazilWorld’s Top 10 PPP GDP Ranking, 20031,6001,4001,2001,0008006004002000China’s GDP and Growth Rate Comparison(US$ billion)9.1%7.5%Estimated1998 1999 2000 2001 2002 2003 2004Russia(US$ billion)0 2,000 4,000 6,000 8,000 10,000 12,000China's GDPChina's annual GDP growth rateMiddle income countries' annual GDP gowth rateOECD countries' annual GDP growth rateLower middle income countries' annual GDP growth rateTransaction Services Strategy GroupSource: 2003 China Yearbook, World Bank Data Query Website. GDPand GDP growth rate for 2004 are estimated by MOFCOM10%9%8%7%6%5%4%3%2%1%0%4

Business opportunities in China…which offer attractive opportunities for foreign investmentsServices 6%As China’s economic structureupgrades, the sector has beengrowing at 16% annually and accountsaround 4% of the total GDP.However, opening up to FDI is agradual processReal estate 13%With China’s large population andhousing welfare system reform, thegrowth rate has been over 10% andaccounts for around 2% of the totalGDPWholesales, retail andcatering 3%Transport, storage, postal andtelecommunication services 4%The sector is growing fast from itsunder-developed stage to around 6% ofthe total GDP. In particular,telecommunication services has beengrowing with an annual rate over 30%.Industry Distribution of Foreign InvestedCapital in China’s FIEs as of 2002Construction 2%Power, Gas andwater supply 3%Others 7%Manufacturing 62%1. Manufacturing accounts foraround 44% of the total GDP.2. Some manufacturing sectorssuch as automotive grow asmuch as 30% annually.3. China’s low production cost andhuge market potential has madeChina the manufacturing centrein the world4. Manufacturing is opened toforeign investment relatively earlyand less regulated than manyother sectors5. From garment and toy toconsumer electronics and toautomotive, different sub-sectorshave been driving FDI intomanufacturingTransaction Services Strategy GroupSource: 2003 China Yearbook5

Business opportunities in ChinaThe economic growth is driven by major economic andindustrial transformations• Increasingly becoming theworld factory - outsourcedmanufacturing as part ofglobal supply chain ormanufacturing migrationDeregulation• WTO enables increasedmarket access across anumber of industries• China is also creatingopportunities for regionalsupply chainChina MarketGlobalisationTransformation andPrivatisationGrowth• Massive migration of SOEsinto shareholding structures• Moving quickly towards amarket economy• Emergence of POEs asmajor growth engine andeconomic driving forcesEconomic liberalisation• Retreat of state ownershipin most competitive marketsegments• The private sector nowdominates China’seconomyTransaction Services Strategy Group6

Business opportunities in ChinaAlthough growing, Australia’s direct investment in China onlyaccounts for less than 1% of the total FDI inflow to ChinaAustralian Foreign Investment Amount in China andIts Share in the Total FDI Inflow to ChinaFDI Inflow to China Ranking by Origin (2002)4000035000300002500020000US$ 10thousandAs percentage ofChina’s total FDI inflowFDI from Australiato China1.00%0.90%0.80%0.70%0.60%0.50%HKBVIUSJapanTaiwanKoreaSingapore150000.40%Kayman Island0.30%100000.20%GermanyUK50000.10%…00.00%AustraliaUS$ million1998 1999 2000 2001 20020 5000 10000 15000 20000Transaction Services Strategy GroupSource: 2003 China Foreign Economic Yearbook7

Business opportunities in ChinaHowever, Australia’s FDI to China is still a relatively significantpercentage to its overall FDI outflowFDI Outflow to China as Percentage of Total FDIOutflow of the Country or Region (2002)KoreaTaiwanHKSingapore• Geographical proximity andcultural similarity can explain therelative importance of China as amajor FDI destination for thesecountries and regions.JapanAustraliaUS• Although the absolute amount isless impressive, China is still oneof the most important FDIdestinations for AustraliaGermanyUK0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%Transaction Services Strategy GroupSource: 2003 China Foreign Economic Yearbook, UNCTAD FDI Database• Although the absolute amount ofFDI outflow to China from thesecountries is huge, it is morescattered.8

