The China Venture

The China Venture:
Business Environment and Strategic Considerations
Prof. Dr. Li Choy Chong, Oliver Kabuth, and Klaus Kukovetz (editors)
The Asia Research Centre,
The Research Institute for International Management,
The University of St. Gallen
featuring papers by
Matthias Weibel
Dr. Michael Loretan
Cinderella Freiin von Dungern
Klaus Kukovetz
Rainer G. Kirchhofer and Stephan Lechner
Matthias Kästner
Brigitta Joho and Jürgen Müller

ACKNOWLEDGEMENTS
I wish to thank the Grundlagenforschungsfonds (GFF) of the University of St. Gallen for
supporting the employment of assistants, Peter Lindstrom, Anita Subramanian and Matthias
Weibel, to work on the project.
I also wish to thank the many student-authors who have contributed to the work of these
three books, in terms of their articles, revisions and updates and other editorial and secretarial
assistance. In particular, I would like to thank Oliver Kabuth, Klaus Kukovetz, Matthias
Weibel, Michael Loretan, Cinderella von Dungern, Rainer Kirchhofer, Stephan Lechner,
Matthias Kästner, Brigitta Joho and Jürgen Müller, for their contributions to the China
Venture book;
Peter Lindstrom, the students of the Vietnam study group (Marc Ammann, Verena Antl,
Andreas Barfuss, Andrea Baumeister, Christian Chalut, Fabian Engl, Thomas Glesti, Urs
Graf, Thomas Gysi, Benjamin Jäggi, Brigitta Joho, Monica Kirchhoff, Chantal Landert,
Florian Lanz, Robert Liebl, Jürgen Müller, Oliver Schwarz, Pascal Sommerhalder, Joel
Widmer and Antonia Zambon, including my assistants Reza Rahimi, Klaus Kukovetz and
Peter Lindstrom), Stefan Otto, Reza Rahami, Tina Habicht, Philipp Reese, Marco Sütterle,
Peter Geiser, Matthias Kästner, and Christian Carduck, for their contributions to the Emerging
Asia book, and
Anita Subramanian, Peter Lindstrom, Marusa Fasano, Christian Börstnar, Marc Oesch,
Andreas Barfuss, Sven Graber, Stefan Graf, Gabriel le Laidier Robert Liebl, and Daniel
Seeli, for their contributions to the Asia Businesses in Europe book.
Finally, I wish to thank my secretary, Kristina Stalder and my personal assistants, Mirweiss
Meidanval and Ricarda Ross for their often unseen and unacknowledged help in my work
place.
Li Choy Chong
ii

Table of Contents
List of Figures ..........................................................................................................................viii
List of Tables .............................................................................................................................ix
Abbreviations ..............................................................................................................................x
1. INTRODUCTION: THE CH INA VENTURE ............................................................ 1
2. THE CHINESE BUSINESS ENVIRONMENT .......................................................... 4
2.1 THE CHINA REFORM STORY (BY MATTHIAS WEIBEL) ...................................................4
2.2 THE LEGAL SYSTEM IN CHINA (BY DR. MICHAEL LORETAN )........................................6
2.2.1 Chinese Legal History..............................................................................................7
2.2.1.1 Traditional Chinese Law ..................................................................................7
2.2.1.2 Modern Chinese Law .......................................................................................8
2.2.2 Governmental structure..........................................................................................10
2.2.3 Legal structure ........................................................................................................11
2.2.4 Judicial Structure ....................................................................................................12
2.2.5 Current problems of the operating legal system ....................................................14
2.2.6 Foreign Investment Law ........................................................................................15
2.2.7 Contract law ...........................................................................................................16
2.2.8 Company Law ........................................................................................................17
2.2.9 Conclusion .............................................................................................................18
2.3 BUSINESS FINANCE IN CHINA (BY CINDERELLA FREIIN VON DUNGERN) .....................19
2.3.1 Financial framework for foreign direct investments..............................................20
2.3.1.1 Financial sector development in China ..........................................................21
2.3.1.2 Financial institutions ......................................................................................23
2.3.1.3 Legal framework for financial structuring .....................................................30
2.3.1.4 Instruments of financial control in China .......................................................32
2.3.2 China’s financial markets.......................................................................................35
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2.3.2.1 Stock market...................................................................................................36
2.3.2.2 Bond market ...................................................................................................37
2.3.2.3 Foreign exchange market...............................................................................38
2.3.2.4 Interbank money market.................................................................................38
2.3.2.5 Short term debt securities market...................................................................40
2.3.3 Instruments of financial management ....................................................................40
2.3.3.1 Equity financing.............................................................................................42
2.3.3.2 Debt financing ................................................................................................45
2.3.3.3 Currency management ....................................................................................48
2.3.4 Conclusions ............................................................................................................50
3. PRE-ENTRY STRATEGIC CONSIDERATIONS TO MAXIMISE BUSINE SS
POTENTIAL................................................................................................................. 53
3.1 PRE-ENTRY CONSIDERATIONS: NEED FOR BUSINESS SELF-EXAMINATION (BY KLAUS
KUKOVETZ).................................................................................................................53
3.1.1 General Readiness to Venture Abroad...................................................................54
3.1.2 Specific Fit with the New Environment: Products and/or Partners .......................54
3.1.3 Practical Illustrations..............................................................................................55
3.1.3.1 Case Study 1: A Swiss labelling and labelling sys tems company (LLSC)....55
3.1.3.2 Case Study 2: Swiss printing systems company (SPSC) ...............................57
3.2 MAXIMISING POTENTIAL THROUGH STRATEGIC FIT WITH POTENTIAL PARTNERS (BY
RAINER G. KIRCHHOFER AND STEPHAN LECHNER) .....................................................61
3.2.1 Issues and Scope of this Paper ...............................................................................61
3.2.2 Changes in China’s Attitude towards Investors.....................................................62
3.2.2.1 The Chinese Government ...............................................................................62
3.2.2.2 Creation of Special Economic Zones (SEZ), Free Trade Zones (FTZ), and
High Technology Development Zones ..........................................................64
3.2.3 Foreign Governments .............................................................................................66
3.2.3.1 Export Risk Insurance ....................................................................................66
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3.2.3.2 Special Funds for Setting Up Businesses .......................................................66
3.2.4 Environment for Investors .....................................................................................67
3.2.4.1 Tax Holidays, Customs Liberation, and Other Incentives .............................67
3.2.4.2 Loans and Guarantees by the State ................................................................68
3.2.4.3 Legal Framework for Foreign Investment .....................................................69
3.2.4.4 Legal Provisions Concerning Land Use.........................................................69
3.2.4.5 Intellectual Property .......................................................................................70
3.2.4.6 Guanxi ............................................................................................................71
3.2.4.7 Environmental Protection ...............................................................................72
3.2.5 Forms of Foreign Investment in China ..................................................................73
3.2.5.1 Sino-foreign Equity Joint Ventures................................................................74
3.2.5.2 Co-operative Joint Ventures (CJV) ................................................................74
3.2.5.3 Wholly Foreign-Owned Enterprises (WFOE)................................................74
3.2.5. 4 Chinese Holding Companies..........................................................................75
3.2.5.5 Comparison between Investment Vehicles ....................................................76
3.2.6 Strategy Planning ...................................................................................................78
3.2.7 Risk Analysis .........................................................................................................79
3.2.8 Key Success Factors in Chinese Investments ........................................................80
3.2.9 Profiles of Partners Participating in an Investment in China.................................83
3.2.9.1 Ideal Profile ....................................................................................................83
3.2.9.2 Dimensions of the Profiles .............................................................................84
3.2.9.3 Profiles of the Partnering Companies .............................................................87
3.2.10 Fund Raising for the Investment in China .............................................................97
3.2.10.1 How can the Swiss Government Support SME's Investing in China? ...........97
3.2.10.2 How can Swiss Banks Function as Partners?.................................................98
3.2.10.3 Which Fund Raising Strategies should SME's follow for Investment in
China?.............................................................................................................98
3.2.11 Management of Human Resources ......................................................................100
3.2.11.1 Managing Labour Law .................................................................................100
v

3.2.11.2 Human Resources as a Cost Factor ..............................................................100
3.2.11.3 Local Staff versus Expatriates ......................................................................101
3.2.11.4 Expatriates and Intercultural Management Skills ........................................101
3.2.12 Management of Relationship ...............................................................................102
3.2.13 Case Study: Swisstec, Lyss ..................................................................................105
3.2.13.1 Company Profile ..........................................................................................105
3.2.13.2 Motivation for Founding Swisstec ...............................................................105
3.2.13.3 Choosing the Partners and Establishment of the Company .........................105
3.2.13.4 Human Resources.........................................................................................106
3.2.13.5 Summary ......................................................................................................106
3.3 MAKING A HIGH - TECH MARKET ENTRY (BY MATTHIAS KÄSTNER)........................107
3.3.1 The Choice of the Market Entry Mode: A Framework........................................108
3.3.1.1 Internal Determinants...................................................................................109
3.3.1.2 External Determinants ..................................................................................110
3.3.1.3 The Role of Technology...............................................................................111
3.3.2 SME’s Objectives for China Activities................................................................111
3.3.2.1 Objective 1: Exploiting Domestic Sales Opportunities................................112
3.3.2.2 Objective 2: Exploiting Existing Know-How and Proprietary Technology 113
3.3.2.3 Objective 3: Exploiting Comparative Cost Advantages ..............................114
3.3.2.4 Objective 4: Providing After Sales Service and Maintenance .....................114
3.3.2.5 Objective 5: Research and Development .....................................................115
3.3.3 Assessment of Bargaining Situations for SMEs ..................................................115
3.3.3.1 Bargaining Situation I: SME – Local Chinese Authorities ..........................118
3.3.3.2 Bargaining Situation II: SME – Chinese Joint Venture Partner ...................120
3.3.3.3 Bargaining Situation III: SME – Trading House / Distributor.....................122
3.3.3.4 Bargaining Relation IV: SME – Chinese Technology Recipient.................123
3.4 NEGOTIATING FOR A JOINT VENTURE: STRATEGIC CONSIDERATIONS (BY BRIGITTA
JOHO AND JÜRGEN MÜLLER) .....................................................................................125
3.4.1 Culture..................................................................................................................126
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3.4.1.1 National Culture ...........................................................................................126
3.4.1.2 Business Culture...........................................................................................127
3.4.1.3 Corporate culture ..........................................................................................127
3.4.2 Comparison of Business and Culture between Germany/Switzerland and China
..............................................................................................................................127
3.4.2.1 Understanding of Confucianism...................................................................128
3.4.2.2 Guanxi and the importance of family and friends ........................................129
3.4.2.3 Self-Presentation ..........................................................................................129
3.4.2.4 Conversation at the first meeting .................................................................131
3.4.2.5 Negotiation process and its communication problems .................................132
3.4.2.6 Yes and No...................................................................................................134
3.4.2.7 Further Differences between Germany/Switzerland and China...................134
3.4.3 Experiences of European Companies with Joint Ventures in China ...................135
3.4.3.1 Interviewed Companies................................................................................135
3.4.3.2 Interviews .....................................................................................................136
3.4.3.3 Important Factors .........................................................................................136
3.4.3.4 Evaluation of the Interviews ........................................................................140
4. POST-ENTRY STRATEGIC CONSIDERATIONS.............................................. 141
4.1 POST -ENTRY CONSIDERATIONS: NEED FOR RE-EVALUATION AND RE-POSITIONING (BY
KLAUS KUKOVETZ) ...................................................................................................141
4.1.1 Introduction ..........................................................................................................141
4.1.2 Case studies..........................................................................................................142
4.1.2.1 Luxury goods company in China (LGC)......................................................142
4.1.2.2 Consumer goods company in China (CGC).................................................144
Epilogue ..................................................................................................................................148
5. REFERENCES........................................................................................................... 149
6. APPENDIX ................................................................................................................. 159
6.1 FACT SHEET PEOPLE’S REPUBLIC OF CHINA..............................................................159
vii

List of Figures
FIGURE 2-1: DEVELOPMENT OF FOREIGN DIRECT INVESTMENTS (IN BILLION USD)
COMBINED WITH KEY EVENTS IN CHINA, 1976 - 2000...................................6
FIGURE 2-2: STRUCTURE OF CHINA'S FINANCIAL SECTOR............................................. 24
FIGURE 2-3: STRUCTURE OF CHINA'S BANKING SECTOR................................................. 25
FIGURE 3-1: ORGANISATION OF THE GOVERNMENT OF THE PEOPLE 'S REPUBLIC OF
CHINA........................................................................................................... 63
FIGURE 3-2: MAP OF CHINA............................................................................................. 65
FIGURE 3-3: PRELIMINARY STRUCTURE OF THE "SINO-SWISS PARTNERSHIP FUND".... 67
FIGURE 3-4: MANAGEMENT CONTROL VS . FINANCIAL EXPOSURE OF VARIOUS
INVESTMENT VEHICLES................................................................................ 76
FIGURE 3-5: DEVELOPMENT OF FORMS OF CO-OPERATION IN CHINA............................. 78
FIGURE 3-6: IDEAL PROFILE OF A COMPANY INVESTING IN CHINA................................... 84
FIGURE 3-7: PROFILE OF A TYPICAL SMALL OR MEDIUM ENTERPRISE............................. 88
FIGURE 3-8: PROFILE OF A CHINESE JOINT VENTURE PARTNER.................................... 89
FIGURE 3-9: PROFILE OF FOREIGN BANKS AND GOVERNMENT INSTITUTIONS................ 90
FIGURE 3-10: PROFILE OF BUSINESS PARKS..................................................................... 91
FIGURE 3-11: PROFILE FOR THE OPTIMUM COMBINATION OF AL L POTENTIAL PARTNERS. 92
FIGURE 3-12: PROFILE OF SUZHOU MFN EMBROIDERY CO. LTD.................................... 93
FIGURE 3-13: PROFILE OF SUZHOU NOVE FASHION & CRAFTS CO. LTD......................... 95
FIGURE 3-14: PROFILE OF SWISSTEC................................................................................ 96
FIGURE 3-15: THE WAY TO "GOLDEN TOWN "..................................................................104
FIGURE 3-16: DETERMINANTS FOR THE CHOICE OF THE MARKET ENTRY STRATEGY......109
FIGURE 3-17: INTERNAL DETERMINANTS .........................................................................110
FIGURE 3-18: THE CHOICE OF MARKET ENTRY STRATEGY.............................................112
FIGURE 3-19: THREE LEVELS OF CULTURE......................................................................126
viii

List of Tables
TABLE 2-1: THE AREAS OF THE FOUR SPECIALISED BANKS............................................ 26
TABLE 2-2: DIFFERENCES IN BANKING SERVICES .......................................................... 29
TABLE 3-1: SWOT ANALYSIS FOR SPSC IN RESPECT TO MARKET ENTRY IN ASIA...... 58
TABLE 3-2: INCENTIVES FOR FOREIGN INVESTORS........................................................ 68
TABLE 3-3: OVERVIEW OF INVESTMENT VEHICLES IN CHINA......................................... 77
TABLE 3-4: STRATEGIC QUESTIONS FOR SME'S PLANNING TO INVEST IN CHINA......... 79
TABLE 3-5: RISK ANALYSIS OF INVESTMENTS IN CHINA................................................. 80
TABLE 3-6: KEY SUCCESS FACTORS C ONCERNING PRODUCTS AND MARKETS............. 81
TABLE 3-7: SUCCESS FACTORS CONCERNING CHINESE PARTNERS.............................. 82
TABLE 3-8: KEY SUCCESS FACTORS CONCERNING COMPANY STRUCTURE AND
ADMINISTRATION .......................................................................................... 83
TABLE 3-9: QUALIFICATION PROFILE OF MANAGERS WORKING IN CHINA....................102
TABLE 3-10: MEMBERS OF THE SWISSTEC ORGANISATION ...........................................105
TABLE 3-11: EXTERNAL DETERMINANTS........................................................................110
TABLE 3-12: TECHNOLOGY DETERMINANTS ..................................................................111
TABLE 3-13: RELATIONS BETWEEN A SME AND ITS BARGAINING PARTNERS...............117
TABLE 3-14: INTERESTS, OBJECTIVES AND EXPECTATIONS BETWEEN HIGH-TECH SMES
AND CHINESE AUTHORITIES......................................................................118
TABLE 3-15: INTERESTS, OBJECTIVES AND EXPECTATIONS BETWEEN HIGH-TECH SMES
AND CHINESE JV P ARTNERS.....................................................................120
TABLE 3-16: INTERESTS, OBJECTIVES AND EXPECTATIONS BETWEEN HIGH-TECH SMES
AND DISTRIBUTORS....................................................................................122
TABLE 3-17: INTERESTS, OBJECTIVES AND EXPECTATIONS BETWEEN HIGH-TECH SMES
AND CHINESE TECHNOLOGY RECIPIENT...................................................123
TABLE 3-18: COMPARISON OF VALUES AND BEHAVIOUR..............................................129
TABLE 3-19: PRESENTATION OF THE OWN PERSON.......................................................130
TABLE 3-20: COMMUNICATION BEHAVIO UR AT THE FIRST MEETING..............................131
TABLE 3-21: MANAGER-THINKING: COMPARISON OF GERMANY/ SWITZERLAND AND
CHINA.........................................................................................................134
ix

Abbreviations
ABC Agricultural Bank of China
ADB Agricultural Development Bank
APEC Asian-Pacific Economic Co-operation
APT Arbitrage Pricing Theory
BOC Bank of China
Bocom Bank of Communications
CAPM Capital Asset Pricing Model
CCB China Construction Bank
CCP Chinese Communist Party
CHF Swiss Franks
CIB China Investment Bank
CITICIB China International Trust and Investment Corporation Industrial Bank
CJV Contractual Joint Venture
CMB China Merchants Bank
CS Credit Suisse
CSRC China Securities Regulatory Commission
DEM German Marks
EBC Everbright Bank of China
EIB Export and Import Bank of China
EJV Equity Joint Venture
EMH Efficient Market Hypothesis
FDI Foreign Direct Investment
FIB Fujian Industrial Bank
FIC Foreign Investment Commission
FIE Foreign Invested Enterprise
GATT General Agreement on Tariffs and Trade
x

GBP Pounds Sterling
GDB Guangdong Development Bank
GDP Gross Domestic Product
GITIC Guandong International Trust and Investment Corporation
HDB Hainan Development Bank
HII High-net-income Individual
HKD Hongkong Dollars
HSBC Hongkong & Shangha i Banking Corp.
HWI High-net-worth individual
HXB Huaxia Bank
ICBC Industrial and Commercial Bank of China
IEB Import and Export Bank
IFC International Finance Corporation
IMD International Institute for Management Development
IPO Initial Public Offering
IT Information Technology
JPY Japanese YEN
M&A Mergers and Acquisition
MPT Modern Portfolio Theory
NBFI Non-Bank Financial Institutions
NETS National Electronic Trading System
OCC Opened Coastal City
OCP Opened Coastal Province
OECD Organisation for Economic Co-operation and Development
OTC Over-the-counter
p. page
PB Private Banking
xi

PBOC People’s Bank of China
PDB Pudong Development Bank
PM Portfolio Management
PRC People’s Republic of China
RMB Renminbi Yua n
SBC Swiss Bank Corporation, now: UBS
SBG Schweizerische Bankgesellschaft, now: UBS
SDB State Development Bank
SEC United States Securities and Exchange Commission
SGD Singapore Dollars
ShDB Shenzhen Development Bank
SOE State-owned enterprise
SSE Shanghai Securities Exchange
STAQS Securities Trading Automated Quotation System
U.K. United Kingdom
U.S. United States (of America)
UBS AG New Name of the united UBS and SBC (Juli 1998)
USD US Dollars
WFOE Wholly Foreign-Owned Enterprise
WTO World Trade Organisation
xii

1. Introduction: The China Venture
Paul Krebs was perplexed and bewildered. Throughout his 22 years as an international
businessman, he has never experienced such inexplicable treatment from his business allies
and acquaintances as he did in China recently. It was not that they treated him badly, or they
tried to cheat him or twist his arms. These would not have been surprising at all. The
perplexing or even bewildering aspect of this episode lies in the fact that they treated him so
very well, treating and feasting him like a VIP, and yet refused to discuss anything relating to
the continuation of a supposedly on-going business, evading and postponing indefinitely
every mention of work and business.
This is definitely strange but should not be inexplicable. After all, these are supposedly
business people and people his firm has been working with over the last 3 years. Indeed,
everything went very well when Mr. Zheng was running the business for him in China. The
business started up in China without a hitch and the deals struck were always profitable.
There was no difficulty whatsoever. No problem was ever brought up to him. He only heard
good news every time he asked. The accounts always looked good, in fact too good to be true.
If everything else were not real, at least the money which flowed into his firm’s bank account
in Switzerland were real.
Is this what Guanxi is all about? He heard so much about Guanxi from others, yet never
experienced any problem with it. Perhaps, his firm’s dealings with China has been bouyed by
Mr. Zheng’s Guanxi. With Mr. Zheng gone, there is no more Guanxi. This seems plausible,
yet it does not explain the extreme kindness and hospitality of the Chinese. If the Guanxi is
still there, why then are the Chinese not talking business with him. If there is no intention of
wanting to do business, why should they be so nice to him? If Guanxi was the web of
relationships which helped buoy his business in China in the past, then it would seem to be a
spider’s web which renders him helpless and unable to move his business now.
Such thoughts have occupied Paul Krebs’ mind since he went on his business trip to China 3
weeks ago. There seems to be no logical explanation for all these. It is incredible how one
man (Mr. Zheng) can do so much difference to a business.
Mr. Zheng was an employee of Paul Krebs. He came to work for Paul’s firm after his
graduation from a university in Germany. He was bright, and very hardworking and
responsible. As a result, he soon ear ned the trust and respect of his boss, Paul. After working
3 years with Paul’s firm, he expressed his desire to return home to China. This was when Paul
1

Krebs decided that he should perhaps venture into China and offered Mr. Zheng the
opportunity to head-up a new venture in China. Mr. Zheng readily agreed and set-up a
successful venture for Paul in Shanghai.
Three months ago, Mr. Zheng told Paul that he had been offered the job of General Manager
by an American company in China to take overall responsibility for its operations there. He
was offered a pay package worth 3 times his salary working for Paul’s firm. It was an
opportunity too good to miss for Mr. Zheng. Paul did not think Mr. Zheng was worth that
money at that point in time. It is not that the venture in China could not generate the kind of
money Mr. Zheng asked for. He could have paid Mr. Zheng more than what the competitor
offered. He just felt that the amount was too high and that the company could replace Mr.
Zheng with some other person at a c heaper salary, or he can just do the job himself. After all,
the past deals involved importing Chinese products and exporting European products to
China. There is nothing so complicated about that, and most times, deals are repeated anyway.
He therefore wished Mr. Zheng “Good luck” and let him go, not realising that following Mr.
Zheng’s departure, there would be no more deals, not even the renewal of the repetitious deals
of the past. There is nothing sinister about this. Mr. Zheng has acted correctly in this matter,
as Paul has realised during his recent trip to China. He did not take any of the past deals with
him to his new company.
Returning to Zurich in Switzerland, Paul’s mind continued to be occupied with his China
Venture. True, he has already closed down his small assembly and warehousing operation in
China. There is also no hope of ever reviving the highly successful and profitable trading
operations he had under Mr. Zheng's management. He should not be wasting his time there,
neither should he be wasting his thoughts now, by thinking about something which is
essentially over. But he just could not get his mind off his China venture.
In a recent family reunion with his brother’s family, he learnt from his niece who studied at
the University of St. Gallen (HSG) that she had been to China with her Management in Asia
class. He was impressed with his niece’s knowledge of China and wished he had a discussion
with her earlier. He managed to get a copy of her class report and started to read about
“Business Environment and Opportunities in China: Shanghai and its Surrounding Regions" 1 .
Thereafter, he decided to contact the Asia Research Centre at the Research Institute for
International Management at the University of St. Gallen.
2

After a short discussion with the professor there, Paul was given a stack of students’ papers in
the area of “Venturing in China: Business Environment and Strategic Considerations”. This,
according to the professor, could provide the information he needed. He took the stack of
pape rs home and started to review them and reflect on his recent past – The China Venture.
The papers provided a comprehensive overview of the business environment and strategic
considerations for business venturing in China. The first couple of papers surveyed the
business environment in China and discussed such environmental aspects like the operating
legal and financial systems.
Knowing the environment in China is only the first step to strategy formulation and business
venturing. Realising one’s own strengths, weaknesses and potentials is just as important.
Business self-examination is therefore a critical pre -entry requirement. It also enables the
business to plan for strategic fit with its potential partners in China in order to maximise its
own potential and to overcome possible problems and avoid potential pitfalls in the new
operating environment in China.
Understanding the social and cultural differences there will certainly go a long way to help
with business negotiations as well as business operations and success in China. Having
technology to offer will also provide the firm with additional bargaining power in negotiations
and help win over strategic allies in China, which could be influential business partners as
well as government officials.
Making a successful business entry into China is important. Sustaining it requires further
effort. There is also the need for continual re -evaluation and re-positioning of the on-going
business given the continuous and rapid changes in the laws and operating environment in
China. Human problems resulting from local employees as well as local business partners,
such as the resignation of your Chinese General Manager, may require a thorough re-
examination or even re-organisation of your business venture there, in spite of its past
success.
Paul ponders about these points as he reviewed these papers, relating always to his own China
venture...
1 The book 'Business Environment and Opportunities in China: Shanghai and its Surrounding Regions'
was published by German University Press, a subsidiary of Gabler Verlag in 1998.
3