Business opportunities in ChinaCompared with other countries, Australia has invested largerpercentage of its total investment in the services and miningsectorComparison of FDI Industry Distribution (2002)ManufacturingReal estate and business servicesWholesale and retailMiningIndustry distribution of totalFDI into ChinaIndustry distribution of FDIfrom Australia into ChinaFinancial ServicesTransportation and warehousingConstructionPower, Gas and Water SupplyEducationInformation Services0% 10% 20% 30% 40% 50% 60% 70% 80%Transaction Services Strategy GroupSource: 2003 China Yearbook, An Analysis of FDI from Australia in China, WuChongbo9

Business opportunities in ChinaAustralian companies are tapping the market growth in Chinabased on their capabilitiesGrowth Rate of China’s Fast Growing Industriesthat Draw Most Australian Direct Investment(2000-2002 CAGR)OpportunitiesExample of AustralianentrantsMining and Dressing• Rich pool of resources• Need fund and technology upgradeRio Tinto, WMCResources, etc.Real estate• Housing welfare system reform• Strong market demandLand lease, AustralandHoldingsConstruction• Infrastructure construction boomLeighton Holdings, Boral• Heavy commercial & residential building investmentSocial Services• Further deregulation and opening up• Demands upgrade with economic developmentMallesons StephenJaques,EducationFinancial Services• English language education, professional andvocational training, higher degree education are themost heated sectors• Further deregulation and opening up• Financial system reform is under wayOrangewood Language,NITANZ Bank,Commonwealth Bank,QBE Insurance, etc.ManufacturingTransportation andWarehousingWhole sale and retail0% 5% 10% 15% 20% 25% 30% 35%Transaction Services Strategy GroupSource: 2003 China Yearbook• Manufacturing as percentage of GDP is rising• Such sectors as automotive is growing at 30%annually• Some sectors such as road and aeroplanetransportation grow faster with the structuralchange• Further deregulation and opening up• Whole supply chain integrationBlue Scope Steel,CSR,Lemarne, etc.P&O, Pioneer RoadServicesFuturis Corporation, AWB,ERG10

Business opportunities in China – future trendAustralian companies should determine their strategic focus inChina along the industry value chainThe manufacturing value-add crunch2000 Resources/ tangible inputs Assembly/manufacture Brand/logistics/design/marketingValue crunch Current VA on lo-tech,labor-int product ≅ 4% retail(20% mfg add x 20% exfac/rp)Value crunch2010Australian economy builthere, massive resourcesales (iron ore, LNG, wool,manganese, coal), now instrong future valueposition as commodityprices begin climbTaiwan economy built here,few significant brands,control of channels, ordesign cap. Lean and ultraleancontract manufacturingChina in same modeEven at early stages, Japaneseeconomy built here, strongbranding, control of trade andchannels, strong designs. Nosignificant toll mfg or contractmanufacturingS. Korea in same modeTransaction Services Strategy Group12


Business issues and challenges in ChinaManagement integrity, corporate governance and managementcontrol are among top concerns for foreign investors investing inChinaCorporatePrivate EquityHigh5.0High5.04.54.54.04.03.53.53.03.02.52.52.02.01.51.51.01.00.50.50.0Low0.0LowIntegrity of managementQuality / transparency of informationManagement controlTax, regulatory, legal concernsQuality of corporate governanceCurrency issuesGovernment's commitment to changeImpact of WTOImmaturity of domestic capital marketsIntegrity of managementQuality of corporate governanceQuality / transparency of informationTax, regulatory, legal concernsManagement controlCurrency issuesImmaturity of domestic capital marketsGovernment’s commitment’to changeImpact of WTOSource: PwC Survey of Foreign Investors in China, 2003Transaction Services Strategy Group16