2. The Chinese Business Environment
The economic transformation of modern China from a Soviet-style, centrally planned
economy to one which is increasingly market-oriented and open to foreign business
investments and operations began in 1978. The story of China’s economic reform based on
the setting up and rapid growth of a market economy which is becoming increasingly
important, and in parallel to an existing and dominant command economy which shrinks in
tandem with the growing dominance of the market economy, provides certainly an interesting
lesson in economic transformation change. Matthias Weibel wrote about the China Reform
story ...
2.1 The China Reform story (by Matthias Weibel)
Under the guidance of Deng Xiaoping the economic reforms started with the “Four
Modernisations“ involving agriculture, industry, science and technology, and national
defence. In agriculture the authorities replaced the old collectivisation with a system of
household responsibility. In industry, the authority of local officials and plant managers were
increased. A wide variety of small-scale enterprises in services and light manufacturing were
also permitted. The economy was opened increasingly to foreign trade and investment.
Knowing that the modernisation of the Chinese industry could not be realised without foreign
resources, the government also decided to establish four Special Economic Zones along the
Chinese south coast, offering attractive incentives for foreign firms and creating a secure
economic environment. In these zones, China offered low tax rates, low bureaucratic hurdles,
and permission to repatriate the profits gained, in addition to relatively cheap land and labour.
At the same time, several provinces (Opened Coastal Provinces - OCPs) 2 and cities (Opened
Coastal Cities - OCCs) 3 were allowed to provide similar incentives for foreign investors.
Chinese firms, especially those in big cities like Shanghai, were selected for greater
autonomy. Since management was no longer subject to central government control, the
resident managers were now in charge of the bottom-line, and had a free hand in the choice of
suppliers, production methods, marketin g, administration and accounting. Banks were also
given greater autonomy in providing loans. The reforms encouraged Chinese companies to
2
Lioning, Hebei, Tianjin, Shandong, Jiangsu, Shanghai, Zhejiang, Fujian, Guangdong, Hainan,
Guangxi.
3
Dalian, Tianjin, Qingdao, Shanghai and Guagzhou.
4

co-operate with other firms, especially foreign firms. (In Shanghai, for example, foreign Joint
Ventures have been allowed since 1983).
To improve the development of science and technology, the government provided substantial
funding to facilitate technology and knowledge transfer from foreign countries to China.
Thousands of students were sent abroad to study. Chinese universities were also rebuilt
(having been suppressed during the Cultural Revolution) and given certain autonomy. Since
then, the expenditure on research has increased enormously and international relationships
multiplied.
Thanks to the reforms, the Chinese economy took off in the 1980s. Agricultural output
doubled during the same period and the country’s GDP had quadrupled since 1978. Industry
posted major gains, especially in coastal areas near Hong Kong and opposite Taiwan, where
foreign investment helped spur output of both domestic and export goods. However, such
rapid economic growth has also been accompanied by unacceptable social consequences like
unnecessary bureaucracy, lassitude, corruption, socially unacceptable greed among parts of
the Chinese populace for windfall gains which threatened cultural values and social order, and
inflation.
The Tiananmen Square incident in June 1989 dampened economic growth temporarily.
Nevertheless, following the announcement of far-reaching reforms during Deng Xiaoping’s
trip to the Southern Special Economic Zones, foreign investments were boosted considerably.
This could in part be attributable to the Bank of Japan’s more expansionary monetary policy
at that time up to the middle of 1996, which also helped other Asia n nations.
In 1992-96 annual growth of GDP accelerated, particularly in the coastal areas - averaging
more than 10% annually according to official figures. In late 1993 China's leadership
approved additional long-term reforms aimed at giving still more scope to market-oriented
institutions and at strengthening the control over the financial system. State enterprises
continue to dominate many key industries in the new "socialist market economy."
In spite of Deng Xiaoping’s death in February 1997, China continued on its road to economic
reform. The Asia Financial Crisis also failed to dampen China’s economic performance. In
fact, the Crisis has led the Chinese government to make extremely tough decisions to reform
the banking institutions and to crack down on corruption. Such rapid changes in laws and
institutions are never comfortable to people who are living and working in China as it affects
their way of life and increase the feeling of uncertainty. Nevertheless, this should bode well
for the economic future of China.
5

45
40
35
30
25
20
15
10
5
0
Joint Venture
Law and SEZs
Begin of the
Four
Modernisations
Rural reforms
announced
Approval of 14
more SEZs
Set up of
WFOE
allowed
Price
reforms
Tienanmen
Square Incident
Deng’s visit
to the South
Stock
Exchange
Opening
Dual exchange
rate abolished
Deng‘s
death
Asian Crisis
started
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
FIGURE 2-1: Development of Foreign Direct Investments (in Billion USD) combined with
key events in China, 1976 - 2000 4
As Paul reads the China Reform Story, he could not help reflecting on his own China venture.
”Deng Xiaoping started the reforms . His reforms lived on and prospered after him. Here was
my China venture. It died when Mr. Zheng left...”. Paul felt little comfort in this thought, yet
he was intrigued with the China Story ... and he read on ...
Dr. Loretan, a trained and practising lawyer who has chosen to further his studies in business
and economies at HSG wrote:
2.2 The Legal System in China (by Dr. Michael Loretan)
It has been 20 years since China opened its door to the world in 1978. China is a land of
opportunities. Its potential purchasing power, especially in the long run, meets the dream of
long-term investors. However, China is also a land of uncertainty for those investors who do
not know much about its legal system, under which the game of investment has been, and will
be played.
4 Data based on IMF, 1997a, p. 296. See also Dony, 1986, p. 52.
6

The Chinese operating legal system is a nascent system, emerging from the unique history,
culture and social structure of China. All these factors should be taken into consideration in
order to gather insightful understandings of the actual operation of the legal system. This
paper provides a brief overview on Chinese legal history and the governmental structure of
the People’s Republic of China. It also provides a short in troduction to some general aspects
of Chinese law, such as the legal structure, the judicial structure and some current problems of
the operating legal system, as well as a first glance at the fields of Chinese law which are of
particular interest to potential investors in one of the most promising markets of the future.
2.2.1 Chinese Legal History
The legal history of China is commonly divided into two parts, namely the part of traditional
Chinese law spanning from the Xia Dynasty, the first dynasty in Chinese history more than
4,000 years ago, to the Qing Dynasty in the early 20 th century, and the part of modern Chinese
law, starting form the legal reforms during the Qing Dynasty to the present time.
2.2.1.1 Traditional Chinese Law
Traditional Chinese Law is, along with the common law family, civil law family, and the
Islamic law family, considered as one of the four major law families. It has its foundations in
the 21 st century BC and persisted until the beginning of this century. Despite the formal repeal
of the Tradit ional Chinese Law in the early 1900s, it continues to exert its influence on
contemporary society. In this sense, traditions may serve as explanation of peculiar practices
and problems of the existing legal system.
The features of the Chinese Legal Tradition which are distinct from Western traditions, and
thus, to a great extent, contrary to the concepts of modern law, are the following:
Traditional Chinese Law was constructed on the feudal system and protected the unequal
status of persons. Equality before law has never been accepted as a legal principle. Social
status has been more important than legal rules. Some practices of inequality before the law in
contemporary China, such as the necessity to seek approval form a higher authority before
investigatin g and prosecuting high-ranking officials, may still be attributed to this legacy.
Traditional Chinese Law was founded on a totalitarian system rather than on a democratic
model. The emperors reigned with absolute power and control over the entire country.
Therefore, the traditional Chinese legal system, in its function as a subordinate of the power
structure, never tolerated the existence of legal rules other than those of the emperor. This
7

forms a sharp contrast to Western civilisations, where the secular and religious powers and the
legal system co-existed and fostered a tradition of plurality and supremacy of law. The
difficulty in today’s China to accept the supremacy of law may be considered as a
consequence of Traditional Chinese Law.
Criminal law formed the backbone of the traditional legal system. As a result, all types of
litigation were subject to criminal procedures and law was generally viewed as a cruel
instrument of suppression. The concept of private law reflecting the spirit of market
exchange s among equal persons has never appeared in the traditional legal system. This again
forms a sharp contrast to Western legal tradition, which is based to a great extent on private
law. The lack of private law in Traditional Chinese Law and the dominance of criminal law
may to a certain extent serve as an explanation of the generally hostile attitude towards
litigation in contemporary China.
Traditional Chinese Law did not know the formal separation of the judicial branch.
Administrative officials exercised both the power of administration and the power of
adjudication. The typical format of a traditional litigation was an inquisitional process backed
by physical torture to obtain a confession. Therefore, the traditional concept was that justice
cannot be found in law, but from the intelligence and honesty of individual officials. This may
serve as an explanation of the still widespread distrust in the official judicial structure. As a
consequence, justice is often searched for outside the formal procedure in today’s China.
The above features overshadow the generally accepted positive values of Traditional Chinese
Law such as the mixed system of codification and precedents, the emphasis on the educational
function of law, the rich experience in legal practice, and the function of law in stabilising
social harmony. Still, the traditional legal system constituted an insurmountable obstacle in
the historical course of transition towards modernisation. It had to be abolished in order to
transit to a new era of Chinese legal development.
2.2.1.2 Modern Chinese Law
In order to cope with the development of the fledgling modern national economy, the Qing
Dynasty promulgated reforms of the legal system in the early 20 th century. The major laws
enacted at that time were all based on German, French and Japanese law. This modelled the
new Chinese legal system according to civil law tradition. The following reasons caused the
introduction of civil rather than common law.
8

First of all, Britain’s predominant international status was dec lining at the beginning of the
20 th century. Secondly, China and Japan are neighbouring countries which share the same
or igin. Also Japan was the nearest modernised and westernised country to China. So it was
convenient for Chinese to go to Japan to study modern Western sciences and knowledge,
including law. As a result, both Chinese legislation and legal theory were substantially
influenced by Japan. Since modern Japanese law was introduced from Germany, Japanese law
was indirectly derived from the Roman law tradition and Chinese law followed the same path.
Thirdly, it was impossible for a country like China, which had a well-established legal system
with more than 4,000 years of history, to introduce common law because of the historical
background and the nature of case law.
In the 1930s the legal modernisation in old China came to its end. By that time, modern
constitutional laws, civil laws, commercial laws, criminal laws, civil procedure laws and
criminal procedure laws were introduced. This also marks the completion of the transition
from the traditional Chinese law system to Roman civil law.
In 1949 the People’s Republic of China (hereafter the PRC) was founded by the Communist
Party of China. The Kuomintang government fled to the province of Taiwan. There, the laws
enacted on the mainland remained implemented. On the mainland however, a new legal
system based on entirely different political, economic and ideological structures was
established.
The legal system in new China was developed by adopting that of the former Soviet Union.
This new system was based on the following principles: in the economic field, public
ownership and a centralised-planned economy; in the political field, people’s democratic
dictatorship and the supremacy of the Party; and in the cultural and ideological field, the
dominance of Marxist theory. 5
In this context the idea arose that the policies of the Party and the State should be more
important than legal rules, and a tendency to neglect or even violate rules and procedures for
the sake of social reform appeared. As a result, law was perceived as something flexible and
manipulatable. To a certain extent, this is still the dominant attitude in contemporary China.
5 See the wording of the first article of the Constitution of the PRC: “The People’s Republic of China is
a socialist state under the people’s democratic dictatorship led by the working class and based on the
alliance of workers and peasants. The socialist system is the basic system of the People’s Republic of
China. Disruption of the socialist state by any organisation or individual is prohibited.”
9

After its suspension during the period from 1956 to 1966, the legal system got literally
destroyed with the so-called “Cultural Revolution”. The country was in a complete chaos, law
was abolished and the legal apparatus, which was already inert, was completely smashed.
After the “Cultural Revolution”, China began to engage in unprecedented legal
reconstruction. Law was regarded as the most efficient and institutionalised means to
safeguard people’s democracy, to prevent sudden social changes and to maintain the sustained
economic development of the country. In the economic field, the policy of structural reform
and opening up to the outside world has been introduced and implemented; the rigid planned
economy has been abandoned in favour of a “Socialist Market Economy”. Corresponding to
such a social scenario, the legal system has been redesigned for the purpose of implementing,
institutionalising and strengthening the reform enterprise. The main achievements of the legal
reconstruction include the following:
The ideological change has to a great extent changed the popular view towards law. Chinese
government and its population have become aware of the importance of law.
Since 1979, China has embarked on a large-scale legislative endeavour with 3 new
constitutions, more than 200 new laws and 80 decisions of the National People’s Congress;
more than 700 administrative regulations of the State Council and its ministries, commissions
and other branches; about 3,000 local regulations, and more than 10,000 local administrative
rules of the local governments and their agencies.
Throughout the country, a legal structure has been established, including the system of the
people’s courts, the system of the people’s procuratorates and various governmental law
enforcement organs.
The legal profession has reappeared.
Despite these achievements, some negative aspects of the systems could not be overridden.
Severe problems due to profound contradictions and structural problems still need to be
solved.
2.2.2 Governmental structure
The structure of the Chinese government exercises a great influence on the operating legal
system. As a socialist country, China’s political structure is established on the system of
pe ople’s congresses which are responsible for creating and supervising the administrative and
judicial organs at all levels. Since the PRC adopts the unitary system and the principle of
10

democratic centralism, all governmental organs function under the unified leadership of the
central authorities, in line with the delegated powers. The following five levels can be
distinguished in the governmental structure of the PRC:
• the central level;
• the provincial level;
• the prefectural level;
• the county and city level;
• the township and village level.
The people’s congresses enjoy exclusive state power at each of the above mentioned five
le vels. Directly below the respective congresses, there exist three branches: the governmental
branch, the judicial branch and the procuratorial branch. The same pattern of structure can in
principle be observed at each level of the governmental structure.
However, it cannot be overlooked that beside the formal structure of the state organs, the
Communist Party, as the leading and only political party possessing state power, has the
decisive role in making, applying and reforming legal rules. Therefore, the comprehension
and interpretation of law needs to follow the Party’s policy and instructions.
2.2.3 Legal structure
As stated above, the legal structure closely relates to the governmental structure of the PRC.
The National People’s Congress (hereafter the NPC) as the highest state organ has the unitary
legislative power over the entire nation, and it delegates certain legislative powers to people’s
congresses at lower levels and the central and local governments.
On the top of the legal structure is the Constitution, the supreme law in China. 6 The
Constitution in force was enacted in 1982 and was revised respectively in 1988 and 1993,
resulting in 11 amendments. Although the Constitution is the supreme law in China, it cannot
be quoted in judicial verdicts and administrative decisions as direct legal ground for solving
concrete disputes and problems. Therefore, it is out of reach for the daily legal practice and
operation. The second level of law are the legal documents promulgated by the NPC,
6 An English translation of the Constitution of the People’s Republic of China may be found under:
http://www.qis.net/chinalaw /prccon5.htm.
11

including laws, decisions and ratified international treaties. 7 The third level are the documents
enacted by the Standing Committee of the NPC. As a consequence of the NPC’s meetings
held only once a year, the Standing Committee in practice represents the most important
organ for the creation of new laws. The forth level comprises the legal documents made by
the State Council (administrative regulations) and the documents issued by its ministries,
commissions and departments (administrative rules).
The above four levels of the legal structure are in a way easy to understand and easy to track.
When it comes to the legal documents of the lower levels of China’s governmental structure,
there exists a practically insurmountable flood of rules and regulations.
A very special part in the Chinese legal struc ture play the documents in relation with the “One
country-Two Systems” policy of the PRC. This set of laws deals with the reunification of
mainland China with Hong Kong and Macau. Thus when realising this reunification, the PRC
may, according to Article 31 of the Constitution, establish special administrative regions to
retain the capitalist systems in these regions. Additionally, the legal system of these special
administrative regions may be safeguarded. Therefore, the NPC on April 04, 1990 adopted the
Basic Law of the Hong Kong Special Administrative Region and decided to establish this
special administrative region on July 01, 1997 when China resumed its sovereignty over Hong
Kong. And on March 31, 1993 it adopted the Basic Law of the Macau Special Administrative
Region and decided to establish this special administrative region on December 20, 1999
when China will resume its sovereignty over Macau. 8 As regards the separation of powers
between the central authorities and the special administrative regions, the powers and
functions enjoyed by the central authorities are strictly limited to those required for the
protection of the national sovereignty and reunification of the motherland.
2.2.4 Judicial Structure
As already explained above, the judicial structure in China not only refers to courts, but also
to procuratorates. The presidents of courts and procurator -generals are appointed by the
pe ople’s congresses on the same levels, whereas the judges and procurators are appointed by
the standing committees of the respective people’s congresses.
7 A list of multinational treaties applicable to China may be found under:
http://www.qis.net/chinalaw/treat1.htm.
8 Legal documents relating to the special administrative regions of Hong Kong and Macau may be
found under: http://www.qis.net/chinalaw/lawtran1.htm.
12

The courts are the state organs exercising exclusive state adjudicatory power. Higher level
courts supervise the work of the lower courts, and the courts at various levels are responsible
to the respective people’s congresse s that created them. The courts have four levels, namely
the Supreme People’s Court at the national level, high courts at provincial level, intermediate
courts at prefectural level and basic courts at county and city level, respectively. The
procuratorates are the organs for legal supervision. Within the structure of the procuratorates,
higher level proc uratorates direct the work of those at lower levels. The procuratorial organs
at various levels are responsible to both the corresponding people’s congresses which created
them and pe ople’s procuratorates at higher levels.
The trial process is greatly influenced by the civil law jurisdiction in which the judge is the
dominant party conducting a trail. In principle, each case has at the most two trails, which
means that the right to appeal is limited. However, the parties may challenge a final decision
through a trial supervision procedure.
According to law, courts are to exercise their power independently and free from interference
from any organisations or individuals. However, there exist in practice all sorts of interfe rence
from inside and outside sources. Whereas interference from inside sources are known to
Western systems as well, interference from outside sources do create a certain unease among
Westerners. Protectionism between judges and the respective appointing bodies is still quite
frequent in contemporary China. Very often judgements are entered under pressure from local
governments and other organisations to bend justice for local interests or economy. Also in
some places, taking gifts from parties to a litigation is not an uncommon practice. 9
The above problems as regards the judicial independence are a lesser issue for foreigners than
for China itself. The so-called Two-track System is a feature in Chinese law that treats foreign
business concerns differently from domestic ones. In different aspects, such as taxation,
foreign exchange, but especially in dispute settlement, foreign firms, as an incentive to
investment in China, are accorded different, and in general more favourable, treatment than
domestic firms. 10 According to this Two-track System, the principal institution for the
resolution of disputes involving foreign firms is the China International Economic and Trade
Arbitration Commission. It serves in all arbitration cases in which a foreign person, legal or
9 This problem has been addressed by a new law lately, the actual results however are yet to be seen.
10 From China’s point of view, this system appears to be a necessary stop-gap measure in the
evolution of its economic and social reform. It was obvious that the general reform of the Chinese legal
system would take time. But the special need for foreign investment law could not wait. Therefore,
China had to start with the latter first, while at the same time beginning to build a body of domestic law.
13

natural, is involved, or even where no foreign person is involved if the case has to do with
international economic activities. The China International Economic and Trade Arbitration
Com mission is prominent in China’s legal system because of its recognised independence
from political control, its adherence to transparent and internationally endorsed arbitration
procedures, and its reputation for fairness. 11
2.2.5 Current problems of the operating legal system
Despite the fact that the Chinese government has made tremendous efforts to built up a legal
system meeting international standards, many problems still need to be solved.
In contemporary China a big gap exists between the law on paper and the law in practice.
Notwithstanding the large number of laws and regulations enacted since 1979, the
implementation of law remains a major challenge to the nascent legal system. Official China
starts to realise that the implementation of law shall be the major task for the next stage of the
legal development in the PRC. In addition to this, the concepts of supremacy of law and the
rule of law are still not entirely accepted by governmental officials. The crucial issue here is
whether the government and the CPC are subject to law, or whether law is merely an
instrument in governing the country.
Another big issue in discussion is the transparency and accessibility of laws and regulations in
China. Lawyers working with foreign clients often point out that it is difficult to get access to
the content of laws and regulations that apply to business operations. The dissemination of
legal information in China is so underdeveloped, so unsystematic that it is often difficult
simply to find the applicable law. Even when the relevant rule can be found, provisions are
often so broad and sketchy that it is difficult to be certain of a correct interpretation. There is
also no systematic compilation of court decisions that would aid in the interpretation of
statutes and regulations. In addition to that, there is the vexing problem of the internal agency
rules. These rules are not published and therefore inaccessible to outsiders. This is even more
irritating because the internal rules are frequently the real rules under which the respective
state organs operate.
Law enforcement not only requires the formal establishment of courts and procuratorates. The
four levels of courts explained above, the Supreme People’s Court, twenty-nine high courts,
11 In contrast, Chinese domestic arbitration cases are handled by the Industrial and Commercial
Arbitration Commission, under the Bureau of Industry and Commerce, which is itself under the
14

more than three hundred intermedia te courts and more than three thousand basic courts, are in
desperate search for qualified staff. Even now, after years of growth, law school graduates can
fill only a fraction of the court system’s needs.
2.2.6 Foreign Investment Law
The legal framework for foreign investments in China is founded on three laws, which are the
Chinese-Foreign Joint Equity Ventures Law, 12 the Chinese -Foreign Joint Co-operative
Ventures Law 13 and the Wholly Foreign-Owned Enterprises Law. 14 Since the enactment of the
Company Law in 1994, an investor appears to have the option to establish a limited liability
company either under the three laws on foreign-invested enterprises or under the Company
Law. 15
In addition to these national laws, regulations and rules on a national level as well as on lower
levels should not be ignored. Furthermore, the policy on foreign investment is an important
part of the legal framework for foreign investment in China. An investor should pay careful
attention to the governing policy which may affect a particular investment project from time
to time.
It is important to note that foreign investment projects in China need to be approved by the
respective state organs before they can be realised. There used to be considerably different
standards for approving such projects in different areas or regions. Since 1995, when the State
Planning Commission, the State Economic and Trade Commission and the Ministry of
Foreign Trade and Economic Co-operation issued the Provisional Guidelines for Foreign
Investment, the situation improved. According to these Guidelines, investment projects are
divided into four categories: foreign investment projects are encouraged, permitted, restricted
or prohibited, as the case may be. The encouraged, restricted and prohibited areas are
specified in a list attached to the Guidelines. The projects falling outside the specified
categories are pe rmitted. Projects of this latter category are allowed with neither preferential
treatment nor restriction, compared with domestic projects.
supervision of the Ge neral Administration of Industry and Commerce. The transparency and fairness
in domestic arbitration cases is still far behind the respective standards on the international level.
12 For the setting up of an equity joint venture see: http://www.qis.net/chinalaw/setejv1.htm.
13 For the setting up of a co-operative joint venture see: http://www.qis.net/chinalaw/setcjv1.htm.
14 For the setting up of wholly foreign owned enterprise see: http://www.qis.net/chinalaw/setfoe1.htm.
15 See below the short overview of the Company Law.
15

2.2.7 Contract law
The Chinese contract law system is divided into civil contracts and economic contracts; the
former being split up into standard civil contracts and contracts relating to technology in the
widest sense of the word (technology contracts), the latter being split up into domestic
economic contracts and foreign economic contracts. 16 The following overview is limited to
some comments with respect to the Foreign Economic Contract Law (hereafter the FECL),
the most applicable source of law for foreign enterprises entering the Chinese Market.
The FECL was promulgated on March 21, 1985 and became effective on July 1 of the same
year. 17 The FECL covers all foreign commercial activities in China ranging from finance and
trade to service and investment. It applies to all economic contracts between Chinese and
foreigners, including the sale of goods, equity joint venture contracts, co-operative joint
venture contracts, contracts for co-operative exploration, loan contracts, lease of property
contracts, contracts for technology transfer, processing and labour contracts etc.
According to the FECL, foreign economic contracts are contracts between enterprises,
economic organisations or individuals of Hong Kong, Macau or a foreign country and
Chinese enterprises. The FECL also applies where both parties to a foreign economic contract
are foreign and the contract is either made or performed in China. 18
The FECL does not apply to contracts between Chinese-foreign equity joint ventures, co-
operative joint ventures, or wholly foreign-owned enterprises and Chinese enterprises or
individuals. In such cases the domestic economic contract law applies due to the fact that
Chinese-foreign equity joint ventures, co-operative joint ventures, or wholly foreign-owned
enterprises are established as Chinese legal persons.
According to Article 6 FECL, where Chinese laws are in conflict with international treaties, to
which China is a signatory, the international treaty shall apply, except for provisions on which
China has declared reservation. 19
16 A big step forward in the legislative history of Chinese contract law is currently under preparation
with the creation of a uniform contract law applying to all types on contracts and specific principles for
individual contracts.
17 On December 11, 1986, China ratified the 1980 United Nations Convention on Contracts for the
International Sale of Goods becoming effective on January 01, 1988.
18 The FECL defines parties form Hong Kong or Macau as being foreign.
19 China has declared reservation to Article 11 1980 United Nations Convention on Contracts for the
International Sale of Goods which states that contracts need not to be in writing. Therefore and
according to the FECL, all foreign economic contract need to be in writing.
16

2.2.8 Company Law
China’s first nation-wide Company law was promulgated on December 29, 1993 and became
effective on July 1, 1994. Until that date, the only legal way in which a foreign registered
company could establish its presence in China was the establishment of a representative
office. A representative office is not allowed to carry on business, except for the activities
involving liaison functions, exhibition, market research and exchange of information. The
representative office may have access to basic facilities and privileges, such as the right of
residence, banking services and the right to import means of transport, which are essential for
its daily operations. There exist detailed rules as regards the procedure and requirements for
the registration, renewal, change and termination of representative offices in China. 20
The Company Law now foresees the possibility for a foreign company to carry on business in
China without the foundation of a Chinese legal person. Article 199 provides that a foreign
company may establish branches in China to undertake production and operational activities.
This enables foreign companies to undertake business activities in China in their own name
without the cost and delay of establishing a joint venture or a wholly foreign ow ned
enterprise. Even though a foreign branch office is not a Chinese legal person, it is nevertheless
subject to Chinese law and has to comply with all relevant rules and regulations. 21
As stated above, a foreign investor appears to have the option to set up a limited liability
company under either the Company Law or the laws on foreign-invested enterprises. One of
the reasons affecting the respective decision is that a company under the laws on foreign-
invested enterprises receives certain benefits and privileges which are theoretically
unavailable to a company established under the Company Law. According to a widely spread
interpretation of Article 18 of the Company Law however, a foreign-invested company
established under the Company Law should be eligible to the benefits and privileges to it as if
it had been formed under the relevant law on foreign investment.
The Company Law provides for two kinds of companies: a limited liability company and a
company limited by shares. The liability of both types of companies is limited, which means
each shareholder in such a company assumes liability toward the company to the extent of the
amount of shares held by him, but the company shall be liable for its debts to the extent of all
20 For the setting up of a representative office see: http://www.qis.net/chinalaw/setrep1.htm.
21 For the setting up of a branch office see: http://www.qis.net/chinalaw/setbrof1.htm.
17

its assets. The regulations with respect to the formation, the governance structure and
dissolution of companies follows civil law tradition.
2.2.9 Conclusion
The Chinese legal system has been developing rapidly since the start of its reform. As
discussed in this paper it cannot be denied that the system is still full of contradictions and
problems. However, it is also true to say that China has achieved a lot in many respects over a
relatively short period of time. The most important factor is that the Chinese legal system has
embarked on the right path according to international sta ndards.
In general, the legal system in China is still in a state of flux. Therefore, Readers are
encouraged to frequently check new laws and regulations and their amendments to ensure the
accuracy of the legal posit ion on a particular issue of Chinese law. The following websites are
highly recommendable for this purpose: http://www.qis.net/chinalaw and
http://www.chinatoday.com/law .
Reading Dr. Loretan’s exposition on the Chinese legal system helped Paul to appreciate the
legal difficulties he felt in China while trying to take over the running of the China venture.
The Chinese legal system has to be understood within the context of Chinese history, culture
and society. The process of thinking through the business has been extremely difficult for
Paul. There are so many things not spelled out in legal terms even though the responsibilities
and obligations of all parties involved are clear. For example: What if a party did not carry out
its obligations? There seems to be no legal redress. This is troubling, even frightening. Yet to
Mr. Zheng, this was never a problem. “We can trust them”, he would always say.
Paul realised that the Chinese legal system is based on a culture and history quite different
from that of his home country. Indeed, the new western based laws which have been
introduced are probably not part of existing social order which defines a set of mutually
acceptable rights and obligations for all parties. This mutuality is often assumed. Some of
them may be spelled out to ensure clarity for all but certainly not for the purpose of legal
enforcement. In other words, the working out of agreements is the result of social cohesion
and mutual understanding among parties involved, and not the result of legal enforcement.
18

Things seem have to become a lot clearer and explicable. There is clearly much more to learn
and understand about China and the China venture...
The next paper focus on Business Financing in China. Cinderella Freiin von Dungern, now a
doctoral candidate working on China, wrote:
2.3 Business Finance in China (by Cinderella Freiin von Dungern)
For investing in the Asian countries, the range of financing services is of significant
importance. Due to the enormous economic growth and increasing welfare in this region, the
efficient allocation of capital becomes an essential issue for further economic development.
The importance of the financial sector in facilitating the transfer of resources from savers to
investors is widely acknowledged. Efficient financial systems facilitate better mobilisation
and use of resources, which accelerates the process of economic growth. 22
The emergence of new markets in Asia, South America and Eastern Europe as well as the
development of new free trade zones and economic areas have enlarged the arena not only for
investments and products but also for client acquisition. Furthermore, the deregulation and
liberalisation of financial markets have speedily led to the rapid internationalisation of
business. On the supply side the disintermediation of financial and capital markets has created
numerous new products, and strategies to capture and serve new clients are emerging. At the
same time, the demand side is undergoing structural changes, primarily induced by clients
becoming more sophisticated. 23
The People’s Republic of China (hereafter „China“), with the highest population in the world,
has the potential to become the biggest economy in the next century. Investing in China does
not only depend on the stability of the legal system and on the openness of the market, but
also on the financial stability and transparency. The financial crisis in Asia put the focus on
the importance of further financial reforms. But due to the reticularly structured Asian
economies, the potential spill-over-effects seriously interfere with efficient reforms. The big
discrepancies between theory and reality became quite obvious.
In spite of the financial crisis in Asia, foreign direct investment (FDI) continues to pour into
China. The proportion of investments made by US and Europe-based multinationals is
increasing, while the nature of the investment deals being struck is beginning to mature. The
22 Zahid, 1995 b.
23 Ehlern, 1997, p. 3.
19

ways in which deals are being packaged are becoming increasingly sophisticated. The FDI
deals have become adept at building an appropriate edifice that best suits the goals of the
inbound foreign investor. The increasing sophistication of the Merger and Acquisition (M&A)
process therefore is mirroring an increasingly sophisticated investment environment. 24
Joint ventures in China are challenging at the best of times. With the turmoil in Asian equity
and currency markets the challenges will intensify. Besides selecting a local partner and
agreeing to the basic focus of a joint venture, the greatest challenge is to create a financial
structure that is both possible and will minimise risk. Many new investors in China
underestimate the financial needs of a new joint venture. Frequently they do not take into
account the long payment delays required to collect accounts receivable or the slowness in the
bank payment system. Often their customers may themselves need long-term financing.
This paper explains the main issues concerning business finance in China. This means first of
all, the analysis of general financial conditions for foreign direct investments in China.
Therefore, the next part looks at the financial sector development and its main institutions. It
also examines legal restrictions for banking in general and instruments of financial control in
particular. The third part describes the single financial markets, which include the capital and
money markets in China. The fourth part provides the reader with potential instruments and
means of financial management. From a theoretical point-of -view, these instruments do not
differ from the ones, used in the Western hemisphere. But, as many things are special in
China, this part points out the most important characteristics. The last part sums up the main
results and finally, draws a conclusion.
2.3.1 Financial framework for foreign direct investments
The role and function of the financial sector in fostering growth has been a matter of debate
and concern for many years. While most analysts and policymakers will agree that a well
func tioning and efficient financial system can help promote economic development, there
continue to be disagreements about the ownership pattern and institutional structure of the
financial sector in most economies. In order to get a fundamental knowledge of financing
facilities, this part explains the basic features of China’s financial system.
24 China Business Review, August 13, 1998.
20

2.3.1.1 Financial sector development in China
In 1949, all banks were expropriated and merged into a monobank system. The monobank,
named The People’s Bank of China (PBOC), had an administrative function within the
centrally planned economy, funnelling budgetary funds to the agricultural and industrial
sectors and acting as a book-keeper. It served the function of retail bank, wholesale bank and
central bank concurrently. The PBOC has undergone a number of fundamental changes in the
reform years, leading to a total restructuring of China’s banking landscape.
Before 1978, the financial system was largely irrelevant to the country’s macroeconomic
performance. The overall paradigm of financial sector reform changed from a moderate to a
more radical stance during four phases of reform beginning in the late 1970s. In the first
phase, from 1979 to 1983, the scope of financial reform was limited to changes in the
structure and operation of the state banking system. At the macro-level, financial institutions
had to be adapted to fulfil the role of the financial intermediaries. On the one hand, the
decentralisation of financial resources into the hands of households led to an explosion in
their saving deposits. On the other hand, bank credit replaced the state budget as the main
source of investment finance. At the micro-level, banks had to start including profitability
among the objectives of their operations. They began to learn to be more selective in granting
loans to enterprises, and to monitor the performance of the latter in order to contribute to
some timid hardening of their budget constraint. In addition, some non-bank financial
institutions (NBFIs) started to develop. 25
The second phase, from 1984 through 1988, was the real start of financial-sector reform. The
rationing of capital in line with the physical plan was abandoned, specialised banks emerged
from the former unified state bank to become the pillars of the new financial system, and new
NBFIs were created. The People’s Bank of China (PBOC) started to lose some of its powers,
becoming solely the central bank in charge of enforcing a direct monetary policy within a
system of directed capital.
The third phase, from 1988 through 1992, was characterised by the experimental nature of
financial-sector reforms. Within the context of a slowdown in reform, caused by the
authorities’ exclusive focus on controlling inflationary pressures, most reforms were limited
in scope, continuously reviewed and sometimes reversed. The authorities faced the dilemma
25 Girardin, 1997, pp. 21.
21

of re-establishing macroeconomic stability under the pressure of increasing demand for
capital. This period also included allowing new financial intermediaries to emerge.
The period starting in 1993 contrasts with the previous one since an attempt at
macroeconomic stabilisation was this time accompanied by an acceleration in the pace of
financial-sector reform. The reforms include the adoption of a new law for the central bank
and for commercial banks stemming from the former specialised banks, and the transfer of
policy lending from the specialised banks to new policy banks.
As a result of the different phases of reform, the system is now characterised by the co-
existence of two components. The main one, made up of specialised banks, is still under the
control of the government. The second component is made up of financial intermediaries,
which either are subject to little control by the authorities or manage to side step existing
regulations. 26
In general, the influence of China’s political system on the financial system is very high, like
in any other mostly state-controlled business sector. The dominance of the state prevents the
capital market from its important functions to mobilise and realise capital as well as allocating
financial resources from investors to productive and efficient investments. The essential
transparency of the capital market gets lost if the influence of the state is too high. On the
other side, it is hardly possible to keep up a high level of stability without the interventions of
the state, as it could be seen at the actual Asian crisis. China needs further reforms of its
financial system, but as everywhere in the economy right now, the government has to face the
dilemma between the necessarily deregulation and liberalisation on the one hand, and
increasing instability and lack of control on the other hand. 27
The Chinese government has the ambition to promote Shanghai to become one of the top
international financial centres competing with New York, Tokyo, London and Hong Kong
etc. in the future. Pudong New Area is becoming the most intensive financial centre of
Shanghai with banks and financial institutions, where also international banks can get the
licence for RMB-business, and where the new building of Shanghai Securities Exchange
(SSE) is situated. The financial reform extended the only investment possibility, the FDIs, to
several forms of indirect investment opportunities, like credits and loans, stocks and
26 Girardin, 1997, pp. 22.
27 Further research-work and more into detail information about the financial system in China can be
gained from Schröder, 1994; Schüller, 1995; Reif, 1995; Liu, 1996; Tam, 1995; Zahid, 1995a and Cao,
1995.
22

securities, trading, initial public offerings as well as usual emissions even on international
capital markets etc. The other securities exchange is located in Shenzhen. But there is still a
long way to go. For example, the full convertibility of RMB, which is a fundamental
requirement for an efficient financial system, has been under discussion for a very long time.
Another barrier to become an international financial centre is the very strong regulated
financial market as can be seen in the following.
In March 1998, the new premier Zhu Rongji, outlined an ambitious reform programme and
promised five years of rapid change. The financial sector reform is one of the three main
objectives which should be achieved by the end of the century. The financial system must be
overhauled, improving the supervisory and regulatory functions of the PBOC and making
state banks operate as independent, commercial entities. The investment system has to be
changed from a system mainly controlled administratively to one run on market principles.
The full convertibility of the Yuan depends on when the ability of the central bank to
supervise and regulate the economy met international standards. 28
2.3.1.2 Financial institutions
The financial institutions can be roughly divided into a bank and a non-bank sector. Figure 2
gives an overview of the broad structure of the financial system in China. The next figure
shows a more precise structure of the banking system itself.
Since 1983, the People’s Bank of China (PBOC) has been declared by the State Council as
China’s central bank. It has established branches at provincial level, secondary branches at
prefecture level and in medium-sized cities and sub-branches at county level. The decision-
making body of the PBOC is its board of directors 29 . In 1993, it was transferred into a kind of
Chinese Federal Reserve. At the National People’s Congress in March 1995, a very bold
attempt was made to separate the PBOC from the executive arm of the government, thus
removing it from the political influence of the Communist Party through the issuance of the
central bank law.
One of the special character of the Chinese banking system is the distinguishment between
policy banks and commercial banks. Apart from the central bank, responsible for monetary
policy and supervision of the financial system, the banking system in the mid-1990s is
28 See South China Morning Post, March 3,1998.
29 Hannan, 1995, p. 50.
23

composed of, on the one hand, huge state commercial banks and on the other hand, new
policy banks. The commercial banks split up in a group of specialised banks for separate
sectors of the economy and a group of smaller commercial banks with either regional or
nation-wide coverage, most of them established in the late 1980s. At the edge is a strong and
growing competitive fringe of NBFIs that has emerged as a force in recent years. There is also
an expanding presence of foreign financial institutions in form of representative and branch
offices.
Policy
Banks
Foreign
Banks
State Council
Central Bank
Banks Non-bank Financial
Financial
Institutions
Market
Commercial
Banks
• state
banks
- state-
-
-
• private
banks
Credit
Cooperatives
• rural
•urban
Trust and Investment
Corporations
Finance
Companies
Leasing
Companies
Insurance
Companies
FIGURE 2-2: Structure of China's Financial Sector 30
Interbankmark
et
Forexmarke
t
Stock
Exchange
OTC Market
Securities
Houses
• investment
•
Rating
agencies
Completing the financial system are two securities exchanges, 17 regional securities trading
centres, two electronic securities networks (STAQS and NETS) and a large number of diverse
ancillary capital market institutions including brokers, dealers and underwriters. Current
financial markets in China include: Stock markets, bond markets, foreign exchange market,
interbank money market and a short -term debt securities market. In Chinese terminology, the
division between capital and money market is less distinct (For a detailed description of the
single markets within the financial system in China also see above). These markets are all
30 Source: Own figure on the basis of Girardin, 1997, p. 23, Schüller, 1995, p. 927 and Horstschäfer
1997, p. 1108.
24

underdeveloped compared with markets in Asia and the West, but have gradually begun to
play an important role, at least in the allocation of funds between banks and non-bank
financial institutions.
Domestic banks
The financial turmoil made clear that the modernisation of the antiquated banking system
needed to become a national priority. The banks in the mainland face huge non-performing
loans, flimsy capitalisation and declining profits. The PBOC has initiated reform measures
since the beginning of the decade that have strengthened its own supervisory capabilities,
while reducing the use of policy lending and introducing domestic institutions to international
standards they will need to reach once the financial system is fully opened to multinational
financial players. The PBOC, too, is being overhauled. The central bank is developing a
structure that resembles the United States Federal Reserve.
A range of new banks outside the „Big Four“ have made noticeable inroads into the
mainland’s banking system in recent years. The impact of these new players is difficult to
measure as statistics do not segregate categories of players adequately.
Central Bank
(PBOC)
Policy Banks State Commercial Private Commercial Foreign Banks
Banks
Banks
State Development
Bank (SDB)
Ex- & Importbank
of China (EIB)
Agricultural
Development Bank
of China (ADB)
Specialised
Banks
BOC
ABC
CCB
ICBC
Universal
Banks
(nationwide)
BOCOM
CITICIB
EBC, CIB
CMB, HXB
Regional
Banks
GDB
ShDB
PDB
HDB
FIB etc.
FIGURE 2-3: Structure of China's banking sector 31
China
Minsheng
Bank
100% WFOE
Branch
Repr.-Office
Joint Venture
31 Source: Own figure on the basis of Girardin, 1997, p. 23, Schüller, 1995, p. 927 and Horstschäfer,
1997, p. 1108.
25

However, the characteristics of the mainland’s banking system have changed rapidly in only
five years. Nevertheless, it is essential not to leave out a basic overview of the structure of the
banking system in China. Therefore Figure 2-3 shows the system as it is structured until now.
At the beginning of the economic reform in the early eighties four specialised banks have
been established: Industrial and Commercial Bank of China (ICBC), Bank of China (BOC),
China Construction Bank (CCB, before March 26, 1996, it was called „People’s Construction
Bank of China“) and Agricultural Bank of China (ABC). Their major task is to grant policy
loans to the state -owned enterprises (SOEs) of a specific economic sector. The areas of the
four specialised banks provides an overview of their areas of specialty.
Establishment Head office Specialised areas
ICBC 1984 Beijing Handling industrial and commercial credits,
loans and savings deposits
BOC Originally in 1912 Shanghai since Handling foreign exchange and foreign
1994
trade
CCB 1980s Beijing Lending long term financing for construction
projects across the industries
ABC 1980s Beijing Handling rural financial business
TABLE 2-1: The areas of the four specialised banks 32
In order to ease the financing pressure on the commercial banks and allow increased
transparency and accountability in lending for large state-sponsored projects, three policy
banks have been established in the middle of 1990s: The State Development Bank, the
Agricultural Development Bank and the Ex- and Import Bank of China 33 . They particularly
provide long-term financing of important state projects. Nine banks, led by the Bank of
Communications (Bocom), formed commercial banks, as the separation of the central and
commercial banking functions began in 1987. The Bocom, which was founded in 1908, has
its headquarter in Shanghai. Its branch in Hong Kong is one of the ten biggest banks there. It’s
also the first bank in China in form of corporation with 50% state share of its registered
capital. The other important commercial banks set up during this period include CITIC
Industrial Bank, China Everbright Bank, China Investment Bank and China Merchants Bank
as well as some regional development banks like Pudong Development Bank in Shanghai.
Nearly all large Chinese banks are located in Shanghai. Private commercial banks are not
typical for China until now, but the increasing emergence of such banks is quite obvious for
the next future. China Minsheng Banking Corp. was China’s first privately owned bank,
32 Source: Hannan, 1995, p. 51-52.
33 Islam/Chowdhury, 1997, p. 279.
26

established in January 1996 by 59 private companies. Minsheng is carving out a niche in
China’s growing private sector, a customer base long neglected by the larger state owned
banks. It may be China’s smallest national commercial bank, a minnow compared to the state-
owned giants of China’s banking industry, but its aspirations are big. 34
The most important domestic competitors are the four state-owned specialised banks, which
together have about 120’000 branches in China. The ICBC, for example, is the biggest of
China’s big four state banks in terms of assets and employees. ICBC still allocates 70% of its
loans to state firms. 35 The Bocom and the specialised banks are highly affected by the
government policy granting loans to SOEs among the state -owned banks. China’s state banks
are being undermined by the sheer scale of non-performing loans, although the conversion of
central bank loans into equity would improve capital adequacy ratios and could be the first
substantive step towards restructuring the sector. The increasing number of new banks pushed
the existing specialised banks to further reforms in transforming themselves into market-
oriented commercial banks, which try to be more flexible and customer focussed. Service at
Chinese banks is getting better, but is still very poor. Nevertheless, since all business in China
requires to be conducted in RMB, it’s wise to let financial transaction done by domestic
banks. The Shanghai government has directed local banks to favour loans to priority
infrastructure projects, and all fixed-asset loans by China’s banks have been under the control
of the central government since January 1994. This makes them not very reliable as a source
for operating credits for either foreign or Chinese firms.
Priority in the reforms, will be given to recapitalising the big four state-owned banks, while
some smaller banks will be allowed to fail. This became clear as the Hainan Development
Bank went bankrupt. Losses from its closure were covered by the authorities, but this may not
be the case once closures and bankruptcies gain pace.
Foreign Banks
The restrictive regulatory environment, most notably the ban on RMB business, has
discouraged and prohibited foreign banks from playing a prominent role in China. Foreign
banks have historically not been allowed to open RMB accounts for customers, but they have
been permitted to open foreign currency accounts for FIEs in Special Economic Zones. 36
Nevertheless, by the end of 1995, 120 branches and 469 representative offices of foreign
34 Business China, 1998, p. 12.
35 Business China, 1998, pp. 12.
27

anks were established in China. China’s commercial and financial capital Shanghai alone
hosts 38 foreign banks and 119 representative offices, in 1997 the number of branches even
raised to 70. This figure is increasing rapidly. 37
However, the international banks can only do little more than arrange capital injection
certification and continue lucrative trade finance because of numerous restrictions for foreign
banks in China. In addition, opening an account with a foreign bank adds extra steps and
expenses. Differences in banking services shows some differences between Chinese and
international banks in financing investment projects in China. Until the end of 1996, no
foreign bank could offer many day-to-day services to foreign companies or individuals in
local currency. In January 1997, it was announced that nine foreign banks had been granted
licences to undertake business in RMB. Among these group were the Citibank, Hong Kong &
Shanghai Banking Corporation, Bank of Tokyo-Mitsubishi, Industrial Bank of Japan, Dai-Ichi
Kangyo Bank, Sanwa Bank, Standard Chartered Bank and International Bank of Paris. Formal
approval to actually transact business in RMB would be forthcoming when the conditions of
the licence had been fulfilled to the satisfaction of the PBOC. According to PBOCs
regulations, the foreign bank must have achieved profit in the last three years and engaged in
medium- to long-term capital financing in China. Such a licence is only granted to those
banks located in the Pudong New Area - the new financial district of Shanghai. (They were
also given the choice to maintain a sub-branch in the older Puxi district of Shanghai, but RMB
business can only be handled in Pudong.) Their total RMB loans are not allowed to exceed
35% of their foreign currency liabilities. Compared with the total loans outstanding in China,
this is only a very small amount. The banks each have to inject foreign currency capital
(equivalent to no less than RMB 30 million) and convert it into RMB as working capital to
run their RMB business. 38
36 Wegner, 1998, pp. 23.
37 Asian Wall Street Journal, April 1, 1996, p. 4; Jin Rong Shi Bao, March 5, 1996, p. 2.
38 Klug, 1997, p. 7 and Wegner, 1998, p. 24.
28

Chinese Banks Foreign Banks
Financing services RMB financing services
financing in foreign currency
export financing
trust loans
required securities Mortgage
capital injection certificate
only 9 of them allowed
allowed
allowed
seldom
only as an additional security
yes
terms short term renewable max. 6-7 years, except longer term
through project and export
financing
other banking services deposit accounts, foreign
exchange, documentary
operations for Chinese partners
TABLE 2-2: Differences in banking services 39
for foreign partners
consulting foreign enterprises in
entering the Chinese market
These foreign banks may only operate RMB accounts for FIEs that have legal registration in
Shanghai. The foreign banks are still able to lend foreign currency funds to Chinese
companies with transactional approval from the regulatory authorities, but under these new
regulations are still not allowed to handle RMB-denominated business for local Chinese
enterprises unless they have listed on an offshore stock exchange. Deposits from local citizens
are also not permitted. The advantage for FIEs based in Shanghai, is that they can use one of
these nine foreign banks for all their local and foreign currency transactions. they can expect
higher standards of service from these banks and a better understanding of their international
businesses.
Many international banks from the German speaking region have set up their branches or
representative offices in Shanghai such as Swiss Bank Corporation (SBC), Union Bank of
Switzerland - in 1998, both banks merged to the new UBS AG - , Credit Suisse,
Commerzbank, Dresdner Bank, Bayerische Vereinsbank or Westdeutsche Landesbank
(WestLB). Most of them applied for a RMB-licence but are still waiting. The PBOC has yet
to announce any specific plans to expand RMB business to other banks or other areas of the
PRC. Due to the globalisation and further deregulation of China’s financial market, the
financial landscape could dramatically change, but looking at the past, it becomes obvious
that China could also suddenly stop every foreign influence and investment. However, it is
expected tha t, as in the past, opening up the market will be on a step-by-step basis.
Non-bank financial institutions
In China, the non-state financial sector does not antedate the state banking sector; rather, it
developed in response to controls over, and deficiencies in, that sector. Indeed, state banks are
39 Klug, 1997, p. 2-6.
29

typically poor at solving the problems of asymmetric information and at monitoring the
performance of their borrowers. By contrast, non-bank financial institutions (NBFI) such as
credit co-operatives, or less for mal organisations have comparative advantages in using local
information, monitoring and enforcing sanctions on borrowers.
NBFIs have greatly transformed the financial sector in China. They share five main
characteristics. Firstly, they have broken the monopoly of state banks. Secondly, they are
outside the narrow credit plan of the central government and the PBOC. Thirdly, they are
more independent than banks, have more incentives to maximise profits and are subject to
fewer regulations. Fourthly, there are very substantial problems of moral hazard in NFBIs,
because they are mostly controlled by banks. Fifthly, regulations and laws concerning NFBIs
are few, or are less well enforced than those concerning state-owned banks. 40 Shanghai is the
most favoured place for non-bank financial institutions ranging from trust and investment
corporations to finance companies, leasing companies, insurance companies, securities
companies and thousands of rural credit co-operatives and urban credit co-operatives, often
acting de facto like banks.
2.3.1.3 Legal framework for financial structuring
The detailed analysis of each and every one of all the established banking rules and
regulations would go far beyond the objectives of this study. Therefore, this part focuses only
on the le gal development and two main laws in order to provide the reader with a basic
understanding of the legal framework. 41 When the PRC was established, the old banking laws
were annulled. As the country practised a planned economy and PBOC was the only bank, a
central bank law was not needed as there were neither other banks to be supervised nor the
requirement of a lender of last resort. Since there were no commercial banks, a law for this
area was beyond consideration. For many years, PBOC carried out its business following state
decisions. Materials show that in the thirty years between 1949 and 1979, there was not a
single statutory law on banking business, and only a few dozen of decisions and orders were
issued by the State Council. 42
With the start of the open-door policy and China’s economic reform, China realised that a
modern economy could only be supported by a complete legal system and therefore, legal
40 Girardin, 1997, pp. 34.
41 For a more precise analysis, look at Huang, 1996, p. 11-16 and Buchmann et al., 1996.
42 Huang, 1996, p. 11.
30

system formulation has been put on the top of the agenda. Between 1979 and 1993, a great
number of administrative rules and regulations were enacted in a wide range of fields. Some
of them dealt with the scope of the establishment of banking institutions or banking business
and others related to operational limitations and requirements. A general review of the law-
making process of this period will reveal two phenomena. The first relates to the
unprecedented number of rules and regulations enacted in China on the banking business in
sharp contrast with the previous period. This is directly linked to the fast development of the
banking industry in China. The other phenomenon relates to the lack of statutory laws on
banking despite so many important administrative rules being enacted.
A key to China’s financial development in the 1990s was the strengthening of the central
bank. The most notable step was the promulgation of the Central Bank Law in 1995, effective
as of March 19, 1995. With it, the role of the PBOC has become more focused. Art. 2 defines
the PBOC’s hierarchical position under the leadership of the State Council. In opting for this
solution, the activities of the central bank remain strongly linked to the requirements of state
policy and the country’s economic plans. The law defines the central bank’s two key
functions, namely the formulation and implementation of monetary policies on the one side
and the supervision and administration of the country’s financial institutions on the other
hand. The strengthening of the PBOC’s position must be seen as an attempt to monitor and
control the financial sector more effectively. 43
Another milestone development in China’s banking sector was the widely acknowledged
promulgation of the Commercial Banking Law, effective from July 1st, 1995. Together with
the Security Law, effective as of October 1, 1995, and the Negotiable Instruments Law,
effective as of January 1, 1996, these laws constitute an important basis and framework for
further financial reform. Moreover, they have to be seen as expression of ongoing efforts
aimed at the creation of a comprehensive legal system. 44
Comprising nine parts, the Commercial Banking Law was formulated to „protect the lawful
rights and interests of commercial banks, depositors and other customers, standardise the acts
of commercial banks, raise the quality of credit and assets and strengthen supervision and
administration of commercial banks“ (Article 1). The law does not only codify and elevate to
statutory level a number of issues that had previously been dealt with by administrative
43 Buchmann et al., 1996, pp. 3, Buxbaum/Gonzalez, 1998, p. 13 and Huang, 1996, pp. 17.
44 Buchmann et al., 1996, p. 1.
31

egulations, but also introduces a new approach towards banking that marks a clear deviation
from the previous banking concept constituted by the elements of a planned economy. The
law introduces prudential novations such as ratios for capital adequacy, loans-to-deposits and
other standards enabling the state banks to eventually become commercial entities. Part four
precisely details the basic rules for lending and other business. Part nine states that the Law
shall apply to foreign investment commercial banks, Sino-foreign equity joint venture banks
and branches of foreign commercial banks, except where laws or administrative regulations
provide otherwise (Article 88).
More than anything, the law is an intentional statement of genuine divergence from the central
planning system and therefore, it is essential to take a closer look at the legal framework for
banking. Still, there is a great lack of transparency and supervision in China, not even
mentioning the money laundering actions. Without an independent institution who controls
and supervises the financial system as a whole, the best reforms are inefficient.
2.3.1.4 Instruments of financial control in China
The Chinese financial system can be characterised as a system of directed capital. The direct
and indirect instruments of monetary control at the disposal of the PBOC, involving the credit
plan and the regulation of interest rates and the RMB currency, are a by-product of a system
of directed credit. Direct instruments are still the most effective, as indirect ones are
underdeveloped, but the monetary authorities face difficulties in their control of banks’ assets
and liabilities. 45 Foreign investors have to take these Chinese control mechanisms into
consideration, making efficient financial management quite complicated if not impossible.
This section describes three instruments, which are most relevant for foreign direct
investments.
Credit control
The credit plan is the main instrument at the disposal of central authorities in their endeavour
to channel bank financing to specified activities in the state sector. Before the reforms of the
late 1970s there was, along with the physical plan, a financial plan composed of three
complementary parts: the budget, the credit plan and the cash plan. After the reforms,
monetary policy still consists mainly of a set of rules and practices adopted to implement the
credit and cash plans.
45 Girardin, 1997, p. 55.
32