Business issues and challenges in ChinaAddressing financial, tax and HR issues early in a set-up ortransaction reduces implementation costsCommon Financial IssuesCommon Tax IssuesCommon HR Issues• Reliance on group companies for supportingservices/facilities• Inadequate employee entitlement provisions• Different business goals of joint venturepartners• Transactions take a long time to complete• Inadequate post-deal planning• Poor quality/unreliable financial information• Inadequate access to information• Poor forecasting and projections• Title to assets unclear• Valuation of assets• Idle/under-utilised assets• Status of land use rights• Improper accounting practices for intangibles• Informal arrangements andrelated parties• …• Non-compliance with the tax orcustoms regulations• Black marks from last tax/customsinspection• Uncertainty in the entitlement to thetax preferences• Informal arrangement with local taxauthorities without formal approval• Transfer pricing exposure• Unfulfilled withholding responsibility• Allowable loss carry forward unclearInadequate tax provision• Control of bonded goods inappropriate• Non-compliance with tax registrationor invoice management requirement• Inadequate planning for transactionaltaxes• …• No available pool of enoughqualified talents• Non-compliance with the local HRand labour laws and regulations• Special training & developmentneeded to align local staff’s skillsand competencies with thecompany’s requirement• Imbalance between labour costsaving and talents attracting andretaining• Cultural incompatibility• Obstacle to organizational andstaffing change• …Transaction Services Strategy Group17

Business issues and challenges in ChinaAustralian companies may also face strategic issues tocompete and survive on the local marketplaceHKJapanUSBVIKoreaUKSingaporeGermanyFranceTaiwanSwitzerlandNetherland…IrelandHungaryDenmarkBahamasNumber of Invested Companies Ranked as the Top500 FIEs with Largest Sales Revenue, 2003~30countriesor regionsin total0 20 40 60 80 100 120 140 160Transaction Services Strategy Group• Though the top 500 weredistributed among 30countries or regions,there is no Australianinvested companiesSource: Invest in China WebsiteCompared with competition from theUS, EU and Japan in China,Australian companies is usuallydisadvantaged in• Scale• Brand recognition and reputation• Global network• Integration opportunities• Local expertiseStrategic Fit is a MustAustralian companies areadvantaged in:• Advanced technology in certainindustries and sectors• Industry strength complementary toChina’s• Experience and expertise in servingsome segments18


China market entry strategiesMarket evaluation – should you be there?What are the WTOregulatory changes andimplications specific toyour business?What are the customers’needs, buying behavioursand key success factors inserving the customers?Market EvaluationWhat are the industrystructure, competitorlandscaping, competitivepositioning in the marketsegment?Transaction Services Strategy GroupWhat are the marketopportunities (market size,growth, segmentation)? Isthe market attractive tocurrent and potentialparticipants?20

China market entry strategiesEntry strategy development – how do you get there?HighAcquisitionDegree of Risk / ComplexitySupplier AgreementsPurchase agreementLowOperating Joint VentureEquity InvestmentShared Distribution ChannelManufacturingProduct LicensingR&D Cost SharingDegree of CommitmentLow HighTransaction Services Strategy Group21

China market entry strategiesEntry execution – getting there?How to get licenses andregulatory approvals?Which location to enter?Which partner to establish ajoint-venture or alliance?Entry ExecutionWhich targe to acquire forM&A?Value chain analysis Operation process analysisTransaction Services Strategy Group22


How PwC can helpInvestment success in China remains a demanding exercise,but the steps are clearPhase 1 Phase 2Phase 3Phase 4Phase 5BusinessOpportunityAssessmentCandidatesSelectionDue DiligenceTransactionStructuring &ClosingPost DealSupportWhatweassistBestPracticeIdentify businessopportunity, evaluatemarket entryobjectives andoptions, and assessthe strategic rationalefor acquisitions,investments oralliances• Opportunities arebest where there is afavorable intersectionof regulatory spacewith market demand• Aggressively studythe market for thehighest value spotIdentify, screen andrank acquisition,investment or alliancetargets based onstrategic attractivenessand transaction risk• The ideal targetsare those withstrategic fit• Have realisticsynergy expectationPerform target duediligence• Commercial• Financial• Operational• Management• Undertake extremediligence on alldomestic entities thatare material to yoursuccessStructure terms of thetransaction and advicemanagement innegotiation and closing• New structuraloptions and complextax requirements candetermine success orfailure• Explore and model indetail all the structuraloptions, with a view tooperational efficiency,scalability, and taxefficiencyAssist in post dealremediation issuesand integration• Build a robust,responsive, andsustainableorganization• Build an organizationthat is closelyconnected to thecorporate center andthe domestic marketTransaction Services Strategy Group24

Market Entry Strategies into China for Australian Companies

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