The separation of production and consumption activities through the use of different types of
money, played a major role in the centralised system designed for the planned mobilisation
and allocation of resources. As a result of the money segmentation, monetary management
during the pre-reform years was dichotomised into controlling cash in circulation and
allocating bank credit to support state industrial and commercial enterprises accor ding to
national plans. In practice, the objective with respect to cash was to be achieved through the
annual cash plan, which tried to maintain a stable relation between currency in circulation and
various measures of retail sales (see also section Exchange Control). The credit plan is
established by the PBOC and supervised by the State Council and the Planning Bureau. A
major innovation occurred in 1988, when the coverage of the credit plan extended from the
specialised and commercial banks to NBFIs and the direct financing of enterprises.
The credit plan consists of a two-stage process: a top-down process followed by a bottom-up
one. In the first stage, the PBOC sets a target for money supply as a function of the planned
growth in output and prices. The credit plan, which is transmitted to the specialised banks,
concerns both the asset side (quota for new loans) and the liabilities side (targets for deposits).
The banks allocate these quotas and targets to their provincial branches, which then do the
same for local branches. In the second stage, provincial branches of the PBOC put together
provincial plans for deposits and loans by centralising the credit and deposit plans of the local
branches of specialised banks. The PBOC then revises its initial credit plan in the light of this
feedback from its branches, and the final credit plan is officially approved. The quotas for
loans include for example the limitations on loans for fixed-capital construction (fixed-asset
investment, five to ten years), on working-capital loans (up to one year) and on technical
renovation loans to finance equipment (one to five years). There is only a limited flexibility to
reallocate credit quotas, for instance between loans for working capital and for technical
renovation. Each category of maturities is further broken down into activities, sub-sectors and
major projects. 46
Quota regulations for short-term working capital loans are much more liberal than loans for
fixed asset investment, as the latter to a much larger degree pertain to the macroeconomic
stabilisation. Working capital lending is partially depending on the increase in banks’ deposits
and partially on an overall credit limit set semi-annually by the PBOC. The banks may use
working capital limits freely, fixed asset limits however not. They are project-specific, and
46 Girardin, 1997, p. 56.
33

only projects approved to receive fixed asset quotas may receive such funds. Depending on
the size of the project, the State Planning Commission or a local Planning Commission must
approve fixed assets investments.
As an allocator of funds, the quota system is an inefficient substitute for a free interest rate.
The credit quota system plays an extremely important role for the whole financial sector. The
quotas constitute the most powerful, and the most devastating, tool in the PBOC’s portfolio of
monetary policy instruments. Therefore, the main task of future reforms should be the change
of these direct instruments towards more indirect tools.
The regulation of interest rates
Interest rates are a main instrument of indirect monetary control in China, next to the lending
by the PBOC to specialised banks and reserve requirements. The PBOC sets or regulates
almost all lending and deposit rates to specialised banks and other financial institutions, as
well as the guidelines for rates on the interbank market. The complex structure of interest
rates set by the monetary authorities, aims at minimising the cost to state-owned banks of
collecting resources so as selectively to subsidise production and investment in the st ate
sector. This regulation of interest rates has indirectly led to great discrepancies in the efficient
allocation of capital. 47
The interest-rate policy follows three general principles: Firstly, the differential treatment
according to the length of the loans or deposits, to the type of industry concerned and to the
location of enterprises. Secondly, a degree of autonomous adjustability, where provincial and
large municipal branches of the specialised banks are allowed substantial leeway to adjust
interest rates on a local basis. Thus, banks can charge interest rates up to 60 per cent higher
than the rate set by the PBOC regulations and can offer a five-point bonus on large time
deposits. At the national level as well, banks have been granted some margin for setting their
lending or deposit rates. Finally, the third principle is the possibility of calculating interest
period by period which is done asymmetrically.
Exchange control
Foreign currency business has traditionally been heavily regulated. Domestic c ompanies have
been allowed to retain only parts of their foreign currency earnings while joint ventures and
other FIEs have been allowed to exchange foreign currency at a number of local so called
47 Girardin, 1997, pp. 57.
34

swap centres (see also above). From the mid-1980s to 1994, there was a dual exchange rate
mechanism in place. In 1994, the foreign exchange system was significantly simplified as the
dual exchange rates were unified and the large number of fragmented swap centres were
linked through the PBOC driven China Foreign Exchange Trade System. 48 Further, the
foreign currency exchange retention system for domestic enterprises was abolished, meaning
that domestic enterprises now must sell all their foreign earnings over the counter to
designated banks as soon as they receive payment.
The financial crisis in Asia has enforced the discussion about fixed or flexible exchange rates,
as well as about the advantages and disadvantages of currency devaluation in less-developed
countries. For China, the best way has not become clearly yet. Devaluation or even a flexible
fully convertible RMB currency would lead China into a serious economic crisis in the short
run with impacts on the whole region. But in the long run, full convertibility would be
beneficial for China’s economy. Through exposure to international market prices and foreign
competition, investment allocation becomes more rational and domestic producers are forced
to improve efficiency. The discussion about these issues hasn’t finished yet, neither has the
crisis, which makes a realistic prediction quite impossible. Anyway, current account
convertibility is a precondition for China’s WTO membership and it has been an announced
goal to make the RMB current account convertible by the year 2000. Convertibility is always
a matter of definition, but it is widely doubted that the PRC authorities are willing to expose
the economy to the shock and instability that a true current account convertibility would
cause.
2.3.2 China’s financial markets
The structure and organisation of the financia l market also influences the possibilities of
business finance. Usually, the financial market exists of a capital and a money market, but in
China there is quite a mixture of both forms. These markets are all underdeveloped in China
compared with more deve loped markets in Asia and the West, but have gradually begun to
play an important role. In the following, some remarks will be made about each single sector
within the financial market. Generally spoken for emerging markets, you must have existing
investment before a secondary market can be developed. The nature of investments being
made in China therefore also depends on the degree of sophistication in the investment
environment which includes both, financial products and financial markets.
48 Tseng, 1994, p. 8.
35

There have been discussions as to whether China is moving toward a German-Japanese model
with strong financial intermediaries or toward an Anglo -American model where financial
markets play a more significant part in the economic process. It seems that the current policy-
makers have a long-term vision of creating a financial system where intermediation plays an
important part and where direct access to financial markets for non-financial institutions will
be strongly regulated and obstructed.
2.3.2.1 Stock market
Since stock markets per definition imply a certain degree of privatisation in the economy, the
development has not been actively encouraged. The experimental phase of stock trading
started with stocks being sporadically sold and bought over the counter in 1982. Since then,
two securities exchanges have emerged: the Shanghai Stock Exchange (SSE) and the
Shenzhen Securities Exchange. They were established in 1984 and 1987 respectively and
received officially recognition in 1990 and 1991. The SSE is China’s largest securities
exchange. It has about 500 members and operates on a cash-only basis. Its computer system is
capable of handling 1’000 transactions per second. Settlement is well functioned and efficient.
In addition, China has companies listed on the Hong Kong Stock exchange, so called „red
chips“ and two on the New York Stock Exchange. Due to the strict listing and trading
regulations, an illegal market for company stocks has emerged. 49
The stocks listed on both domestic stock exchanges are divided in A- and B-shares. The
former is only available for Chinese investors while the latter is only tradable by foreign
investors with nomination in RMB but settlement in US$ in Shanghai or HK$ in Shenzhen.
One of the reasons for this division is the lack of full convertibility of the RMB. Only a few
listed companies have no interest holdings by the government. The regulatory mechanism of
the capital market is still centralised through the China Securities Regulatory Commission
(CSRC), which is primarily responsible for implementing and regulations and for supervising
securities forms and markets.
The A-shares tend to maintain price-equity ratios well above those in more mature markets,
although trading is volatile, while the B-shares have more similar price -equity ratios to those
in western exchanges, but with small selection and insufficient liquidity. One of the reasons
for the high volatility in the domestic secondary markets, is the dominance of individual
49 Semkow et al., 1995, p. 266-267, Schüller, 1995, pp. 933 and Chan, 1995, pp. 1.
36

investors with little experience and knowledge about the securities trading. The only limit set
by the Shanghai Stock Exchange, is that one transaction cannot move the market more than
10% up or down from the preceding one.
2.3.2.2 Bond market
China has developed relatively mature primary and secondary markets for long-term
securitised debt. According to the issuer there are three types of bonds in China: 50
state bonds, issued by the Ministry of Finance
financial bonds, project specific bonds normally issued by the CCB
corporate bonds, normally issued by SOEs.
The dominant type is the state bond with more of 90% of the total bond market value. The
second largest are the financial bonds, which are issued by financial institutions, mainly by
domestic banks. Corporate bonds have the smallest share of market value, since the
government set very strict eligible criteria and approval procedures for the SOEs as potential
bond issuer. Over 80% of China’s government bonds are traded at the Shanghai Stock
Exchange. A big issue recently on the SSE has been the three gorges bond of RMB 16 billion
Yuan (USD 120 million) with 3-year term and 11% annual interest rate. The bond market is
growing rapidly in size, and the driving force for the boom has been the two times interest
rate cut in 1996. In the year 1997, the government had the intention to improve the scale and
variety of the corporate bond market. On the investor side, bonds are judged as a more secure
form of investment. Investors start to change their focus from the very speculative stock
market to the quite stable bond market.
The main players in the bond market are the “primary dealers”, similar as market makers in
the UK. They amount to a total of 30 and include both, banks and securities houses. For any
issue, they have to underwrite a minimum of 1% of the total amount. Auctioning was also
introduced in the primary market. Most of the lead managers for underwriting government
bonds are banks, who have the only financial muscle to buy such a large issuance before
placing it. In the secondary market, brokers trade both, bonds and shares, from the same stock
exchange seat and trading is dominated by securities houses. The biggest trader is China’s
largest brokerage company, the Shenyin Wanguo, who is a merger between the two securities
houses, Shanghai Shenyin and Shanghai International. Several securities companies
37

specialising in bonds have been set up, such as the Shanghai Securities Financial Company.
Other securities houses are in the process of establishing specialist departments to run their
bond business, rather than just dealing with it in a general securities department. Both,
paperless and physical bonds, are traded on the SSE.
Foreign invested enterprises are not allowed to issue securities on their corporate debt. One
reason behind this ban is control of monetary expansion. Another reason is that the MOF sees
no reason to allow competitors into a market it almost monopolises and thus jeopardise the
effectiveness of its budget deficit financing vehicle.
2.3.2.3 Foreign exchange market
Since foreign banks are not allowed to conduct RMB business (or only to a limited numbers
of businesses), the only financial market which is of direct relevance to them is the foreign
exchange market. Throughout the reform era, the PRC authorities have experimented
extensively with the structure of this market. Via complex rules, the authorities have allocated
funds through quotas, regulated plural, dual or unified exchange rates and monitored retention
rates and foreign exchange balancing. The overall objectives of the foreign exchange market
reform have been to give incentives for export, control the exchange rate and thereby promote
macroeconomic stability. Further, in recent years, current account convertibility has been a
goal in the foreign exchange reforms, partially due to WTO requirements.
After the period of se veral foreign exchange centres serving with different exchange rates of
RMB in China, the Foreign Exchange Centre in Shanghai now takes the function of providing
a unified nation-wide spot foreign exchange rate of the RMB, through which a preparatory
step is made for the full convertibility of RMB.
2.3.2.4 Interbank money market
The interbank market is synonymous with the money and debt markets in the Chinese
terminology. Operators on this market include banks and other financial institutions. Before
1979, the allocation of credit was vertical from the State Council to bank branches through the
PBOC. The only thing a bank branch with surplus funds could do was to try to hold onto
50 Semkow et al., 1995, p. 42-58.
38

them, while a branch with a shortage of funds could in no way get in contact with another
branch. 51
The reforms in 1979 put limits on the credit banks could extend and made their lending
capacity conditional on their deposit-raising abilities. In 1983, an unofficial interbank market
was created on an experimental basis by a regional branch of the ABC. This horizontal
interface between branches marked a change from the previous, vertical system. The
experiment proved such a success that branches of other banks were included in the system.
As a result of early moves to liberalise the financial sector, sporadic interbank trading
between branches of specialised banks emerged in 1985. The reason was the increasing need
for local interbank markets which came from the shortage of credit through a restrictive
monetary policy implemented by the PBOC in 1985. In November 1995, the PBOC
announced its intentions to link the banks and the most important regional money markets
electronically. But still, the interest rates are tightly controlled, which makes the money
market not very effective. By the end of 1987, interbank markets existed in nearly all regions.
But the lack of proper regulatory framework and of supervision by monetary authorities
allowed the creation of „finance companies“ and development of unauthorised activities, such
as short-term borrowing and long-term lending. As the PBOC declared that no authorities
would intervene in any way, interbank activities of various kind sprang up in most large cities
across the country.
In 1989, these finance companies were abolished by the PBOC and in 1990, standardised
operating principles of interbank markets came into effect. The interbank activities were
centralised in some well-defined market places in Shanghai, Wuhan, Beijing/Tianjin,
Shenyang, Xi’an and Chongqing. In Shanghai, the market took a more structured form in
August 1986 with the establishment of the „Shanghai Money Market“, organised by the
ICBC. The ICBC often accounts for more than three quarters of all interbank activities in
China, although in principle, any financial institution may operate on this market after
approval by the PBOC. Still, the interbank market is quite segmented while the extent of
segmentation depends on the stature of the region or centre concerned. It is organised in three
layers: markets, centres and networks. The market itself is organised locally by financial
institutions and sponsored by local branches of the PBOC. Links between these three layers
are poor due to the underdeveloped telecommunications, the inadequacy of organisation by
51 See Dipchand et. Al, 1994; Girardin, 1997 and Xia, 1995.
39

financial authorities and the protectionism of local government and banks. Altogether, looking
at the inefficient use of financial and human resources, the interbank market would highly
benefit from further reforms not only in the financial system as a whole but also in the way
this market is managed and organised. 52
2.3.2.5 Short term debt securities market
Debt securities with short maturities have only recently been issued in China. The main
obstacle against short term securities has been the inefficient and slow primary markets.
Shorter maturities have gradually been introduced as part of a seemingly concentrated effort
to develop China’s money markets and replace direct with indirect monetary policy
instruments.
The market for short term debt instruments can roughly be divided into a government bills
market, where securities are issued in three different maturities by the MOF and are traded on
the secondary market, and the market for commercial papers, bankers acceptances and
certificates of deposites not issued by the MOF. The latter is negligible because of a slow
underwriting. Since these instruments compete with the government instruments of the first
mentioned market, they are not actively promoted and the eligibility requirements are hard.
Further, secondary markets do not exist, and the lack of a legal and regulatory framework, as
well as market transparency has discouraged issues.
2.3.3 Instruments of financial management
With the business licence issued by the State ICAB, any foreign-invested enterprise can open
both bank accounts of foreign exchange and RMB at any bank or at any other financial
institution which is permitted to handle foreign exchange business by the State Foreign
Exchange Administration Department. According to the needs of business, a foreign-invested
enterprise can also apply for a loan of either foreign exchange or RMB from any bank inside
China which runs the business of foreign exchange. The interest rate upon loans is
promulgated by the PBOC.
Debt or equity - a number of financing options are available to foreign investors wishing to
start up a joint venture or wholly foreign-owned enterprise in China, as well as to foreign
investors with existing interests in ventures in China wishing to make additional investments.
52 For further information see Xia, 1995 and Girardin, 1997, pp. 77.
40

Loans, public offerings of shares, bonds, countertrade and leasing are just some of the
options. 53 The recent economic turbulence in Asia has resulted in a tighter credit environment
for many PRC investors. On the other hand, increasing M & A opportunities and further
deregulation and liberalisation of the banking system have led to a higher sophistication and
availability of financing instruments. It remains to be seen whether PRC investors face better
and more efficient means of financing their investments in the future.
This section focuses on the instruments and means of financial management which are most
commonly used by foreign enterprises in China. But before looking at financing options, it is
essential to describe the general categories of investment structures which are most common
in today’s merger and acquisition market in China.
There are two main categories of FDI in China: direct and indirect acquisition. The first type
of investment involves the purchase of local assets either through a mainland-registered
company or by direct purchase of shares in a listed or unlisted company registered there. It
includes the traditional business vehicles, such as equity or co-operative joint venture
companies (EJV, CJV) and wholly foreign-owned enterprises (WFOE) or, most recently, a
joint-stock limited company. In the past, the traditional joint venture was the vehicle of
choice, mainly because the Chinese partner was considered an essential tool for approval and
business finance. Today, however, investors are wiser and more experienced, which replaced
the joint venture by the WFOE as the most common type of investment structure. On top of
that, the purchase of shares of mainland-listed or unlisted companies has become a new, more
straightforward way for foreign investors. The target company most often is a joint-stock
limited one. Although the transferral of shares remains an uncertainty in China, joint-stock
companies enjoy advantages over more traditional investment vehicles which have also an
impact on financing possibilities. Firstly, raising capital is easier than with an equity joint
venture or a WFOE. Secondly, joint-stock companies present fewer problems in regard to
minority shareholder rights, giving the investor a freer hand in deciding policy and managing
the business.
The second general category of investment vehicle is known as an indirect acquisition where
the foreign enterprise purchases shares in a non-Chinese company, the assets of which include
an interest in a company or companies registered on the mainland. Indirect acquisition has a
number of a dvantages and is becoming more and more visible.
53 Buxbaum/Gonzalez, 1998, p. 10.
41

After the decision for the investment structure has been taken, central issues for PRC
investors are the composition of capital and extent of participation as well as the best
financing option. Choosing the right structure can significantly affect profitability further
down the road. 54
For foreign invested enterprises, China is a new site. According to Western standards, the
financial institutions and instruments in China for debt financing are underdeveloped.
Because of the stage of economic development and the system - that is to be reformed - it is
difficult for companies to raise debt capital from international financial markets. For every
investment it is therefore necessary to systematically analyse the possibilities and boundaries
of debt financing for foreign companies, which must encompass the short-term as well as the
long-term debt financing forms.
FIEs, especially their foreign investors, are exposed as in most developing countries, also in
China to the currency risk, that means the exchange rate risk and the transfer risk. The foreign
currency problem is intensified on the one hand because of the big demand for foreign
exchange for buying materials from abroad and for paying the dividends for foreign investors,
and on the other hand through the difficulties of earning foreign exchange in the start up
phase. FIEs’ finance management has to solve most of all problems of equity financing, debt
financing and currency management. These three issues shall be analysed in the following. 55
2.3.3.1 Equity financing
Every FIE in China is required to have a certain amount of registered capital, as specified in
its approval documents. According to these approval documents, the foreign investor’s
minimum share of equity capital must amount 25 % of the whole capital of the enterprise.
Unless such registered capital is contributed, which must be done in a manner in accordance
with Chinese law, the foreign enterprise cannot exist as a legal entity in China. Aside from the
obvious method of investing registered capital in the form of cash, there are several other
ways of contributing the required amount to the venture which may save a foreign investor
money. Commonly, local partners have little cash to invest. Therefore, the Chine se company
often may provide machinery, land-use rights and factories, or other assets as their portion of
the investment, its share of registered capital (all of which are inherently difficult to value).
Only a few local enterprises have readily accessible cash. Their very desire for a joint venture
54 Pausenberger/Völker, 1985, p. 21-24.
55 Pausenberger 1980, pp. 53 and Pausenberger/Glaum, 1993, p. 764 -768.
42

is often to acquire foreign capital and technology. Foreign investors should be aware of how
their partner will finance their share of the investment. The foreign partner often contributes
know-how, immaterial goods, machinery and technology from overseas. Foreign investors
should keep in mind the requirement that only 25% of the foreign investor’s registered capital
contribution to an FIE may comprise technology. 56
The foreign investor could also get his share of registered capital financed through loans from
banking institutions or through investment grants from national and international finance
companies such as KfW in Germany. The foreign investor as well as the Chinese counterpart,
or the venture itself, could also use Chinese banks for financing their registered capital via
loans. They may procure capital other than the registered capital through preferential-interest
loans if it imports goods or machinery from the US or Europe via special government „soft-
loans“, „mixed-loans“ or export credit programs, the purpose of which is to encourage the
purchase of such goods. Applying for such loans requires certain guarantees, housing or real
security and the approval of the venture through the authorities. The US Export-Import Bank
offers bank guarantees to foreign purchasers of machinery and equipment from the US. The
life of these loan contract is generally one to three years. 57 A foreign investor wishing to
participate in a joint venture with a Chinese company may also raise money overseas by
entering into a joint venture contract with a Chinese party. To raise public funds outside the
PRC for use as registered capital, the investor first needs to set up a company overseas, if one
does not already exist. Currency lending from outside China will require the approval of the
State Administration of Foreign Exchange. This method of financing can also be used to raise
capital for a joint venture that already exists.
While a foreign investor must be prepared to initially contribute a good deal of equity to a
venture to satisfy the Chinese regulations regarding registered capital, a wise financier would
also attempt to invest equipment purchased abroad with the help of low-interest loan as a part
of registered capital attributed to the FIE. Alternatively, a foreign party wishing to fund his
enterprise with a Chinese party may prefer to issue shares in a separate overseas company,
and then use the proceeds from the offering specifically for the purpose of funding the joint
ve nture. Leasing of equipment and machinery in China provides another suitable alternative
to loans for some investors in that such agreements are convenient to enter into and may have
tax advantages. Another possibility of funding capital is inside financing through cash flows,
56 Buxbaum/Gonzalez, 1998, p. 10; de Waal, 1998, pp. 16.
57 Fan, 1994, pp. 189.
43

evenue sharing, deprecations and other reserves. But this is a relatively new and unknown
form of financing tool available to foreign investors and therefore not often practised. Also,
the revenues of just started FIEs and the rates of depreciation are rather low in China, which
makes inside financing quite difficult looking at the rather high amount of required capital. In
spite of this underdevelopment, these financing tools offer substantial tax advantages, in that
the income received from such investments may not be immediately taxable. 58 Generally
spoken, the FIE’s have a great flexibility in the way they want to allocate and use their
revenues as long as both partners agree, which is sometimes difficult in China, especially
when the Chinese partner has debt financed his share of investment. If a local partner has
borrowed to fund his portion of equity, he will have a different attitude than his foreign
partner as to such important issues as dividends and future capital injections. Several joint
ventures were unable to expand their venture in conjunction with the opportunities in the
marketplace. Often a local partner’s inability or unwillingness to increase equity has limited
the joint venture’s expansion. 59
For most investors the surest way to minimise risk is to minimise the amount of their equity
investment - unfortunately, this is often not the case for a joint venture in China. Foreign
investors cannot assume that debt will be available or that their partner has good friends in the
local banking community. Too often, foreign investors seek to minimise the amount of paid -in
capital only to find that they must then provide payment guarantees for 100 % of the venture’s
debt requirement. While the minimum percentage of equity financing is easy to determine,
investors should keep in mind that this may not be the appropriate percentage for their
particular investment. If debt is not possible without parent company guarantees and if the
local partner cannot provide their portion of debt guarantees, then the foreign investor should
demand a higher equity-to-debt ratio. 60
In addition to the required amount of registered capital, all enterprises in China must have
working capital with which to handle daily business affairs. The parties may contribute
working capital to the venture at any time. A venture is normally better off borrowing money
for working capital, which can be obtained from Chinese banks in China or from overseas
banks or other lending institutions (see next part).
58 Buxbaum/Gonzalez, 1998, p. 14.
59 Pausenberger/Völker, 1985, p. 24.
60 de Waal, 1998, p. 16.
44

2.3.3.2 Debt financing
As getting the status of Chinese legal entities through official approval, FIEs are treated
through the authorities and financial institutions as if they are Chinese domestic enterprises.
According to the goal of the government to promote foreign direct investment into China, the
FIEs can generally obtain more financial instruments of debt financing than their Chinese
counterpart. The government also provides grants and financial support for financing
corporate debt, if the potential debtors fulfil certain restrictions similar to Western standards.
Similarly to Western standards, the loans can also vary in China according to currency, time
limits, finance purpose etc. Nevertheless, Chinese authorities use different definitions for
long- and short-term loans. Long-term loans include all loans with a time limit of more than
twelve months. Loans with a maturity of 12 months or less are considered to be working
capital, and are subject to different quota restrictions than longer maturity loans (see also part
0). The definition of maturity orientates mainly on the financing purpose, as if the loan is
meant to be for fixed or current assets. For investment projects, which exceed certain limits
set by the Planning Bureau, approval of authorities is necessary. 61 Large infrastructure
projects are still often funded over the budget state or provincial budget. Another issue to
address is whether debt financing should be in RMB or foreign currency (usually USD).
Many foreign investors have no choice. Often corporate policies require that investments be
funded in local currency. Many consumer product companies with wide -spread activities in
China will only consider expansion if they can secure adequate local currency funding. As
policy they will not take the risk of a devaluation of the RMB. While conditions vary from
place to place in China, in recent months it has generally been easier for joint ventures to
obtain reasonably structured debt financing. Positive impacts by the PBOC on RMB debt
financing have been its announcement to abolish the lending quota system and its lowering of
RMB interest rates, because of the decline in economic growth and the fall in inflation. 62
A joint venture or a WFOE in China may, according to the „PRC Commercial Bank Law“
obtain a RMB loan from a Chinese bank. Having sufficient RMB is necessary to cover the
costs of everyday expenses such as raw materials, labour and public utilities. Security interest
for the loan may be required by the bank issuing the loan, and such security may take the form
of a guarantee or charge over various assets of the enterprise. Concerning the security,
investors have to keep in mind some Chinese specific features, such as the non-conveyance of
61 Fan, 1994, pp. 198.
45

eal estate (after the upcoming reforms, this might change) which does not allow real estate to
serve as security, neither do machines and assets used for own purposes and therefore
imported tax-free to China. As when lending to local companies, before approving a loan the
bank may investigate various factors such as the payment ability of the potential debtor, assets
of the company, the validity and strength of any guarantee, the use of the loan and other
financial information. Again, the investor must be aware of the in-transparency and
asymmetric information in China. In China, several restrictions and laws concerning financing
business have been promulgated but their implementation and execution suffers a lot.
Decisions related to developing business andextending credit in China must take into account
risk factors particular to the market. The absence of reliable information in general, and
performance-related information (financial statements, payment experiences, court records) in
particular, plus the special risk factors of „triangular debt“, obsolete inventories and
unprofitable and technically bankrupt SOEs, make it imperative to deal with customers and
suppliers face -to-face in addition to obtaining information from external information
sources. 63 Another serious problem with RMB loans has been the tenor. Chinese banks often
told customers that they could not lend medium or long-term RMB loans unless the project
was officially part of the current five -year plan. Quota (also see part 0) was also a problem as
each bank was give n an annual limit on the amount of loans it could make. Often banks with
excess deposits were unable to lend because of inadequate quota. Some banks were willing to
lend for very short periods of time as long as the loans would be repaid before quotas would
be re-checked. With the recent announcement that the quota system will no longer be used,
the PBOC hopes to see more loans made on the basis of economic viability and credit
worthiness. Unfortunately, only a few bankers have credit training or background, most of
them are totally inexperienced with market-oriented credit rating. 64
Generally, FIEs are able to obtain long-term loans from every Chinese bank but the CCB is
the leading bank for financing new investments. The speciality banks orientate themselves on
the industry sector in which the FIE is located. Borrowing RMB currency must almost
invariably be done in China and can be expensive. Overseas loans at lower interest rates can
be obtained, and at times converted into RMB at market rates, to keep down the cash cost in
the PRC investment. As mentioned above, currency lending from outside the PRC will require
62 de Waal, 1998, pp. 17.
63 Dun & Bradstedt, 1998, pp. 15.
64 de Waal, 1998, p. 18.
46

the approval of special authorities. In the past, the Bank of China was the only institution
which can provide FIEs with long-term loans in foreign currencies. Nowadays, this monopoly
doesn’t exist anymore. Short -term debt financing in China is mainly offered by banks. Due to
the financial reforms, several new financing tools especially for short-term finance on the
money markets, are being created, but they are still underdeveloped. 65 Alternative sources of
debt financing include export credit agencies and the World Bank’s International Finance
Corporation (IFC). Export credit agencies have had a difficult time structuring credits to
China that do not carry sovereign risk guarantees. Often their pricing is more expensive than
commercial bank debt. The IFC has been very active in China, but their approval process can
be lengthy. They are frequently also willing to take a small equity stake in the venture.
Next to these more traditional bank loans, FIEs could also get their corporate debt long-term
financed via issuing bonds directly on the capital market. In China, the PBOC is in charge and
control of the approval for such bonds. Any enterprise in China may float a bond on the local
or foreign markets or make a public offering of its own corporate shares on the local or
foreign markets, with the approval of the relevant state authorities, which requires detailed
documentation, such as business reports, financial statements and balance sheets, specific
terms and conditions of the bond to be issued, and the manner in which the funds will be
managed and the debt repaid. Additional requirements and procedures are necessary if the
bond is to be used for fixed asset investment. These requirements are strict and sometimes
make it very difficult to obtain approval from the relevant authorities. Of course, while in
some situations obtaining funds through issuing securities may be more preferable than
getting a loan, the FIE owners will be giving up some of their ownership in the company, and
as such, should be careful not to give away too many of their rights. Given the present state of
the markets, if the offering is to be made in Hong Kong or China, FIE owners may wish to
wait for a more propitious time. Especially foreign investors, may have to face national and
cultural barriers. 66
An indirect method of getting funding for a project is through transactions called forfeiting or
countertrade, of which the latter means that an FIE links its purchase of machinery or other
assets with the sale of certain products. This method may be attractive to FIEs that rely mainly
on raw materials and labour in China, as these production costs are quite low when compared
to their profit margin. Therefore, countertrade has become a necessary component for most
65 Fan, 1994, pp. 202.
66 Buxbaum/Gonzalez, 1998, p. 11 -12.
47

foreign investors in structuring the finance of their venture, in large part because the RMB is
not fully convertible. Compensation trade is one form of countertrade in which the investor
pays for the cost of machinery or other asset being purchased with items produced by the
machinery itself. Other forms of countertrade exist, such as those in which the asset purchased
is paid off using products other than those produced by the machinery acquired. Using one of
these methods is helpful for companies reducing their use of foreign exchange, but they
should be careful, however, to ensure that this method is cost -effective and that the cost of the
goods which will be used to pay for the asset is less than the cost of taking out a loan. Leasing
of equipment and machinery also provides a suitable alternative for FIEs that do not wish to
pay the full price for the equipment immediately on purchase. Financing the venture by
leasing is also attractive because the fixed lease payments are not subject to the vagaries of
floating interest rates, and because leases are at times much more convenient to obtain and
handle than loans. 67
2.3.3.3 Currency management
International enterprises operate in China with a wide range of high volatile currencies. They
are permanently faced with currency risk, which includes transfer and exchange risk. The
current concern for all investors in China is whether or not China will devalue its currency.
There seems to be a distinct polarisation between those with a political point of view (who
believe that China’s leaders cannot afford to lose face by reversing their public commitments
to maintain current rates) versus those with an economic point of view (who believe that
China cannot forever avoid the impact of the regional devaluation in Asia). Most businesses
are not getting into the debate, but are rather reviewing their exposures and trying to hedge
their positions as much as possible. 68
The RMB is not fully convertible on world markets and most companies must endure
restrictions on foreign exchange. In addition to that, the exchange rates of the RMB towards
other currencies do not express the real values. FIEs are heavily exposed to a variety of
currencies used for their working capital and cash assets as well as for their balance sheet
values. The strict currency control (see also part Exchange Control) accelerates the currency
risk for the FIEs although they are in advantage of more freedom in the area of currency
67 Buxbaum/Gonzalez, 1998, p. 12.
68 de Waal, 1998, p. 19.
48

control compared to national enterprises. 69 A significant devaluation has not occurred for
more than four years in China, therefore, many investors have become (too) complacent with
a stable exchange rate and easy access to foreign exchange.
FIEs have to gain their currencies, which they need for procurement from abroad,
compensation of their foreign staff and for paying dividends to their foreign investors on a
self-operating basis. The Chinese government supports them only poorly. The balancing of
these foreign exchange positions is one of the most difficult tasks and therefore a high barrier
for FIEs in China. In a controlled market like China, it is complicated to gain all the necessary
currencies for the daily business. However, in spite of all techniques of hedging currency
exposures, devaluation will fundamentally alter a company’s revenues and costs and thus its
cash flow. If devaluation occurs, a company that imports parts and components to
manufacture products that will be sold in China, must raise local currency prices to avoid
losing money on every sale. Each investor in China should review their cash flow by currency
and determine what impact various levels of devaluation would have on that cash flow. 70
When a company’s assets and liabilities are denominate d in different currencies, changes in
the relative value of the currencies involved will bring about a change in the relative value of
the assets and liabilities. To avoid this, financial managers have the objective to keep the same
ratio between currencie s on both sides of the balance sheet. By borrowing in the same
currency as they will receive from future business, companies hedge against exchange rate
risk. This is problematic when one of the currencies involved is the RMB. Firstly, rigid RMB
maturities complicate matching. The dates for payment and repayment of the loans are often
inflexibly set by the bank. Secondly, the interest rates on these loans can be preclusively high
(see 2.3.3.2). Regulatory peculiarities also create exchange risks. Conversion of RMB into
foreign currency for import payments are allowed not earlier than three months before
payment. The importing company is exposed to a depreciating RMB from the point in time
when the purchase was decided until three months before payment. A FIE selling on the
domestic market is therefore exposed to the risk of a RMB depreciation in the period between
the closing of the deal and payment, although the RMB is officially a fixed exchange rate.
Since the crisis in Asia has seriously touched Japan and other competitor countries in Asia,
the Chinese government could be forced to devalue the RMB in the next year. 71 The main task
69
See for more information Fan, 1994, pp. 208.
70
de Waal, 1998, p. 19.
71
See Madura, 1993, p. 136-140 and Fan, 1994, pp. 207.
49

of the currency management is to predict, prevent or hedge these currency risks as good as
possible, which is of essential importance especially for operating in emerging markets. 72 The
most obvious way to hedge a long RMB exposure is to borrow in RMB. Some companies are
borrowing even though they do not currently need RMB. Non-deliverable forwards are
another way to hedge RMB exposures. This market is completely outside China. The market
for these instruments are still underdeveloped. On top of that, there are significant internal
accounting issues that will need to be resolved for most companies that use de rivative
instruments to hedge their actual exposure in China. However, currency management is an
issue with highest priority for foreign investors, because devaluation would fundamentally
alter a joint venture’s future profitability.
2.3.4 Conclusions
China will continue to be an exciting market. Changes in China and the region will be
challenging and perhaps frustrating. China’s economy faces a host of problems as it changes
from being a centrally planned colossus into a decentralised market driven net of indepe ndent
entities. The political unwillingness to seriously reform the loss making SOE sector is perhaps
the single most serious obstacle to a balanced economic growth in China. The inefficiency of
the SOE sector has arrested the development of the financial sector primarily via the former
specialised banks. They have been used as vehicles for subsidising SOEs and thereby social
stability. The fact that policy lending has burdened the state banks with bad debt to the extent
that they would be rendered ripe for bankruptcy by any Western standards, prevents them
from fully pursuing independence and privatisation. Another obstacle for the state banks is
their history as a part of a central planning administrative organisation as well as the
provincial governments’ power apparatus. They have only recently been subjected to the first
experiments with market conditions and therefore lack basic banking skills, most notably the
ability to carry out credit risk evaluation.
This paper has shed some light on the structure and system of the Chinese financial system in
general and of business finance in particular. The recent changes in banking and capital
markets policies provide both opportunities and obstacles for PRC investors. Credit and China
risk limits have tightened, but recent political developments and increasing M&A
opportunities give grounds for investor optimism. However due to the early stage of financial
reforms in China, the study has had to leave questions open. Future research on the banking
72 See Pausenberger/Glaum, 1993, p. 764-767.
50

usiness in China and related issues is desirable in order to gain better insights into the
complexities of financing opportunities. It is essential to keep in mind that Beijing is not
implementing financial reform measures in a sealed greenhouse but in a tough and
contradictory environment, where banks require better asset management while the economy
requires sustainable liquidity. Whether all these steps taken together will transform the
mainland’s financial sector and allow the country’s large banks to retreat from the precipice
remains to be seen. There are, however, few alternatives.
Financially sound joint ventures that understand their risks and cash flow profiles will have a
distinct advantage. Given these exciting and volatile times, direct investors in China should
consider their financial structuring as a most important issue. In establishing a finance plan for
a venture, one must remember that for all FIEs there are requirements which dictate that
registered capital must be invested by a certain date pursuant to the contract and Chinese law.
There are numerous restrictions in a system with foreign currency controls and general
controls on foreign investment. In order to ensure the highest return on investment, one must
first consider the nature of the project invested in. There are, for example, two ways to borrow
capital from abroad and yet have it count as one’s investment in a Chinese enterprise, freeing
up capital for other uses. The equity-to-debt-ratio, the portion of every partner’s investment,
the sources of equity and debt financing, the currency and maturity of loans, the relationship
with Chinese and foreign banks, the own capabilities of currency management, are all factors
which highly influence success and failure of ventures in China. Clearly, the lower the
amount of money foreign investors put into a FIE, and the larger the share of capital they can
obtain, the greater their return in proportion to their investment. Any foreign investor wishing
to put together a finance plan for investment in a venture in China, should be prepared to be
familiar with a large range of financing vehicles, as various restrictions of the Chinese
government make it difficult, sometimes impossible, to use certain types of financing for
specific projects. This aside, the realities of doing business in China necessitate that some
methods of financing will be more preferable than others. A comprehensive financing strategy
is the key component of a healthy PRC investment.
Over the past year since Cinderella’s study was written, the Chinese government has
continued with the banking and financial reforms. Drastic reorganisation of the banking
51

institutions and control systems have occurred to create greater transparency, such as to
remove the ability of local officials to influence banking decisions. Action was also taken to
dissolve loss-making SOEs. One major on-going reform is the removal of the military links
with business, thus increasing the privatisation of business while professionalising the
military.. These are far reaching changes which demonstrated the Chinese government’s
resolve to build a modern and efficient market economy.
Looking at the tremendous changes in the banking and financial sector, Paul realised also the
many faceted dimensions of Chinese economy and policy. Clearly, given China’s communist
government and the immensity and complexity of the country, China has made tremendous
strides forward in the making of a market economy. The pace of change has been sure and
rapid. In such a situation of rapid change, everything would seem to be in a flux, with the
exception of genuine human relationships and understanding. This is probably the key to
success for the China venture. Is this not also Mr. Zheng’s key to success in China?
52

3. Pre-Entry Strategic Considerations to Maximise Business
Potential
Understanding the operating environment for foreign businesses in China is only a first step to
strategic formulation. Understanding oneself or one’s own business in terms of its strengths
and weaknesses provides an important basis for strategic formulation. Paul remembered
vaguely the old Chinese proverb: “Know yourself, know your enemies. A hundred battles
fought. A hundred won.” A critical consideration before entering a new business arena, in this
case, ventur ing into China, is therefore to know one’s own business in terms of its strengths
and weaknesses and in relation to existing and potential players in China. Paul started to read
about the “Need for business self-examination” ...
Klaus Kukovetz, a doctoral student working in China wrote:
3.1 Pre-Entry Considerations: Need for Business Self-examination (by Klaus
Kukovetz)
A lot of publications and business guides are available which explain the does and don'ts of
market entrance into China. These are valuable tools to avoid the most common and pitfalls of
such an endeavour. Many of them, however, neglect the very first stage of market entry:
business self-examination. Even in a simple and well known business environment, the
product-to-market and company-to-market fit is a precondition for success. This is even more
true for a complex and alien environment like China. Even if the market is found to be very
attractive and relatively risk-free, and even if a strong demand for the company's products can
be assumed, market entry is not self evident. The company must be fit for market entry as
well. For an SME such fitness should not be taken for granted prematurely, but should be
assessed with great diligence. Any company's strategy move a into new territory will
necessarily consume a substantial amount of resources. For SMEs which generally do not
have sufficient personnel and management resources. This would not be an easy problem to
solve.
Before a company ventures into a new market, it must determine it’s own strengths and
weaknesses as well as the opportunities (and threats) offered in the new environment. In the
first case, the general readiness to enter the Chinese market was found to be lacking even
though there is a good fit in the relevance of its product in the Chinese market. In the second
case, a thorough analysis of a company’s strengths and weaknesses in relation to the
opportunities and threats in the new environment has enabled the company to develop a sound
53

entry strategy into the China market. Venturing successfully abroad requires preparatory
measures to ensure the general fitness and compatibility of a company in relation to its
partners and markets in the new environment.
3.1.1 General Readiness to Venture Abroad
As a first step the company should ask whether it is ready to enter the Chinese market. It has
to investigate, for instance whether it has enough free management and capital resources. The
management time needed for a new market entry is almost more than what one expect. Due to
the novelty of the venture, employees working on the market entry project will need a
disproportional amount of top-level guidance and advice. Top management itself will need to
travel to China to establish valuable business contacts. These business contacts will then
demand attention and time to be kept alive. It is therefore recommended that there should be
one member of the top management team who is strongly dedicated to the market entry
project and who is prepared to invest a substantial amount of his or her time for the project. In
SMEs this high level manager with free time resources often does not exist. Such a company
will therefore have to work first on internal processes to create such a capacity it will be ready
to proceed to a next step.
Monetary resources are important. Even if planning is done very rigorously, money invested
in a high-risk emerging market like China should not be crucial to the survival of the
company. There will be ways to keep investment down to a minimum level - market entry
into China does not necessarily have to be expensive - but it is very difficult to reduce risk.
No amount of planning will be sufficient to account for the complexity and rapid pace of
development of the market. For this reason, the company needs to be prepared to write -off its
investments in the worst case scenario (see paper 8 for two examples).
3.1.2 Specific Fit with the New Environment: Products and/or Partners
The company's products must fit with the market conditions in China. Here, it must be
assessed whether the company offers an attractive product mix for the Chinese market. The
level of investigation should be relatively deep as special features or mismatches might easily
be overlooked. At this stage, the company will try to evaluate whether its most promising
product or product category has chances to succeed in China as it is, or whether some special
modification will be necessary. The degree of localisation needed may vary greatly between
simple adaptations in the packaging process on the one hand, and the development of
completely new features on the other hand.
54

While the testing for the general readiness of a company to venture abroad may be done
internally, testing for the specific product-market fit will require a lot of market information,
which may have to be acquired from external sources.
3.1.3 Practical Illustrations
3.1.3.1 Case Study 1: A Swiss labelling and labelling systems company (LLSC)
LLSC is a family owned business with subsidiary companies in Germany, France, England
and the United States. According to turnover and number of employees, it is clearly an SME.
Nevertheless, LLSC is one of the world's leading companies in its market segment.
Around three quarters of LLSC's products are self-adhesive labels, with labelling system
machines taking up the rest. The company is renown for its quality, as well as fast and reliable
after sales service. A particular strength of the company is a sophisticated network, which,
however, is operational mainly in the company's Swiss home market. The company's largest
clients are the world's leading consumer products firms which use LLSC's products for
normal labelling purposes, on-product marketing, and related purposes.
By the end of the 1990s, LLSC's geographical reach had spread from Switzerland, to
neighbouring European countries and then to the large market of the United States. However,
until 1997, the company's experience in the Asian markets remained very limited. There was
no clear strategy for the region, even though interest in China's large market kept growing.
This interest was generated mainly by the top management's contacts with friends and
associates, who were doing business with China. Every now and then, an initiative was started
to generate more information but these efforts never resulted in a long lasting project.
In late 1997, the company asked a team of student researchers 73 from the University of St.
Gallen, to help assess the company-to-market fit of LLSC and China. The results of this
investigation are reported here. As the company asked to investigate the market potential, the
specific fit analysis was carried out and is presented here.
Specific Fit
To assess the specific fit of the company's products to the Chinese market, a market study was
conducted among the company's leading customers, as well as industry experts abroad and
73 The author was leader of the team, which comprised the following fellow researchers: Guo Zhaoui,
Kölsch Manfred, Zambon Antonia, Zeng Lingyan.
55

from within China to assess local market conditions. It was in particularly necessary to find
out which level of sophistication the Chinese labelling market had reached, which trend could
be expected in future, how the company's European clients met their labelling needs in Asia,
and whether they were satisfied by the product variety and quality currently existing in China.
The result of this investigation was the finding that LLSC's target market, sophisticated self-
adhesive labelling syste ms, was growing quickly, albeit from a relatively small basis. The
majority of labels used in China were still based on older techniques.
The competitive environment was of particular interest for the company. There were clear
indications that international competitors had started to enter the self -adhesive labelling
market recently. Judging from the development of European and US markets, as well as from
the interest of the company's - mainly Japanese - competitors, the market potentials seemed
very promising.
General Readiness
Taken alone, the findings of the specific fit investigation would have suggested to pursue the
goal of market entry into China vigorously. This conclusion was not drawn however, as a
general readiness analysis lead to different recommendations.
LLSC is a relatively conservative company with firm control and leadership methods, which
were well proven in Switzerland's stable environment. It does not boost large reserves in
capital and management resources. Knowledge of foreign markets, especially the Chinese
one, is also very rudimentary.
This background led the company to pursue a prudent expansion strategy in Europe and the
US. Each of its subsidiaries was founded in co-operation with a local entrepreneur who
contributed local market familiarity and a significant share of capital to LLSC's mainly
technical know -how.
A similar strategy of co-operation with sophisticated local entrepreneurs was not found
feasible for China. Most co-operation strategies in China between foreign and Chinese
businesses are joint ventures between the foreign firm and usually a state owned or state
affiliated company or organisation. While these organisations or companies may contribute a
lot of market knowledge, experience of other foreign companies in the Chinese market has
shown that operating a joint venture successfully demands a lot of skills from the foreign
party. In particular, the generation of a sound understanding of the Chinese market and the
Chinese way of business must not be neglected. While local partners generally offer a variety
56

of relevant contacts to suppliers and customers, their technical and management skills are
much more limited than those of LLSC's typical western co-operation partners.
Therefore, it was concluded that LLSC did not have the relevant skills to pursue market entry
speedily in China. This was true especially as China would have been the company's first
major venture into an Asian market.
It was therefore recommended that LLSC should follow a more moderate approach, acquiring
relevant market knowledge, as well as know -how of joint venture management with Chinese
characteristics. At the same time the company was advised to step up its marketing efforts in
China through agents or similar distribution channels to gain first hand market experience
without any significant investment in the region.
This preparation phase would also allow some time for the top management to familiarise
itself with the different market conditions and requirements it would meet in the Chinese
market. With a sufficient preparation phase, management capacity can be built up, and
financing secured.
All planning steps should be pursued with the background knowledge that the specific fit
investigation showed that China was a promising market. As soon as the company's general
readiness is assured, market entry will be very promising for LLSC.
3.1.3.2 Case Study 2: Swiss printing systems company (SPSC)
SPSC is a SME with nearly 500 employees and a turnover of some 150m CHF. It has 2
production facilities and 9 subs idiaries world wide. It focuses on labelling printing machines,
which it partly produces itself and partly trades. One of its strengths is a sophisticated service
system which assures reliable and fast after sales service.
Until the 1980s SPSC was a local company, selling to an international market through
independent agents. This strategy was modified in 1982 with the founding of a subsidiary in
the United States, to which more subsidiaries were added throughout the early 1990s.
In 1994, the company realised, that it has to grow quickly to become a global player in its
market niche. For this reason it re-examined its business, resulting in a reformulation of its
strategy. The company's leadership believed that quick and profitable growth was necessary
to survive in an increasingly global and increasingly competitive market environment.
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General readiness
The first step of SPSC's two-fold analysis and self-examination process was to investigate the
company's strengths and weaknesses in face of the new strategic goal. The results of such a
SWOT (strengths - weaknesses; opportunities - threats) analysis are shown in TABLE 2-1:
STRENGTHS
• High quality
• Well known products in niche markets
• Strong production skills
• Reputation for excellent service
• Flexibility in business processes
OPPORTUNITIES
• spreading of risk and becoming global
player
• realisation of cost advantages
• realising market potentials
WEAKNESSES
• weak negotiating position
• limited financing resources
• limited personnel, especially management
resources
• little internal information about target
countries and markets
THREATS
• investments of significant magnitude
• market risks difficult to evaluated
• political and various other risks
• potentially too high quality standards for
target market
TABLE 3-1: SWOT analysis for SPSC in respect to market entry in Asia
In the first phase of the analysis process, SPSC therefore realised that its organisation was not
prepared for the typical direct investment market entry method of many large multinational
companies (MNCs). While MNCs have relatively easy access to capital markets and do not
encounter difficulties in hiring able job applicants, smaller companies like SPSC are
disadvantaged in both areas. The opportunities, on the other hand, especially the perceived
necessity of becoming a global player, convinced the management to continue pursuing its
goals, albeit with the results of the business self -examination in mind.
The company's management reasoned that it needed a tailor-made market entry strategy to
overcome its company specific limitations and to reduce the threats involved in large scale
market entry. The result of this analysis process was a strategy of opening up only one wholly
ow ned subsidiary in Southeast- and East Asia and to co-operate in the other countries closely
with locally well-connected partner companies on a contractual basis. The plan was to find
58

partner companies with free servicing resources and to support these regional partners through
the core subsidiary company. This strategy would allow a rapid growth in the target region
through relatively uncomplicated partnership agreements while limiting SPSC's own risk
exposure.
Specific fit
After the important first step of investigation was completed, SPSC had to do a more detailed
specific fit analysis.
In its particular case, it was more important to investigate the fit of partner company to SPSC,
rather than the fit of a world-standard product to local necessities. For this reason, project
groups were formed which investigated each potential partner in detail. To achieve reliable
results in a short time, external experts were consulted, who added detailed market knowledge
and a network of local contacts to the project teams.
This specific fit analysis generated not only a list of promising co-operation partners, but also
a good understanding about local markets and the competitive environment. Potential success
factors were also side products of this investigation, as well as a list of likely future clients.
Through this two fold pre -entry business self-examination, SPSC therefore created a highly
successful strategy, that prepared the company in an optimal way for a more global business
environment. In particular, it managed to achieve the following tasks:
Transfer of strengths
The own strength of superior customer service could be transferred to the target region by a
carefully selected number of local partner companies.
Through signing partnership agreements with 15 companies in as many countries in only a
few months, economies of scale could be achieved rapidly without an overly usage of capital
and personnel resources.
Reduction of weaknesses
As a result of the new strategy, SPSC's multinational client face an equally multinational
supplier. Additionally, the utilisation of company resources could be kept to a minimum.
Finally, an innovative company with global visions has now a much better chance to attract
highly qualified job applicants.
59

Realising opportunities
Participation in growing markets is realised within an organisational structure that is flexible
enough to allow more aggressive growth if needed, through the finding of more wholly owned
subsidiaries. On the other hand - especially in the view of the recent Asia crisis - the flexible
organisational structure keeps risks at a minimum by having only very few own resources tied
up in the region.
Avoiding of threats
Capital invested in foreign countries is kept minimal. Through the network of local contacts in
connection with a wholly owned subsidiary, gathering of relevant information has become
much more easy. Lastly, overall business risk is being reduced by spreading the activities over
a large variety of markets.
The example of SPSC shows how a detailed business self-examination can help to find a very
attractive market entry strategy. By carefully relating the organisation's strengths and
weaknesses to the market entry's opportunities and threats, the company could design a truly
tailor-made and innovative ma rket entry strategy. Analysing the target market alone would
not have been enough. Only the connection with the unique characteristics of the own
company helps to avoid mistakes in the very important early phases of strategic planning for
market entry.
After long months or even years of planning, many - often fruitless - negotiation rounds, and
finally the work intensive phase of building up or revamping Chinese production facilities,
many companies are inclined to lean back and turn their attention to new projects. In a
business environment that is both relatively new and alien to a European SME, as well as
rapidly changing and evolving, such an approach might well be very destructive. A
continuous process of re-evaluation and subsequent re-positioning is necessary in many
projects and often crucial in China.
As Paul started to reflect on his China business, he began to appreciate the extensiveness of
Mr. Zheng’s preparatory work in the positioning of his China Venture and in the choice of
partners in China. He can see the complimentary nature of his former business partners in
China which Mr. Zheng had chosen to work with. Indeed, his business partners have clear
60

strengths which his own company lacks, particularly in relation to the operating environment
and personnel in China. The next paper entitled “Maximising potential through strategy fit
with potential partners” started to make sense even before Paul started to read it. The more he
reads, the more he seems to appreciate the wisdom of Mr. Zheng in his choice of business
collaborators as well as his understanding of China and doing business there.
Rainer Kirchhofer, a senior Swiss banker and Stephan Lechner, a practising engineer who
both chose to further their management studies at the HSG (NDU programme), wrote:
3.2 Maximising Potential Through Strategic Fit with Potential Partners (by
Rainer G. Kirchhofer and Stephan Lechner)
Going from Switzerland to the PRC, one encounters not only a different culture and language,
but also a completely different economic system. In many aspects, e.g. infrastructure and
similar facilities, China progresses at a slow pace. Yet in other aspects, such as its dynamic
economic growth and its capability to plan and guide this huge empire, China is far ahead of
developing countries. China’s diversity from the Yangtze Delta Zone, its vast agricultural
hinterland, and its new Chinese metropolis Hong Kong, as well as its size and long
independent development over thousands of years make China in every respect a special case.
This can be seen particularly in its economic development and reform movement. In an
atmosphere reminiscent of the "Klondike Gold Rush“, the streets of Shanghai China are filled
with handily equipped foreign business people struggling to learn how to make a profit in a
challenging but at the same time, frustrating, economic environment. 74
3.2.1 Issues and Scope of this Paper
Having had the opportunity to visit the Shanghai area, the authors of this text realised how
difficult it is to do business in China. This was seen by visiting some Joint Venture (JV)
companies as well as by experiencing first-hand the rapidly growing economy. This study will
focus on Swiss small and medium sized enterprises (SME's) entering the attractive Shanghai
market (see Special Economic Zones (SEZ)). Whether the market entrance is independent or
financially supported by other Swiss institutions or branches within China, the following
points will be taken into consideration:
74 The trade volume between China and Switzerland reached over one billion Swiss Francs in imports
and approx. 840 million Swiss Francs in exports in 1996 (Source: Bulletin of Swiss-Chinese Chamber
of Commerce 01/1997).
61

• What are the roles of and the reasons for the Chinese government’s creating special
economic or free trade zones?
• Where are risks, opportunities, barriers, hurdles, regulations, and laws relating to foreign
investors?
• What kind of support does the Swiss Government provide?
• What role do foreign banks play in supporting SME's entering the Chinese market?
• What are the reasons for Swiss SME's to engage themselves in the Chinese market?
• What are the strategic factors for SME's to be successful in Chinese business?
• What are the requirements for SME's before they even should plan to invest in China?
• What are the strategies most likely to prove success for setting up business in China?
3.2.2 Changes in China’s Attitude towards Investors
3.2.2.1 The Chinese Government
The 15 th China Communist Party Congress, which took place in September 1997, was the first
congress in 20 years without the physical presence of Deng Xiaoping. Yet the congress was
still under the influence of the "great banner of the Deng-Theory“ to lead and forge the
extensive development of ‘China socialism’ into the 21 st century. The start of the largest
Government reform in the history of the People’s Republic resulted from this congress and
will be published by the spring of 1998 after its ratification of the National People’s
Congress. 75
Mainland China is ruled by a Communist Politburo that consists of retired powerful leaders.
These leaders must answer to this Politburo and are required to implement party policies. The
primary legislators of state power are the State Council or Cabinet and the National People’s
Congress (NPC). Members of the State Council include a premier or Prime Minister, several
vice-premiers, nine state councillors, and the heads of various ministries, commissions, and
agencies attached to the State Council.
75 Neue Zürcher Zeitung, 13.9.97.
62

Central Committee
of the Communist Party
National People's Congress
Consultative Congress
of the Chinese People
President and Vice President State Council Supreme Prosecutor Supreme Court
State Commissions Ministries
State Administrations
and Bureaus
Institutions
e.g. for e.g. for e.g. for - Chinese Academy
of Science
- State Planning - Foreign Trade and - Customs - Chinese Academy
- Industry and Commerce Economic Cooperation - Industry and Commerce of Social Sciences
- Science and Technology - Finance - Taxation - Centre for Research
- Science and Technology - Justice - Environment and Development
for defense - Energy, Water and Railways - Press and Publications - Xinghua Press Agency
- Post and Telecommunication - Statistics
- Radio, Film and Television - Technology Transfer
- specific industry branches
- Agriculture
- People's Bank of China
- State Security
- National Defense
Administrations and Bureaus of the
Commissions and Ministries
- State Administration of Exchange Control
- State Administration for Import and Export of Raw Material
- State Expert Bureau
- State Bureau for Nuclear Security
- State Bureau for Copyright
- State Bureau for Patents
FIGURE 3-1: Organisation of the Government of the People's Republic of China 76
Under the Chinese constitution, the NPC is theoretically the state’s highest governing body.
Members are elected by secret ballot for a five-year term by provincial-level People’s
congresses. They meet annually for about two weeks to review major new policy initiatives
presented by the State Council after they have been endorsed by the Communist Party’s
Central Committee. Although the NPC generally approves these initiatives, the NPC
committees debate in closed sessions, and changes may be made to accommodate alternative
views. 77
Overall, China finds itself in a difficult transition phase between market and plan. The longing
for wealth is one of the main motivations for the actual dynamism of economic development.
However, there is still tendency for a family and clan economy, which supports small and
work intensive enterprise entities and not large and progressive investments in high tech fields
or such areas of businesses. China would like to be more than a cheap salary country and an
"outsourced“ work-table for foreign investors. Instead of low tech fields, modern future
76 China - Wirtschaftspartner zwischen Wunsch u nd Wirklichkeit, Reisach et al., 1997, p. 30.
63

technologies and great amounts of capital should be brought into the country. Europe and the
USA are more than welcome to enter the new modern model of the Chinese economy. Yet
success is far from guaranteed. Deng’s reforms liberated millions to earn a decent living and
some to become wealthy. Farmers in the countryside can still only profit from the land but
may not own it outright. People in China’s richer coastal provinces look to foreign markets
and investments, rather than to Mr. Jiang’s Beijing. "Today China’s state-owned enterprises
still account for around two-fifths of industrial output and soak up four-fifths of investment,
blocking opportunities for more productive companies to create wealth and jobs. In many
ways China remains a collectivist nightmare. Nine out of ten Communists at party
headquarters tell you it must stay that way.“ 78
3.2.2.2 Creation of Special Economic Zones (SEZ), Free Trade Zones (FTZ),
and High Technology Development Zones
Special Economic Zones (SEZ)
Deng Xiaoping’s idea that some regions should get preferential treatment and become rich
sooner than others was essential. Between 1979 and 1980, in order to attract foreign
investments, the Chinese Government entitled the Guangdong and Fujian provinces to special
preferential policies and flexibility in their economic activities. On a "trial basis“ five special
economic zones were opened (Shenzhen, Zhuhai, Xiamen, Shantou, and Hainan Island). 79 In
May 1984, China opened 14 coastal cities including Shanghai. In the 1990s, the Shanghai
Pudong New Area was opened. The opening of all these areas has had a great impact on
inland China and the border areas.
So far China has established special economic zones, economic and technological
development zones, coastal open cities, coastal open economic regions, riverside open cities,
and tourism and vacation zones. In total, there are ten different types of open regions where
preferential policies are granted for foreign investment. Within these regions, a large number
of infrastructure and service facilities have been established: communications, electric power
supply, telecommunications, water supply, and industrial facilities. All this creates a sound
77
Craighead’s Country Reports, 1996.
78
The Economist, 9/97.
79
Ernst and Young, Doing Business in China, 1994.
64

environment for foreign investment and good living conditions for foreign staff working in
China. 80
FIGURE 3-2: Map of China 81
The run to China (possibly due to low growth rates in the industrial countries) favoured the
idea and implementation of special zones. Today approximately 288 special zones are found
within China, each having different tax concessions and supportive measures for foreign
investors. Generally, technology and export intensive companies can rely on generous
privileges. Mostly terms and conditions depend on good negotiation skills by the investors.
Suzhou and Wuxi (Province Jiangsu) e.g., two hours from Shanghai by car, are known for
conceding even more privileges in order to attract important foreign investors. 82
Free Trade Zones (FTZ) and High-Technology Development Zones
Free Trade Zones, also known as bonded trade zones, were established primarily to encourage
export processing by allowing the duty-free import of goods and materials. By the end of
1993, there were 13 FTZ's.
China has approximately 50 hi-tech industry development zones. These zones were
established to encourage economic and technological development and to attract technology-
intensive and knowledge -intensive enterprises that research, develop, or produce several types
of new technology and related projects, including microelectronics, information technology
and computer software, laser technology, biotechnology, life science and pharmaceuticals,
etc..
80 Wang Yongjun, Investment in China, 1997.
81 Source: Internet http://www.emulateme.com/chinamap.htm.
82 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997.
65

3.2.3 Foreign Governments
This paper will focus on Swiss Government practices concerning export risk guarantees and
special funding.
3.2.3.1 Export Risk Insurance
The Export Risk Guarantee (ERG) is an instrument to facilitate Swiss exporters entering into
contracts with purchasers in countries where uncertain political or economic conditions could
jeopardise receipt of payment. The ERG is based on the Swiss Federal Law of September 26,
1958, the relevant decree of the Swiss Fe deral Council of January 15, 1969 and the order of
the Federal Department of the Economy of March 15, 1985. The law and decree have since
undergone a number of amendments to adapt them to the rapidly changing requirements of
today's export promotion.
The Export Risk Guarantee is available to companies established and registered in
Switzerland and cover may be obtained for the following:
• exports of consumer and capital goods
• constructions and engineering work and other services
• licensing and know -how agreements
• goods on consignment abroad or on exhibition at trade fairs
(cover against seizure of goods or impossibility of re-exportation)
• bid-bonds, down payment guarantees, and performance guarantees
The coverable risks include Political risk, Transfer Risk, Commercial Risk, "Unlimited“
contingent currency risk, Manufacturing risk, and Non-coverable risk.
3.2.3.2 Special Funds for Setting Up Businesses
"The Government of Switzerland and China signed a ‘memorandum of understanding’ in
October 1996 to launch the ‘Sino-Swiss Partnership Fund’. The fund aims at financing and
actively supporting Swiss small and medium sized companies to set-up joint ventures in
China faster, in a more efficient way, or in a larger proportion than would be possible without
this new investment promotion initiative. A contribution to sustainable development in the
PRC and improvement of the currently difficult situation of Swiss small and medium sized
enterprises as the basis of the Swiss economy should also be achieved. This fund serves as a
pilot direct investment-program in the PRC and will have a significant impact on the future
66

legal and regulatory environment of direct investment in China. The Swiss Government has
nominated a subsidiary of the ‘State Development Bank of China’ to be eventually appointed
fund manager once mutually agreeable negotiations have been concluded and all necessary
details of the funds structure have been approved by the Swiss Federal Council.“ 83
Swiss JV
Partners
+
Subsidiary of State
Development Bank
Investment Committee
PRC JV
Partners
Investments
Debt: min 50%
Equity: min 67%
Joint Venture
Projects
Sino-Swiss
Partnership Fund
Switzerland (min 51%)
Chinese Government
In-/Divestment Due Diligence / Management Support
Administration Decision Control Authority
In-/Divestments:
Debt: max 50%
Equity: max 33%
Max. CHF 5 Mio./project
Initial injection:
Min. CHF 15 Mio.
Max. CHF 49 Mio.
FIGURE 3-3: Preliminary structure of the "Sino-Swiss Partnership Fund" 84
3.2.4 Environment for Investors
3.2.4.1 Tax Holidays, Customs Liberation, and Other Incentives
To encourage foreign investment, several tax holidays and benefits are granted. To support
special development in certain areas, the Government has granted special status to the SEZ’s,
14 open coastal cities, coastal open economic zones, high-technology development zones, and
other areas. In these regions, special incentives and privileges are accorded to foreign
investors. These include reduced corporate income tax rates, tax holidays, exemption from or
reduction in withholding taxes for profits remitted overseas, exemption from or reduction in
import and export taxes, lower land-use fees and simplified entry and exit procedures. 85
83
Source: Dr. Daniel V. Christen (Consultant of the Sino-Swiss Partnership Fund), Beijing, March 19,
1997.
84
Source: Seminar OSEC in Zurich, March 19, 1997.
85 Doing Business in China, Ernst and Young, 1994.
67

Incentives for Foreign Investors:
In general:
Reduced corporate tax (15 - 24% instead of normally 30%)
No additional income tax (normally 3 - 10% of the corporate tax)
No industry or trade taxes levied on export products
In addition for Sino-foreign production joint ventures:
No corporate tax for the first two years with profits
50% tax reduction for the following 3 respectively 5 years
Additional incentives for the reinvestment of profits for foreign investors:
40% reimbursement of the already paid corporate tax on the reinvested portion of the profit for
minimum 5 following years
100% reimbursement possible in case the reinvestment is used to found a high-tech enterprise for
export purposes only
Customs:
Liberation from customs (and liberation from industry and commerce tax) for the import of raw
materials as well as manufacturing equipment for joint ventures (this regulation was cancelled for
the coastal regions per April 1 st 1996)
Other incentives:
Cheap rents for land use
Good access to public infrastructure
Flexible Government administration
TABLE 3-2: Incentives for foreign investors 86
3.2.4.2 Loans and Guarantees by the State
Currently, financing for foreign-investment projects in China is generally provided partially
by foreign investors and partially through borrowing from overseas banks with suitable
guarantees provided by the Chinese parties. Such external debt is monitored by the State
Administration of Exchange (SAEC). The Bank of China may provide several types of loans
to foreign-investment enterprises, including fixed asset loans, working capital loans, and loans
secured with cash deposits. Foreign companies may also apply for RMB loans to be secured
by their own foreign-exchange reserves, including foreign exchange borrowed from abroad.
To control the loan guarantee activities of Chinese entities, the Ministry of Foreign Trade and
Economic Co-operation (MOFTEC) has produced a list of Chinese and foreign entities that
are authorised to make financial guarantees to PRC investment projects. The Government has
co-operative relationships with the World Bank and is a member of the Asia Development
Bank. In addition, China has been granted low -interest loans by many state-owned banks of
different countries, and these loans may be used to finance investment projects in China. 87
86 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, p. 60.
87 Doing Business in China, Ernst and Young, 1994.
68

3.2.4.3 Legal Framework for Foreign Investment
China’s various types of law and accounting firms are extremely important and indispensable
to foreign investment since a foreign business’s investment in a Chinese enterprise is
governed by Chinese law, as are investment and operational activities. The state council
initiates and oversees the legislative process, with the assistance and input of the appropriate
Government departments, organisations, and other relevant institutions. Laws subsequently
are voted on by the NPC or its standing committee.
Since the beginning of Deng’s open door policy, China has begun to develop a legal
framework to benefit investors and to facilitate foreign investment. Much of the enacted
legislation is broadly written, and China is gradually filling in the details. The Chinese
economy is developing more rapidly than its legal system. In addition, Chinese law is often
inaccessible since some laws are published only in Chinese, and many internal regulations are
not published at all. 88
Since the fostering of foreign investment today is one of the ultimate goals, China places great
importance on establishing, also in respect of law, a calculable environment for foreign
capital. As long as China wants to maintain its image as a magnet for world -wide investment
streams into its country, there will be some degree of dependability. This could mean, as
Spinoza said, "Everyone has as much right as he has power“.
Due to the relatively underdeveloped legal system, detailed written contracts are crucial in
order to forestall misunderstandings and to fill existing gaps. Concerning accounting, for all
foreign companies (including WFOE’s) accounting rules and re gulations have to be followed
according to Chinese rules and in the Chinese language. Legal basis is the Accounting
Regulations Application to Sino-Foreign Equity Joint Ventures of the years 1985/1992
respectively to Sino-Foreign Investment Enterprises of July 1992. 89
3.2.4.4 Legal Provisions Concerning Land Use
The main policies, laws, and regulations concerning land use by FIE’s are the Law of the PRC
on Land Administration and the Law of the PRC on Chinese-Foreign Equity JV. Land-use by
FIE’s means the use of land necessary for the construction, operation, and production of their
projects as well as the development and management of tracts of land by such enterprises. The
88 Doing Business in China, Ernst and Young, 1994.
89 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, p.133.
69

characteristics in this regard can be summed up as the use of land with compensation and
within a limited period of time by foreign-invested enterprises and by signing a land use
contract, defining the rights and obligations of both the land user and the land owner.
In China, there are different ways for foreign-invested enterprises to obtain state-owned land
use rights. The following two ways are most practised:
Granting of State-Owned Land Use Rights
According to the Provisional Regulations on Granting and Transferring of Use Rights of
Urban State-Owned Land of the PRC, the state as the landowner, may, by means of public
bidding, auction, or agreement, extend land use rights for a certain number of years to FIE’s
(maximum 50 years).
FIE’s pay for it a lump-sum fee, sign a contract obtaining the land use rights with the state
land management department, go through registration formalities, and acquire a land use
certificate. Land use rights obtained in this way can be transferred, leased, or mortgaged.
Leasing Buildings and Sites
By this land use method, FIE's may lease buildings or sites directly from state-run enterprises,
urban collective -run enterprises, township enterprises, or other urban collective economic
organisations and pay them either annual or monthly rent as set out in the leasing contract
between them. 90
3.2.4.5 Intellectual Property
The Trademark Law is a modern piece of legislation (NPC,1983) drawn from extensive
research carried out by Chinese specialists who worked in foreign countries and as well with
the World Intellectual Property Organization of the United Nations. The Trademark Law led
to the following major developments:
• the emergence of the concept of exclusive rights in China
• the introduction of a voluntary registration system
• clear procedures for trademark application examination and registration
• the linking of trademark rights to quality control
90 Investement in China, Wang Yongjun, 1997, pp 147.
70

• China’s entry into membership of the Paris Convention for the Protection of Intellectual
Property
The patent law was introduced in 1985. To satisfy foreign investor concerns over the
protection of computer software, specific regulations were promulgated by the Government to
protect computer software and to establish a system of registration. As a result of these
important developments, China’s system for the protection of intellectual property is
complete. 91
3.2.4.6 Guanxi
China’s traditional politic al system was fundamentally a pattern of personal relationships.
Today, personal relationships known as guanxi form an invisible network which often
provides the most efficient way of getting anything done. Therefore, the extent of one’s own
personal guanxi may determine the legality of what one does. Given the strong increase of
Chinese legislation, it is easy to assume that the written law in itself is the law. Unaware of
the informal systems functioning beyond the statute, a foreigner may find himself working
with only part of the system. The obligation to help and support is the crucial factor in
Chinese networks. There are three different degrees of obligation:
• the strongest form of guanxi is caused through birth. For family members it is a natural
duty to support and trust each other. The family is the central basis of Chinese society and
the business environment, which is supported by their "Confucian“ values.
• the second form of obligation stems from life experience. These are personal ties formed
prior to a business career. School-, University-, Army-friendships, which build life -long
solidarity towards each other.
• the third and weakest form of obligation is based on personal connections from business.
Since the reform area has started, business associations, such as the "Individual Laborers
Associations“ or "The Young Factory Director and Manager Associations“, etc. have been
established in Shanghai in order to build a business network.
Most successful businessmen realise the importance of guanxi, and all of them have their
relationships, but only in their "Western world“ and business environment. The above
mentioned first form is inaccessible to foreigners, and the second is very hard to achieve.
91 The Business Guide to China, Lawrence Brahm, Li Daoran, 1996, p.19.
71

Only a so called "ad-hoc guanxi“ or the relationship thr ough informal associations could be a
realistic aim for a foreign investor in order to build up an obligation relationship with Chinese
partners. 92
It is a prejudice in the Western world that Chinese entrepreneurs are regarded as "patriarchal
autocrats" who alone reign over huge and hierarchically structured companies. A
decentralised leadership culture is much more common relying on delegation of responsibility
and trustful connections. This is mostly due to the control of the family network still present
today and widely used by the middle class as a reliably working credit system. 93 In China,
with her close knit of family ties, borrowing from family members is very common. Other
sources of financing are "tontines" or "huay", an informal system of banking commonly found
among Chinese. 94
3.2.4.7 Environmental Protection
According to the relevant Chinese laws and regulations, projects with foreign investments that
affect the environment must be in compliance with China’s regulations regarding
environmental protection of investment projects, following examination and approval
procedures, to avoid damage to China’s environment arising from random construction.
According to the Decision of the State Council on the Focal Points of the Present Industrial
Policies, China does the following:
• exercises strict control over imported raw materials, products, technologies, and equipment
that result in serious environmental pollution that is hard to treat, in order to prevent
foreign polluting sources from entering China
• forbids the introduction of projects that degrade natural resources or human health or
seriously pollute the environment with no effective counteractive measures or emit
pollutants that exceed State standards
• restricts the introduction of projects that may result in serious hard to treat environmental
pollution, such as dismantling and reconditioning of old vehicles or retreating of old tires
92 Students' report on excursion to Shanghai, FIM at Hochschule St. Gallen, 1997.
93 Source: "The Chinese Connection" from Swiss periodical "Bilanz", issue 6/1997, p. 94.
94 Sources of business financing and financing practices, Chong Li Choy, 1990.
72

• stipulates that advanced technologies and relevant advanced facilities for environmental
protection shall be concurrently introduced for projects involving pollution problems for
which China does not have relevant treatment facilities.
Foreign businesses are encouraged to introduce highly efficient pesticide technologies with
low toxic content and environmental pollution treatment technologies and to establish projects
with advanced technologies such as commodity paper pulp, leather processing, highly
efficient raw chemical drugs and pharmaceutical intermediates. 95
3.2.5 Forms of Foreign Investment in China
In general, Foreign Investment Enterprises (FIE’s) must contribute to the development of
China’s economy. The Chinese State planners and MOFTEC describe the following goals
concerning foreign investments: 96
• Import of technology and promotion of technical renovation
• Import of capital and increase foreign-currency income
• Quick returns, greater profitability, and promotion of efficiency
• Improvement of product quality and increase product variety and the international
competitiveness
• Improvement of the Chinese balance of trade through exports to other countries
• Enabling the training of technical and managerial personnel
FIE’s include:
• Sino-foreign equity joint ventures
• co-operative (or contractual) joint ventures
• wholly foreign-owned enterprises
• Chinese holding companies
95 Investement in China, Wang Yongjun, 1997, pp. 153.
96 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, p.133 and
Doing Business in China, Ernst & Young, 1994, p. 44.
73

3.2.5.1 Sino-foreign Equity Joint Ventures
Equity Joint Ventures are governed by the law on "JV-Using Chinese and Foreign
Investment“ (1979/1990) and by related regulations on such matters as registration, taxation,
labour, accounting, minimum equity requirements, and contributions of registered capital. An
equity JV must be formed as a limited liability company. Parties to the JV may include
Chinese corporations, enterprises or other entities, and one or more foreign companies,
enterprises, or individuals. (Schindler, Switzerland, 4.7.1980, first JV in China). 97
Equity investments in JV's may be made in the form of cash, equipment and machinery,
technology and industrial property rights, and other assets. By law, the foreign party must
contribute at least 25% of the total registered capital. In practice, the capital contribution
percentage is normally closer to 50% for each investor. The most common contributions from
Chinese partners are land, labour, factory buildings, and raw materials. Partners share profits
and bear risks and losses in proportion to their equity contributions. 98
3.2.5.2 Co-operative Joint Ventures (CJV)
In contrast to equity JV's, Co-operative Joint Ventures offer greater flexibility in structuring
an investment. The participants may use buildings, equipment, land-use rights, intellectual
property, and other investments without having to express these contributions in monetary
terms. Parties are free to agree on the method or timing of profit distribution. In addition,
arrangements may be made to enable the foreign partner to recover its investments before the
expiration of the JV-investors establish CJV's for projects that have a limited duration and a
specific objective, such as the construction of a building, hotel, or factory. 99
3.2.5.3 Wholly Foreign-Owned Enterprises (WFOE)
Wholly foreign-owned enterprises are governed by the law on "Sole Foreign Investment
Enterprises“ (1986). Although JV's are the most common form of foreign investment in
China, investments in WFOE have increased substantially in recent years as a result of the
relative convenience and simplicity in setting up and operating such enterprises. Like equity
JV's, WFOE's must stress the development of China’s economy. In general, a WFOE is
formed as a limited liability company but may be established as another form of entity upon
97 Doing Business in China, Ernst & Young, 1994, p. 43.
98 Ernst & Young, 1994, p. 44.
99 Ernst & Young, 1994, p. 45.
74

Government approval. Foreign investors may remit abroad profits earned from the enterprise
or other legitimate income. 100
After a survey of the "Delegation of German Industry and Commerce (1995)“, a WFOE is
preferred by foreign investors under the following conditions:
• the produced products target a narrowly limited customer base (which the Western
enterprise knows and to which it alone can also provide services without a Chinese partner.
• the head enterprise is deeply rooted in the Western culture and would like to transfer its
corporate culture exactly on a one -to-one basis
• the enterprise produces in the high-tech-area and would like to exercise maximum control
over production processes and products
• the enterprise operates in a surroundings (location) within China, in which the legal and
administrative infrastructure is relative advanced, efficient, and reliable (this point makes it
especially clear why so many purely foreign companies are found in the coastal regions).
• it concerns a small and medium sized enterprise
3.2.5.4 Chinese Holding Companies
Chinese authorities finally have approved the formation of Chinese Holding Companies
(CHC) by foreign investors. CHC’s are corporate arrangements under which a foreign
investor forms a wholly owned subsidiary in China for the sole purpose of holding investment
interests, including equity joint ventures and WFOE’s. So far no published regulations
concerning the approval of CHC’s exist, and CHC’s are approved on a case -by-case basis by
MOFTEC. The minimum capital investment of a CHC must be at least US$ 30 million.
CHC's enjoy a number of tax and other advantages as for e.g. employ local PRC nationals in
its own name without going through authorised employment agencies or act as an agent for
sourcing raw materials a nd for export sales of finished goods from its subsidiaries, etc. 101
100 Doing Business in China, Ernst & Young, 1994, p. 45.
101 Doing Business in China, Ernst & Young, 1994, p. 46 and China - Wirtschaftspartner zwischen
Wunsch und Wirklichkeit, Reisach et al., 1997.
75

3.2.5.5 Comparison between Investment Vehicles
The form of investment chosen is a function of balancing management control with financial
exposure 102 :
Cooperative Joint Venture
Equity Joint Venture
Wholly Foreign-Owned
Enterprise
increased control
Chinese Holding Company
(see text above)
FIGURE 3-4: Management control vs. financial exposure of various investment vehicles
102 The Business Guide to China, Lawrence Brahm, Li Daoran, 1996, p. 17 and China -
Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, p.134.
increased exposure
76

Co-operative Joint
Venture
Status Partner structure
May acquire status of
legal entity if
requirements are met and
stated in contract
Liability Individual Liability of
parties may be limited by
parties in their contract
Manage -ment If registered as a legal
entity Board of Directors
must be established at the
outset
If not established as a
legal entity, a joint
management committee
Capital
contribution
should be set up
Law does not provide for
capital contribution ratio
between p arties
Foreign: usually
equipment and technology
Chinese: usually labour,
land and cash
Equity Joint Venture Wholly Foreign-owned
Investment Enterprise
Corporate structure
Status of legal entity
Limited liability within
limits of parties’ capital
Board of Directors
Regulate by articles of
association
Joint management and
operation
Specific min. on foreign
party’s contribution:25%
of registered capital
Foreign: usually
equipment and technology
Chinese: usually labour,
land and cash
Set time schedule for
putting up contribution
Corporate structure
Status of legal entity
Liability limited to
registered capital
Board of Directors
Regulated by articles of
association
Autonomy in operation
and management
Solely from foreign
investors
Profits from other JV's in
China with permission
from authorities
Restrictions Nil Nil Advanced technology
Export oriented
Profit-sharing According to ratio According to capital No sharing, entirely for
specified in contract contribution ratio the foreign pocket
Termination According to the contract Terms: generally 10-50
years
No perpetual succession
Specific Flexible structure and Most common for JV's Permit only obtainable
features more liberty status than "expected" from Chinese with high-tech production
with EJV's
side
facilities and export of
Suitable for small projects
min. 50% of manufactured
without foreign
involvement in
management
goods
TABLE 3-3: Overview of investment vehicles in China
The following table gives an overview of the development of forms of co-operation in
China: 103
103 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, p. 135.
77

Number of Projects
60000
50000
40000
30000
20000
10000
0
Equity Joint Ventures
Cooperative Joint Ventures
Wholly Foreign Owned Enterprises
1979-
1989
1990 1991 1992 1993 1994
FIGURE 3-5: Development of forms of co-operation in China
3.2.6 Strategy Planning
Normally businesses are only oriented to China if enterprises are convinced to have suitable
products, technologies or even ideas. One knows the Home and the European markets, basing
thereon successfully proven concepts and strategies and now wants to participate in the huge
economic increase and chances of the Chinese market.
But even the most experienced and successful businessman is confronted here with hurdles
and challenges he has never met. The chances of this booming world region lure companies
from everywhere. But here they meet competitors from the Asian region who profit from the
advantage to be located closer to China than he is. The reason of the difficulties of Western
enterprises lies also on the different culture and the complicated economic system.
"Men who do not think in advance, normally face difficulties“ said Confucius. Every
engagement in China therefore should be carefully planned. It needs a profound market
research and a matching check with the own goals and possibilities. This means also a need
for co-ordination amongst product- and productivity-profiles and market demand as well as a
provisional cost/benefit-calculation. Crucial as well are a realistic time horizon and the
preparation of the necessary resources.
78

Reflecting on these points the following checklist helps to find answers to various strategic
questions concerning the China engagement:
Subject Questions
Goals Which goals do we want to achieve with our engagement within China? Do we expect
higher turnover and returns or do we expect primarily a bigger market share and a
physical presence in this huge and fast growing market?
Time horizon What is our time horizon? Do we consider China as a sales market or as a base for
production or even as a base of investment and distribution in the whole of Asia?
Business field,
products and services
Technologies, material
and process
What is suitable for this market respectively which new solutions are needed? Are we
capable (resources, know how) and do we wish to develop new products or innovations
for this market?
Which technologies are appropriate and useful for the sales respectively the production
in China? Where is a need for further adapted technologies and research activities or
innovations?
Market Which markets (product markets, regional markets) and which clients (state, private)
do we want to reach and primarily serve? Is there a fit between customer target groups
and/or regional target groups with our organisational concept? W hat is to do to be
Production-place &
infrastructure
better placed (market) and positioned (marketing) in these markets?
Where are suitable production places and facilities? Can we achieve our investment
goals and can we manage logistical problems? Where do we get funding? Can we rely
on State promotion (tax holidays and other incentives)?
Partners & suppliers Who are our partners and suppliers – state or private organisations within China or
other partners from other states? Do we have to look for new suppliers or do we have
to focus on other supply industries and clients?
Competitors How strong is the position of our competitors? Do we know their strategies and goals?
Where are they active and why? Whom do they work with? Where do we differ from
our com petitors? Where do we have comparative advantages, where are we on a weak
Human resources &
training
Product ion-place &
infrastructure
position?
Do we have the necessary skilled human resources in our company to be active in
China and even expand our activities and engagement? Is there a market for qualified
Swiss/Chinese candidates that we could employ? How should training activities be
organised in order to make us successful? How can we integrate our new enterprise in
China in our training concept and personnel planning system?
Where are suitable production places and facilities? Can we achieve our investment
goals and can we manage logistical problems? Where do we get funding? Can we rely
on State promotion (tax holidays and other incentives)?
Partners & suppliers Who are our partners and suppliers – state or private organisations within China or
other partners from other states? Do we have to look for new suppliers or do we have
to focus on other supply industries and clients?
Competitors How strong is the position of our competitors? Do we know their strategies and goals?
Where are they active and why? Whom do they work with? Where do we differ from
our competitors? Where do we have comparative advantages, where are we on a weak
Human resources &
training
position?
Do we have the necessary skilled human resources in our company to be active in
China and even expand our activities and engagement? Is there a market for qualified
Swiss/Chinese candidates that we could employ? How should training activities be
organised in order to make us successful? How can we integrate our new enterprise in
China in our training concept and personnel planning system?
TABLE 3-4: Strategic questions for SME's planning to invest in China
3.2.7 Risk Analysis
Risks from business engagement in China may be minimised by thorough preparation not
only in the economic but also in the cultural sector as the peculiarities of China significantly
79

influence all activities. A deeper understanding of economic and social connections is
virtually impossible without having at least a basic knowledge of the Chinese language, way
of thinking, and culture.
Only a dedicated preparation well in advance helps to avoid the most common errors when
setting up business in China: 104
Type of Risk Consequences
Risks from false
estimation of the
economic environment
Risks from intercultural
misinterpretations
Risks from the human
resources environment of
the company
Risks from the
environment of
expatriates
losses through unforeseen changes of China’s economy politics (e.g. project
acceptance, custom and import regulations)
false investments due to the fact that market prognoses were wrong, or strategy
non-fit (market entry, JV -foundation, technology transfer, product design,
marketing)
costly errors when evaluating projects, partners and location
wrong estimation of Chinese partner’s performance and intents (different wishes
and conditions at common projects)
Difficulties at the acceptance and realisation of delivery of goods and projects
(further negotiations, delay of time, delivery and payments)
Unexpected changes concerning priorities, wishes, regulations or conditions of
the Chinese partner or involved State partner delivery delays or production stops
through unreliable partners or through faults in the Chinese infrastructure
technology setbacks through quality deficits
mutual mistrust and false estimations
insufficient information transfer
delays and failures at negotiations and in project planning
Too much expectations from Chinese workers and insufficient instructions at the
workplace
Frustration and early repatriation of expatriates
damage of company image in China
errors and failures at the search and selection of qualified employees (Chinese
workers and expatriates)
Management problems when working together because of insufficient preparation
and instruction of new employees or new projects
Loss of quality because of insufficient training of employees
High expatriate costs at "repatriation-actions“
Wrong investment in training and education at high labour fluctuation (Chinese
workers very often quickly change jobs)
personal load through different life-style and conditions and lack of adaptability at
the host location
Tense situations and problems within families or partnership
Career break in case of failure
early repatriation
TABLE 3-5: Risk analysis of investments in China
3.2.8 Key Success Factors in Chinese Investments
The following tables give an overview of the key success factors for an engagement in China.
Some of the factors are valid for any business in China, whereas others are specific for one or
the other form of co-operation:
104 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach e t al., 1997, p. 146.
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Success Factors concerning Products and Markets: 105
Success Factors Success Criteria
Chinese clients
respectively
suppliers
knowledge of needs, purchasing power
market volumina, market structure (regional, client and product oriented)
consumer habits
Products market adapted product choice and product spectrum
adoption at local consum er habits (e.g. washing of clothes with cold water only)
and distribution channels (critical: perishable goods)
matching quantity, price and quality
Price costs of production, delivery and supply
import/export: including customs, transport and insurance
joint ventures: incl. compensation and benefits (locals and expatriates)
costs for all kind of raw material, auxiliary material and finished products (incl.
energy)
cost of waste disposal
lease for land use and tax write-offs of manufacturing facilities, machines and
production facilities
travel costs for negotiators, company-own consultants, training and delegation
journeys, engineers and salesmen
competitor situation
Technology &
Know -how
price sensitiveness of customers
technology transfer, adaptability to customer income-situation, needs, and quality
degree (power supply irregularities)
legal protection of industrial property
training need of sales department employees and clients
Competition local, regional and international competitors and their product spectrum,
distribution channels and strategies
For Licensing Agreements and Joint Ventures additionally: toughening up own and
future competition
Sales & Marketing brand name usable within China or introduction of new brand name for the new
China market
reputation and image (of quality) of company and brand
brand protection
take into consideration the Chinese symbolic meaning of certain signs, words,
colours and forms
Environment trade roots, ports (Shanghai, Hong Kong)
infrastructure for transport, warehousing and distribution, delivery times and costs
(and security)
customs and tax aspects
actual foreign economy and trade policy
For JV and WFOE’s additionally: long negotiations and permits of state involved
persons and offices
TABLE 3-6: Key success factors concerning products and markets
105 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, pp. 139.
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Success Factors concerning Chinese Partners: 106
Success Factors Success Criteria
Suppliers and
distributors
knowledge of country and market, sources of supply, distribution channels,
guanxi
compatible goals at JV (Problem: same bed, different dreams)
productivity, strengths and weaknesses
reliability and mentality
Management say import/export businesses:
- no limitation of entrepreneurial liberties
- fair supply conditions for both sides
Joint Ventures:
- sharing out of management responsibilities
- consensus finding in strategic, tactic and operational questions
– entrepreneurial liberties sometimes limited due to Chinese laws, rules and
regulations
WFOE’s:
no limitation of entrepreneurial liberties but possibly difficult acting as a
foreigner in an existing relationship network (sometimes also restrictions due to
Chinese laws, rules and regulations)
Human Resources import/export businesses:
-experience and qualification of local Chinese workers and partners
-employment and loyalty of Chinese workers and partners respectively
fairness and experience of business agents
Joint Ventures:
- Chinese workers mostly come from Chinese partner,
- depending on the JV contract only limited say in personnel politics
(selection, compensation, dismissing)
- possibly very expensive social benefits, if partner was former
State enterprise
- experience and qualification of Chinese staff (especially
knowledge of modern technology and work tools, quality
and cost awareness, accounting and calculation, marketing)
- performance and loyalty of Chinese staff
- high compensation amounts for expatriates, management personnel and
specialists (up to CHF 500’000.- per capita
per year)
- intercultural collaboration, intercultural training
- training and education in China and at home base
WFOE’s:
- possibly difficulties with hiring new personnel: direct or via Chinese (semi-)
State Employment Agency
- experience and qualification of Chinese staff
- possibly minor loyalty to a wholly foreign-owned company
- intercultural training
- training and education in China and at home base
TABLE 3-7: Key success factors concerning Chinese partners
106 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, pp. 139.
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Success Factors concerning Company Structure and Administration: 107
Success Factors Success Criteria
Financing import/export:
- pre financing need
– securities
– payment methods (generally letter of credit)
– international experience of involved bank
co-operation:
- height and settlement date of financial liabilities
- take out of earnings and transfer of earnings
– availability of foreign exchange
- risk sharing and loss liabilities
Joint Ventures:
- amount of investment (equity provisions, capital investment,
valuation of investments input
– prerequisites and settlement dates of financial investments
- take out of earnings and transfer of earnings
– availability of foreign exchange
- risk sharing and loss liabilities
WFOE’s:
- amount of investment
– availability of foreign exchange and transfer of earnings
– risk sharing and loss liabilities
Accounting Import/export:
- balancing, valuation of goods, delivery responsibilities and valuation
of goods in transfer
Joint Ventures and WFOE’s:
- valuation of involved investment
– introduction of modern accounting systems
– adoption of accounting and balancing to Chinese rules
and regulations (trade and tax law)
Administration Import/export:
- comparatively low need of adoption of organisation
– securing of an efficient handling on site and in the headquarters
Joint Ventures and WFOE’s:
- adoption of structure to headquarters (establishing a separate entity
in China or fitting in into headquarters product
or business division)
– securing a special report system from foreign site to headquarters
TABLE 3-8: Key success factors concerning company structure and administration
3.2.9 Profiles of Partners Participating in an Investment in China
3.2.9.1 Ideal Profile
From the facts discussed in the previous papers, an "ideal profile" for an entity (either being
an SME on its own or together with Chinese and other partners) may be defined. The
following diagrams show a combination of characteristics of partnering companies, which are
considered to be essential for a business engagement in China.
107 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, pp. 139.
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On each axis of the diagram a scale of 1 to 10 gives an indication to what extent the property
is realised within the respective partnering company.
An ideal profile for installing a successful business is defined as value 10 on each single
dimension:
Available Distribution
Channels
Market Knowledge
Relationship (Guan Xi)
Financial Power & Capital
10
9
8
7
6
5
4
3
2
1
0
Quality of
Infrastructure
Available Management
Resources
Suitability of Product &
Services Portfolio
Production Know-how
FIGURE 3-6: Ideal profile of a company investing in China
3.2.9.2 Dimensions of the Profiles
Financial Power and Capital
This dimension expresses a company’s ability to raise capital for an investment in China.
Fund raising is a major problem for SME’s: generally European banks’ do not want to get
involved into an engagement with an SME having highly risky strategies like setting up a
production facility in China. Also potential Chinese partners being state owned companies
with rather unsatisfying performance rarely can afford the funds to invest into such projects.
Therefore successful SME’s would either be capable of financing the project completely from
their cash flow or would look for other non-Chinese partner companies to raise the necessary
capital.
Another source of funds may be Government programs to support small and medium
enterprises with venture capital. However, usually only innovative and projects involved in
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high-technology are eligible for these schemes. Hence access is limited to a fairly small
number of SME’s.
Available Management Resources
SME’s rarely have enough human resources to allow their managers to dedicate themselves
completely to setting up the new business in China.
Therefore it is crucial to plan well in advance an expansion into the Chinese market in order
to provide in time the absolutely necessary management manpower for such a project.
The person in charge of the China project does not necessarily have to be of European origin -
in fact it is very helpful to employ a Chinese for this task as he will not have to overcome the
barriers of language and mentality. According to opinions of SME’s having set up business in
China successfully management resources is among the most important factors deciding over
success or failure of the enterprise.
Suitability of Product and Service Portfolio
The products and/or services to be manufactured in China should sell well on the Chinese
domestic market. Chinese Government does not appreciate manufacturing for export only as
this would not benefit the Chinese economy to the desired extent.
An exception to that rule are goods requiring a high-tech production lines as in this case the
Chinese economy benefits from technology and know-how transfer from the foreign investor.
Also total production costs of the goods (raw materials, energy, labour, taxes, etc.) are
comparatively high so that - in case one looks for cheap production only - investment in a
different country would be more recommended.
Production Know-how
This dimension describes the level of know-how for manufacturing specific goods.
Generally this know-how is very high in SME’s, but may be at a comparatively low level at
the Chinese partners.
It is a pre-requisite for joint ventures that the SME is willing to share its know -how with the
Chinese partner. In case the manufacturing technology should not be disclosed for strategic
reasons the SME should only invest into a wholly foreign owned company in China.
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Quality of Infrastructure
One major task for the set-up of a new enterprise is finding the appropriate location to install a
manufacturing plant. Although local governments are willing to attract new businesses in
order to increase their tax income, the procedure for obtaining various permits is tedious and
time consuming. Potential Chinese partners could provide a suitable infrastructure with their
existing manufacturing plants to a certain extent. However, buildings and equipment are
generally not at the desired level of technology so that they probably may not be used further
for production without major investment and upgrades.
However, several business parks have been set up by provincial and regional governments or
even by joint-ventures between local and foreign governments (e.g. Singapore-Suzhou
Business Park in Suzhou (Zhejiang)). These business parks provide excellent facilities for
manufacturing plants with all necessary installations for water, electricity and communication.
They also set up accommodation for management and leading personnel within their
premises.
Relationship (Guanxi)
Guanxi is the magic word in Chinese business: without personal relationship to authorities,
customers, business partners etc. virtually no business is possible in China. As it takes time to
build relationships, SME’s generally do not have sufficient guanxi in the start-up phase of
their project to be successful on the Chinese domestic market. Therefore it is advisable to
found a joint venture with a Chinese partner who brings his guanxi into the partnership. Also
the involvement of a local person in the management of the manufacturing plant is extremely
helpful due to that reason.
Market Knowledge
SME’s planning to invest in China most probably already have a certain knowledge of the
local market. However, this knowledge may be restricted to the import of goods only, which
may differ significantly from selling locally produced goods on the market. As with guanxi,
the know -how of a Chinese partner will significantly influence the success of a newly
established enterprise.
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Available Distribution Channels
A major problem in China is the geographic distribution of the manufactured goods. Not only
road transport is lengthy and unsafe but also railway transport is unreliable due to the
authorities’ preference policy for "strategic transports" like coal or military equipment. It is
also necessary to be accepted as a supplier for certain goods by major customers (like
wholesalers, supermarkets, etc.) - a task which mostly can be accomplished only with
sufficient guanxi. Here again the know-how of the Chinese partner is vital.
3.2.9.3 Profiles of the Partnering Companies
Small or Medium Enterprises
A small or medium enterprise planning to invest in China has to have a suitable portfolio of
products and/or services for the Chinese domestic market. As this is a pre -requisite for any
further reflection this dimension is marked 10 in the following diagram. The enterprises also
have an excellent know-how of their production technology as they otherwise could not even
survive on their home market.
All dimensions concerning local Chinese factors such as infrastructure, distribution channels
and especially guanxi are only little developed if at all and have to be backed up by a suitable
partner. However, there is a certain knowledge of the Chinese market as SME’s typically
already have a relationship with China due to export business prior to planning a direct
investment.
Financial power of SME’s generally is not sufficient in order to install a business in China so
that either external financial sources have to be found (which usually is difficult due to the
high exposure to risk) or alternative solutions have to be practised such as providing
machinery and equipment for a joint venture. However, free management resources are the
most difficult problem to solve for SME’s and at the same time are the most crucial success
factor. Without full support by management any trial to set up a business in China is most
likely to fail.
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Available Distribution
Channels
Market Knowledge
Relationship (Guan Xi)
Financial Power & Capital
10
9
8
7
6
5
4
3
2
1
0
Quality of
Infrastructure
Available Management
Resources
Suitability of Product &
Services Portfolio
Production Know-how
FIGURE 3-7: Profile of a typical small or medium enterprise
Chinese Partners for a Joint Venture
Potential Chinese partners for a joint venture bring good relationship with customers,
suppliers, authorities etc. with them but usually lack production know-how and/or the
appropriate manufacturing equipment and machinery. Their infrastructure and technology
have to be updated to reach acceptable standards. Additionally, their product portfolio may
not meet the market demand any longer due to the recent changes in Chinese society. Being
state -owned enterprises they not only lack financial power to restructure the company
appropriately but also very unlikely have the necessary management resources for such a task.
Except for financial power and management resources they are the ideal partners for SME’s.
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Available Distribution
Channels
Market Knowledge
Relationship (Guan Xi)
Financial Power & Capital
10
9
8
7
6
5
4
3
2
1
0
Quality of
Infrastructure
FIGURE 3-8: Profile of a Chinese Joint Venture partner
Banks and Government Institutions
Available Management
Resources
Suitability of Product &
Services Portfolio
Production Know-how
Foreign banks may act as lenders of capital for SME’s and their Chinese joint venture
partners. However, the present practice of European banks is not to take fairly high risks with
such an engagement in return of a comparatively low margin. Therefore, it is disappointingly
difficult to raise capital through banks for this kind of projects. Alternatively, foreign
governments run programs to support SME’s with venture capital to a certain extent.
Once established in China, SME’s may use the banks’ connections to the industry to gain
access to certain markets. Also Government institutions like the "Delegation of German
Industry and Commerce“ or the Swiss Embassy based Beijing and Shanghai support SME’s
with know-how and makes contact to various potential partners for joint ventures. They also
assist with legal advice during the set-up phase of the new company.
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Available Distribution
Channels
Market Knowledge
Relationship (Guan Xi)
Financial Power & Capital
10
9
8
7
6
5
4
3
2
1
0
Quality of
Infrastructure
Available Management
Resources
Suitability of Product &
Services Portfolio
Production Know-how
FIGURE 3-9: Profile of foreign banks and Government institutions
Business Parks
Business parks are established to attract foreign investors to China by providing the necessary
infrastructure such as land, buildings, electricity, energy, etc. Although they charge a certain
price for their services they may be a good choice for SME’s not intending to set up a joint
venture with a Chinese partner. Certain business parks also provide so called "Incubators“,
which are already equipped facilities specially designed for small enterprises still developing
marketable products for China. Access to these facilities is given with time limits only to
enable also other young enterprises to take advantage of these institution. Business parks may
further act as platform for information exchange by providing access to other companies
being in a similar situation of starting up business.
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Available Distribution
Channels
Market Knowledge
Relationship (Guan Xi)
Financial Power & Capital
10
9
8
7
6
5
4
3
2
1
0
Quality of
Infrastructure
FIGURE 3-10: Profile of business parks
Optimum Partnership
Available Management
Resources
Suitability of Product &
Services Portfolio
Production Know-how
The following profile shows a theoretical optimum for the combination of the characteristics
of SME’s, Chinese joint venture partners, banks, Government institutions and business parks.
Obviously all important dimensions may be covered by such a partnership except the
management resources (the gray enveloping area represents the profile of this "optimum
partnership").
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Available Distribution
Channels
Market Knowledge
Relationship (Guan Xi)
Financial Power & Capital
10
9
8
7
6
5
4
3
2
1
0
Quality of
Infrastructure
SME Chinese Partner
Banks & Government
Available Management
Resources
Suitability of Product &
Services Portfolio
Production Know-how
Business Parks
FIGURE 3-11: Profile for the optimum combination of all potential partners
Practical experience shows that the necessary available management resources pose the most
difficult problem to overcome. However, it is equally important to gain access to local
authorities and government institutions by guanxi.
The combined profile of the joint venture partners should well extend on the diagram axis
"management resources" - "guanxi" in order to have sustainable success, although lacking
management resources may be partly balanced by extensive guanxi and vice versa.
All other dimensions do not necessarily have to be at the optimum as practical case studies
(please refer to the appendices) show.
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Illustrative Case Studies
The following case studies should illustrate different approaches of companies how to
optimise their profiles together with various partners as stipulated above.
All profiles shown in the figures are for illustration purposes only to emphasise certain
aspects and are not to be interpreted as valuation of the companies!
Suzhou MFN Embroidery Co. Ltd.
The first case covers a Wholly Foreign-Owned Joint Venture in the textile (embroidery)
branch:
Available Distribution
Channels
Market Knowledge
Relationship (Guan Xi)
Financial Power & Capital
10
9
8
7
6
5
4
3
2
1
0
Quality of
Infrastructure
Forster Rohner AG Mizorogi, Nisshinbo Suzhou
Available Management
Resources
Suitability of Product &
Services Portfolio
Production Know-how
FIGURE 3-12: Profile of Suzhou MFN Embroidery Co. Ltd.
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The joint venture was established by Forster Rohner AG, Switzerland, Mizorogi Co. and
Nisshinbo Industries Inc., both located in Tokyo, Japan, and named "Suzhou MFN
Embroidery Co. Ltd.". MFN had to follow their European customers setting up their new
manufacturing units in China. Except from occasional contacts to the Chinese market MFN
had only little knowledge of the Chinese business environment. Therefore it is interesting to
see, how they managed to get access to the other vital profile dimensions which they could
not provide themselves:
Their key advantage was their dedicated management decision to move to China and to
provide the necessary management resources for this task. They further were in the lucky
position to have a Chinese born manager available, who had been employed by one of the
Japanese partners a couple of years earlier. That is why they could build their guanxi to local
authorities in a comparatively short time.
Their good contact to the provincial government helped them to get access to the
infrastructure thereby filling the last gap in their profile (marked as "Suzhou" in above
diagram).
At the moment they emphasise on the build-up of the domestic market in order to stabilise the
company (this will result in "pushing out" the envelope line in the diagram closer towards the
optimum profile!).
Suzhou Nove Fashion & Crafts Co. Ltd.
The second case study also deals with the textile (knitwear) industry - this company was set
up in order to gain access to the local raw material market and to export high quality products
to Europe.
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Available Distribution
Channels
Market Knowledge
Relationship (Guan Xi)
Nove Marzo AG
Financial Power, Capital & Land
10
9
8
7
6
5
4
3
2
1
0
Quality of
Infrastructure
Available Management
Resources
Suitability of Product &
Services Portfolio
Production Know-how
Lubei Village
FIGURE 3-13: Profile of Suzhou Nove Fashion & Crafts Co. Ltd.
The company was set up as a joint venture between Nove Marzo AG, Switzerland, and the
Chinese village Lubei, where the knitwear factory was built. The reasons for this choice are
fairly obvious: the village of Lubei not only provides land and infrastructure, but being a
government institution also brings in guanxi into the joint venture. Again, the dimension
"available management capacity" has to be emphasised: in the beginning of the project the
company was entirely ma naged by Europeans, but a local management was built up at the
same time. Today the company is run by a local management with European involvement
reduced to the absolutely necessary minimum.
Swisstec
The third case differs from the above two as the company discussed is a sales organisation in
China without direct investment into production facilities (see Case Study: Swisstec, Lyss).
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Available Distribution
Channels
Market Knowledge
Relationship (Guan Xi)
Swisstec,
Swiss Partners
FIGURE 3-14: Profile of Swisstec
Financial Power & Capital
10
9
8
7
6
5
4
3
2
1
0
Quality of
Infrastructure
Available Management
Resources
Suitability of Product &
Services Portfolio
Production Know-how
Chinese
Representative
At a first glance, Swisstec has nearly none of the characteristics necessary for entering the
Chinese business. But their way to success is very creative and probably could act as a model
for other SME's. Swisstec is a co-operation of nine SME's of the machine manufacturing
industry which all have customers in the Chinese market. Being unable to set up their own
sales organisation in China for cost reasons, they used "western guanxi" and formed a joint
sales organisation. But still the Swiss partners lacked important dimensions like market
knowledge, guanxi, etc. necessary for long-term business. This was all brought in by their
Chinese partner - the former representative of some of the nine SME's. In this special case the
management resources are also brought in by the Chinese partner resulting in an aggressive
expansion of the Chinese network.
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Which Aspects should SME's Focus on?
From the facts discussed in the previous sections there are a few vital points each SME should
take into consideration when going to China:
The first question to be asked is whether the engagement in China fits into one's strategy. As
strategic considerations are a basic task in all business environments we would like to
concentrate on specific characteristics of the Chinese market:
Fund raising for investment in a high-risk environment definitely asks for tailored solutions in
each respect. Section 3.2.10 discusses various approaches SME's should take into
consideration.
Another important subject is how to provide the vital management resources for this type of
project. Questions like whether one should employ local staff or rely on expatriates are
discussed in detail in section 3.2.11.
Finally, anybody doing business in China should be aware of the cultural differences between
Western and Chinese people. As the right approach to country and people is critical for
success the "Management of Relationship" is discussed in section 3.2.12.
3.2.10 Fund Raising for the Investment in China
3.2.10.1 How can the Swiss Government Support SME's Investing in
China?
Besides "classic" support like the Export Risk Guarantee the Swiss Government is going to
create a "Swiss-Sino Partnership Fund" in the near future to help setting up joint ventures
between Swiss SME's and Chinese partners. This fund is aimed to support SME's investing in
China by not only giving the necessary capital but also non-financial support like unbiased
advice for both prospective partners during the negotiation and preparation phase as well as
active board level representation after the formation of the partnership. In return, the Fund
will be a shareholder in the joint venture. The fund serves as a pilot direc t-investment
program and still has to be ratified by the Swiss Government. Therefore no information on
detailed application procedures and eligibility is available yet.
Further to that, Swiss embassies also provide similar functions as chambers of commerce by
supporting the prospective SME with information on the market, making contact to potential
Chinese joint venture partners and giving legal advice to business related subjects. Other
97

countries like Germany employ dedicated offices like the "Delegiertenbüro der deutschen
Wirtschaft" to fulfil these tasks - in special cases their services are also open to Swiss SME's.
3.2.10.2 How can Swiss Banks Function as Partners?
The Swiss banks have been very active in the recent years in working with both exporters and
foreign importers of Swiss goods and services through the financing of Swiss exports and the
provision of other banking services. However, the role of Swiss banks as partners for other
banking activities except the above mentioned presently is somewhat ambiguous: although
they provide a certain infrastructure with their representative offices in major cities in China,
they do not seem to be too much interested in supporting SME's with financial funds to enter
the Chinese market.
This attitude is very similar to their behaviour on the Swiss domestic market, where SME's
find themselves in difficulties raising funds for investment into their "risky" companies,
whereas larger industrial units have by far easier access to capital. The authors are aware of
the fact that an engagement with an SME does not give as fast a payback to the banks as other
investments. However, it might be worthwhile to rethink the actual practices as a long term
engagement may bring significant revenues to the banks in future.
There is a certa in discrepancy in the fact that, once the SME's are already established in
China, Swiss banks are willing to assist in daily banking life by having connections to
Chinese banks and other business partners using their own guanxi to solve problems like
delayed payments, etc. 108 So far Swiss banks are not allowed to trade in Renminbi, so that in
any case the services of a Chinese bank have to be used.
3.2.10.3 Which Fund Raising Strategies should SME's follow for Investment
in China?
Following the present situation of limited availability of Swiss Government funding and high
"risk-consciousness" of Swiss banks, an SME has the following options or strategies to
successfully setting up business in China by providing enough funds:
108 Source: Mr. Gu Qi (Deputy Representative, Shanghai Representative Office of SBC Warburg Dillon
Read), 1997.
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Strategy No. 1: Have Cash
A comfortable amount of equity definitely eases the market entry into China. This criterion is
generally fulfilled in large companies, whereas SME's very often find their weak point here.
It is absolutely necessary to have enough funds available also for the first years of operation
as the time before profit is generated from the new enterprises may vary between 5 to 7 years.
Strategy No. 2: Be Innovative
Young and innovative enterprises may benefit not only from Swiss Government programs but
also enjoy special support from the Chinese Government. They are eligible to set up their
businesses in so called "incubators", which are special zones in business parks set up to foster
new technologies and products.
The only drawback for innovative enterprises may be the transfer of technology and know-
how requested by Chinese regulations.
Strategy No. 3: Tailor Your Expenses
The majority of SME's most probably does not find itself in the position to follow one of the
two above strategies. However, even then a successful engagement in China is possible:
As the Chinese partner normally brings workforce and relationships into the joint venture, the
SME's part is to provide production know -how and technology. One should be aware of the
fact that Western state of the art concerning productivity is not necessarily the optimum
technology to be employed in Chinese manufacturing facilities. Therefore also older
equipment imported from Europe may still serve the purpose thereby reducing investment
costs and financial risk.
The disadvantage of this concept is the valuation of the equipment to define the SME's capital
share of the joint venture. However, once an agreement is found this concept proves very
successful in practice.
Another major cost factor is the employment of expatriates as managers. One should therefore
thoroughly consider the possibility to employ local Chinese people and train them in Europe
to prepare them for their management tasks. Especially the Shanghai area has a high potential
of well educated candidates due to its large university network.
Strategy No. 4: Use Western Guanxi
One does not necessarily have to start with networking only in China. Why not looking for
potential partners also in Europe or other industrialised countries?
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These partnerships may not only be advantage ous in respect of increasing the investment
capital but also because of combined experience and market presence. Provided the other
partners come from within the same business field also the base of potential customers is
enlarged (it is assumed that this partnership does not interfere with the home market of the
partners). 109 A further advantage of a partnership between Western companies may be the
shared financial exposure of the single company and thereby also the reduced risk. So for
example the cost for expatriates or marketing campaigns in China could be shared. 110
These are just examples of using probably already existing relationships for the China
business. Definitely the success of these partnerships depends on the creativity of each single
partner.
3.2.11 Management of Human Resources
As we have seen already under section “Available Management Resources” SME’s rarely
have enough free human resources capacity to allow the management to focus seriously on
setting up new businesses in China. Various factors have to be regarded as critical.
3.2.11.1 Managing Labour Law
The labour law applies broadly to all enterprises and individuals hiring staff or workers within
China. This means that the law covers the representative offices and branches of foreign
investment enterprises as well as domestic entities.
Managing labour is highly sensitive and it is advisable for FIE’s to pay careful attention to the
Chinese regulations. The main advantage of investing in China may be the pool of low-cost
labour, but one should be conscious that exploitation of labour is viewed very seriously by the
Chinese authorities. It is recommended to enter into individual labour contracts whenever
possible.
3.2.11.2 Human Resources as a Cost Factor
Cost factors can play an important role considering the assignment either of local staff or from
the home country. For the salary of an expatriate (costs of several hundred thousand CHF per
year all inclusive) one can hire four local employees at the same level (also with comparable
education). The high wages of expatriates often raise discussions in many JV’s, because these
109 Paper 3.2.13 Case Study: Swisstec.
110 Paper 3.2.13 Case Study: Swisstec.
100

expenses have a detrimental effect on the revenues. Chinese partners only hardly understand,
why expatriate incomes are many times larger than theirs. Under the aspect of costs it is
recommended to employ as much local staff as possible.
3.2.11.3 Local Staff versus Expatriates
The first question during the planning phase (establishment of a representative or sales office
or also a JV) always focuses on hiring new staff on the Chinese site or bring them in from the
home country. Both has advantages and disadvantages: the knowledge of the home company,
its products and decision making process and also Western know-how versus the
understanding of the Chinese mentality, language and possibly relationship (guanxi) to the
customers and State officials on site.
Highly qualified and experienced managers often profit internally but also in the client’s view
a certain trust. Often clients even expect that the company's representative comes from the
home country. The positions of the general manager and also technical director respectively
production manager mostly are filled with expatriates. In human resources departments or
marketing offices often Chinese managers hold these positions. They know local conditions
and have more guanxi to potential clients or prospective workforce for the company.
3.2.11.4 Expatriates and Intercultural Management Skills
FIE’s also should be very aware of the personality and cultural factors. Failures in the
selection process for a China assignment can become very expensive. Not only costs of the
assignment or "quick repatriation exercises“ have to be considered but also and - more
important - the influence of wrong management personnel on the business (turnover,
revenues, market share and image). These risks can be banned and minimised by carefully
selecting and preparing the right people.
Most of the questioned managers (see study below 111 ) emphasise the importance of the
intercultural and negotiation skills. Also as critical they regarded knowledge of law, language,
communication skills, etc.
111 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, p. 205.
101

Qualification profile
(what manager should know before they start their assignment)
Intercultural skills 74.5%
Negotiation skills 74.5%
Know how of contractual law 50.9%
Language 47.3%
Communication skills 41.8%
Management of personnel (HR) 41.8%
Knowledge of political environment 40.0%
Marketing skills 40.0%
Financial management skills 27.3%
Co-operation ability 23.6%
Knowledge of economical environment 18.2%
Logistical skills (information technology) 12.7%
International relations 10.9%
TABLE 3-9: Qualification profile of managers working in China
% of managers
working for companies
in China
The assignee’s profile should additionally show a high degree of self-initiative, willingness to
take risks, ability to improvise and - as a part of the intercultural skills - a lot of empathy and
sensitiveness towards the foreign partners and their culture.
It should be a must to also evaluate intercultural skills during the selection process for
expatriates. Most common in practice are assessment centres as China related tests ("critical
incidents“, case studies, role or plan plays) to assess the multicultural skills of a candidate. In
Switzerland various external consultants offer this kind of selection tool which may be used
and adapted to the specific needs of an SME selecting external or internal employees for such
assignments.
Besides leadership skills, professional, social and self-competency (personality) other
personal factors of an assignee should also be considered like good physical health, emotional
stability and willingness to work long hours. The good integration of the partner and/or family
in the host country may have a huge impact on the success of the assignee. So also from the
partner and/or family flexibility and adaptability are demanded.
Decisions whether somebody starts an assignment or not should never be taken without the
partner of a candidate assignee, as today dual career couples are fairly common.
3.2.12 Management of Relationship
One of the key points certainly is the use of guanxi or also the use of "Western guanxi" before
starting with a project within China.
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As a conclusion, network oriented measures (for any activities) are key. First of all, it is
recommended to do business with "small numbers". Before investing considerable funds,
official partners or future JV partners should be tested.
Business contacts should be implemented step by step. If not possible (in case of huge
projects) it has to be tried to become part of a multilateral network (even beyond Switzerland
or Europe). As long as foreign competitors can be played off against each other, the Chinese
Government will do it.
Try to establish excellent bilateral contacts. This also means long journeys to China with
significant persons from the own company (or Swiss Government officials or Swiss
ambassadors) in the delegation.
Do not always and in all phases of the process of a project or JV include lawyers in
negotiations. This could create mistrust and defence. A common dinner counts more than ten
negotiation days.
Collect information about your partners (preferred drinks, number of children, etc.). This is
not against data protection but attentiveness towards your partner. Show interest in your
partner, discuss themes like family, roots, training, life experience, financial situation. Never
forget to stay in contact. Unacceptable are missing greetings to the Chinese New Year.
The atmosphere in coming together with Chinese people always plays an important role. For
example, conflict points should be discussed at informal occasions like dinner. Business and
friendship cannot - as in European countries - be separated: they always go together. That is
why one should never do business with a Chinese partner if one does not like each other. 112
Finally, never forget that the construction of a long-lasting network or even friendship can be
a long process even though your partner may call you "old friend" after two meetings.
Do also not forget, that instead of subject and monochrome related procedures, Chinese
partners often plan in person-oriented and polychrome ways. The black dots indicate useful
persons which all are connected within one network. The following chart may help to clarify
this understanding:
112 Source: Swiss newspaper "Handelszeitung", issue 24, June 12, 1997, p. 57.
103

Ressource 3
Ressource 2
Ressource 1
Golden Town Golden Town
Step 3
Step 2
Step 1
Resources are planned to be used when needed
and relay on the reliability of the calculation and
plan
Time
Start Start
FIGURE 3-15: The way to "Golden Town" 113
relays primarly on the reliability of the network
and on the capability to take chances whenever
they occur
We are not saying that Chinese partners are not able to follow a straight strategy or plan a
critical path. Considering the external environmental conditions in China the "Chinese way"
may be quicker and more successful as too many unforeseen circumstances exist in this
growth market with rapidly changing infrastructures, laws, financial institutions and system,
politics, labour m arket and distribution market.
A study by Arthur Andersen Consulting shows that for a selected group of 75 FIE's in China,
companies with the best results focused most on partner relationships and human resources
management. 114 Due to realistic expectations, a clear strategy, long lasting relationships and
also “luck”, many companies are successful in China. But one should also distinguish
between reality and myths!
113 China - Wirtschaftspartner zwischen Wunsch und Wirklichkeit, Reisach et al., 1997, p.313.
114 Source: "Der Monat", issue 12/1996, Swiss Bank Corporation, p. 40.
104

3.2.13 Case Study: Swisstec, Lyss
3.2.13.1 Company Profile
Swisstec is a co-operation of various Swiss mechanical engineering companies to market their
products in the People's Republic of China. The company was founded by Feintool AG Lyss
as successor for its local agent organisation in Beijing, Chongquing and Shanghai and today
has the following members (shown in Table 3-10).
Company Activities
BalTec Maschinenbau AG,
Pfäffikon/ZH
Dama Optikmaschinen AG,
Wetzikon
Fehlmann AG,
Seon
Feintool AG Lyss,
Lyss
Hämmerle AG,
Brugg
Mikron Agno,
Agno
Sempac AG,
Cham
Weinberger AG,
Dietikon
Kardex AG,
Volketswil
Sheet metal working machines, riveting machines
Micro engineering for precision, mechanics, optics, glass and
ceramics
Metal milling and drilling machines
Fineblanking technology and forming presses
Sheet metal working machines (flat metal part roll-leveling
machines)
Automatic machining systems for small parts
Production lines for chip cards
Photonics instrumentation for the analysis of fast motion
Modular storage and retrieval systems
TABLE 3-10: Members of the Swisstec organisation
Swisstec offices are located in Beijing, Shanghai and Chongquing with plans to open a
Guangzhou office in the near future.
3.2.13.2 Motivation for Founding Swisstec
Due to retirement of Feintool's representative in Beijing, who also acted as agent for about a
dozen other Swiss companies, a solution for a succeeding organisation was sought. Given that
the office infrastructure was too big and therefore too expensive for Feintoool to bear alone,
the alternative seemed to be to appoint one of the large Swiss trading companies in China as
agent. However, these trading companies would normally have a high number of agencies and
Feintool feared that they might not pay enough attention to its relatively small market
segment.
As a result Feintool sought the co-operation of the other companies which were represented
by the same agent in China.
105

3.2.13.3 Choosing the Partners and Establishment of the Company
The potential Swiss partners reacted positively to Feintool`s proposal, as they were not direct
competitors to one another and could only benefit from such a joint representative office. The
proposal requires each company to pay its share of the total costs. At the same time, they are
free to use the connections and guanxi which their former agent had built up over many years.
3.2.13.4 Human Resources
All the personnel of the former agent were employed in this new agency set up by Swisstec.
This ensured the smooth running of the business operations. New personnel is presently
recruited to expand the activities to other pa rts of China. Generally, expatriates are employed
only for the start-up phase, and local Chinese are given preference over expatriates for the
ongoing business. All new Chinese staff is trained in Switzerland in order to be competent
partners for Chinese customers. Wages paid have a high content of provision (up to 50%) to
give incentive for active marketing and promotion of the Swiss products.
3.2.13.5 Summary
For a comparatively small China business, it was not worth Feintool`s while to set up its own
sales agenc y in China. The form of co-operation found with other Swiss SME's brought
reduced financial involvement and therefore reduced risk, without having to accept the
disadvantages of being represented by large trading houses. This act of "self-help" and
entrepreneurial initiative brought advantages to all partners and could be a prototype of co-
operation for various other applications.
Determining a strategic fit with one`s potential business partners is certainly important.
Attracting an appropriate potential partner to become your strategic business partner may
need some persuasion. Here, it is important that one is able to fulfil the needs of the potential
partner adequately in order to ensure a stable long-term business relationship which is
mutually benefic ial. The potential ability of the foreign firm to fulfil the needs of potential
Chinese partners provide the foreign firm with its bargaining position vis-a-vis the Chinese
partner. Technology, which the Chinese firms and government authorities require, is one
106

factor which makes the foreign firm attractive to its potential Chinese partners. Access to
foreign markets is yet another attractive factor.
Having something attractive to offer one’s potential partner provides one with a basis for
negotiation. Successfully conducting the negotiation and working successfully with the
business partners to make the cross-cultural venture a success, requires cultural understanding
and knowledge.
Matthias Kästner, a doctoral student at HSG and a director of a high-tech company wrote:
3.3 Making a High - Tech Market Entry (by Matthias Kästner)
Economic reforms under Deng Xiaoping led to a massive increase in foreign trade and to
substantial foreign direct investment in China. Having realised that modern technology is
essential for sustainable economic growth, China favours ventures with a high technology
content. Multinational companies and overseas Chinese investors were the early movers in
this new market. To date many MNCs have established considerable operations in China
whereas Western small and medium sized enterprises (SMEs) are still largely
underrepresented. Only recently, foreign governments have started to promote China -related
trade and foreign direct investment by SMEs through special funds, export guarantees, sino-
foreign trade fairs and other means of support.
The purpose of this paper is twofold:
• First, to identify factors which influence the choice of market entry strategies for high-tech
SMEs for the Chinese market. Previous research concentrated mainly on determinants
which are relevant for the decision making process within large multinational companies,
while it was largely ignored that the market entry choice by SMEs may depend on different
factors. Therefore, it is interesting to have a closer look at SME relevant determinants.
Special focus is given to the role of technology, which is expected to have a significant
impact on the market entry mode decision of SMEs.
• Second, to help SMEs understand their strategic assets, strengths and weaknesses in
bargaining situations with Chinese authorities, customers and partners.
Interviews with Swiss, German and Austrian SME managers revealed that prior to China
activities most preparation is spent on the investigation of the Chinese market potential and
understanding the legal issues. Both are certainly prerequisites for success, however, they are
not sufficient. Usually, little time is spent on evaluating and understanding the company’s
107

assets in negotiations; consequently, these cannot be used to the SMEs' full advantage. Again,
advanced technology has a special role: it seems to be one important, if not the most
important, asset.
3.3.1 The Choice of the Market Entry Mode: A Framework
Co-operative joint ventures, equity joint ventures, wholly owned subsidiaries, representative
offices or simply direct or indirect exporting are possible vehicles for China activities. In each
category there are examples of successful companies that are happy with their specific
decision as well as numerous examples of complete failures. If one market entry form turned
out to be superior over others, it would be the strategy of choice for all newcomers with
“China ambitions”. However, a strategy that fits for all companies, products and in every
situation does not exist. There is no best strategy for China activities. Whether an entry
strategy is appropriate in a certain situation depends on a multitude of determinants.
The contingency approach which is one school of organisational theories can be used to
explain the choice of different market entry modes. Originally, the contingency approach was
one-dimensional: only one factor such as firm size or technology intensity was used to explain
the existence of different organisational forms. The deficiency that only a single factor has
explanatory value for the existence of different organisational forms was recognised by Kieser
and Kubicek (1992) who developed the one -dimensional contingency theory into a multi
factor approach. Obviously, by introducing other explanatory variables they added complexity
to the approach. To remove some of the added complexity in order to make its application
easier they propose to distinguish between internal determinants which can be influenced by
the organisation and factors related to the external environment which are - at least for a SME
- de facto given.
The internal factors are linked to the nature of the SME itself, they are controllable by the
SME to some extent. External factors include the microeconomic and macroeconomic
environment. Though they are not necessarily a given datum, they often can be influenced to a
certain degree, too, depending on bargaining power and skills. While large multinational
companies may have the necessary power to influence the external environment significantly,
SMEs are more likely to be in a position of compliance.
Although technology formally belongs to the group of internal determinants, it merits to
receive special attention. As outlined above, the nature of high technology plays an important
role in the choice of the market entry mode for high-tech SMEs. Although technology is
108

developed within the SME, its impact is not limited to the internal environment. Many
external determinants in the Chinese context are a function of the level of technology
involved: rapid approval for high-tech ventures, waiver of mandatory export quotas under the
condition that certain technology requirements are met or dedicated investment zones with
superior infrastructure for high-tech companies are only a few examples. Therefore it is
appropriate to introduce factors related to technology as a separate third group: Technology
determinants.
The following section gives an overview of an analytical framework that integrates the
determinants which are relevant for the choice of the market entry strategy.
Micro
Environment
China
Understanding of
own Bargaining
Position
External Determinants
Technology Determinants
Internal Determinants
Choice of
Market Entry
Strategy
Understanding
the Role of
Technology
FIGURE 3-16: Determinants for the choice of the market entry strategy
3.3.1.1 Internal Determinants
Macro
Environment
China
Internal determinants are related to the nature of the SME. Limited financial and limited
human resources are often a real impediment in risky China activities. The ownership
structure, characteristics of the industry in which the SME operates, the degree of
specialisation and the positioning in the market are expected to influence market entry
strategies.
109

Internal Determinants
� Organization and ownership structure
� Size
� Financial Resources
� Type of company: niche producer,
quality leader, etc...
FIGURE 3-17: Internal Determinants
3.3.1.2 External Determinants
� Human Resources
� Industry Characteristics
� Degree of specialization
External determinants are divided into macroeconomic factors and microeconomic factors.
Laws and regulations, market data, infrastructure and Chinese technology policy form the first
group, characteristics of Chinese companies, be they customers or potential partners for a
joint venture or co-production belong to the micro environment.
External Determinants
Macro Environment Micro Environment
� Laws and regulations
1. Trade barriers
2. Investment regulations
3. Licensing and Patent Laws
4. Export requirements
5. Employment regulations
6. Investment incentives
7. Repatriation of profit
� Market data
1. Economic growth
2. Demand for foreign high-tech products
(industrial and consumer)
� Infrastructure
1. Physical infrastructure
2. Scientific infrastructure
3. Supplier infrastructure
4. Human resource infrastructure
5. Financial services infrastructure
� Technology policy of central government
TABLE 3-11: External Determinants
� Chinese Customers
1. Need for technology
2. Preferred business model for
technology transfer
3. Financial situation,
access to hard currency
4. Size
� Chinese Joint Venture Partners
1. Type of company (ownership) and
its characteristics
2. Technological capabilities
3. Size
4. Guanxi
5. Financial Situation
110

3.3.1.3 The Role of Technology
Management of SMEs is certainly aware of the importance of proprietary technology and
know-how for the company, yet the role of technology in the internationalisation process and
especially in the Chinese context may not be fully understood.
� History of Chinese technology imports
� Type of technology (process or product)
� Competition for the specific technology
� Protection of technology
TABLE 3-12: Technology Determinants
Technology Determinants
3.3.2 SME’s Objectives for China Activities
� Transferability of technology
� Dependance of SME on that technology
� Payment for Technology
� Length of technology cycle
Unlike the “conventional” proceeding, that is to investigate pros and cons of the different
market entry vehicles, the concept of underlying “objectives”, which initially trigger the
SME’s China activities, shall be introduced. The reason is that in the logical sequential
process companies define an objective such as “cheap production for the world market” or
“e xploiting domestic sales opportunities” before they select a vehicle to accomplish the
chosen objective. Depending on the underlying objective, one and the same entry mode could
be either the best choice or totally inappropriate. A given objective may reduce the number of
appropriate market entry vehicles to chose from; a company that intends to use China as
cheap production base for example, will certainly not consider exporting as viable strategy to
reach its goal.
The “underlying objective” is the element of the company’s overall strategy which defines the
company’s goal for international activities. It determines which of the internal, external and
technology elements are relevant and influence the market entry mode decision. Speaking in
terms of a contingency approach, the underlying objective is a new variable on a higher level,
determining the relevance of internal, external and technological factors.
111

Exploiting Sales
Opportunities
Micro Environment China
IP Trading
Understanding of
own Bargaining
Position
SME’s Objectives in China
External Determinants
Technology Determinants
Internal Determinants
Choice of
Market Entry
Strategy
Exploiting Comparative Cost Advantages
FIGURE 3-18: The choice of Market Entry Strategy
Understanding
the Role of
Technology
Macro Environment China
Research
Cooperation
The following sections attempt to categorise the objectives of high-tech SMEs who engage in
business activities with or in China. Feasible business vehicles are listed for each of the five
identified categories without giving a ranking or an evaluation.
3.3.2.1 Objective 1: Exploiting Domestic Sales Opportunities
The acceleration of technological change has shortened product life cycles and made product
development more costly, especially for companies in R&D intensive high-tech industries.
Foreign sales may help to recover R&D expenditures quickly before the product or
technology developed becomes obsolete or imitated by competitors. Besides, economies of
scale in R&D make it too expensive for SMEs to engage in several isolated research projects
in parallel (Lindquvist 1991). Without diversification through product and process
development, accessing foreign markets may be the only viable option for growth.
Export only
The first objective SMEs may have is to exploit perceived sales opportunities for their high-
tech products without building substantial operations in China. SMEs who follow this path
consider their products to be competitive on the Chinese market or want to test customer
acceptance. Initially, these companies do not intend to produce locally but rely on their
manufacturing sites which are located elsewhere, most likely in their home country. Often a
market entry through “sales only” is a first step in sequential market penetration process.
Maintenance and
After Sales Servivce
112

Indirect export and direct export are two possible vehicles to build up sales in China. While
indirect export does not permit influence on the marketing and distribution channels because
of intermediaries involved, direct export gives at least some control on marketing and
distribution. It relies on the followin g principal vehicles: the foreign agent/distributor channel
and the branch/subsidiary channel (Root, 1982). In China the latter is limited to a mere
representative function; by Chinese law, representative offices are not allowed to conduct any
business activities such as concluding commercial contracts.
Finding a well established trading house in China is a difficult task, especially for SMEs.
Large trading houses with a good geographical coverage in China prefer to work with big
companies who boast high sales volumes. Problems increase when the SME wants the trading
house to market and sell high tech products that require sophisticated service and
maintenance. SMEs most likely have to rely on smaller companies which do not cover all
Chinese provinces and ha ve less resources to provide technical maintenance and after sales
service.
Market Opportunities: “Going China” as a Strategic Long Term Decision
More resources are required when China engagement is seen as long term strategic decision,
i.e. the Chinese market is considered a strategic target market for the company. Beside
pr oduction facilities in the country, marketing and sales activities are essential for a long term
foothold. SMEs who follow this path may want to set up a representative office first, but as
these are not allowed to conduct any business, this cannot be more than an initial step. All
joint venture forms and the wholly owned foreign enterprise (WOFE) are possible vehicles for
long term presence.
3.3.2.2 Objective 2: Exploiting Existing Know-How and Proprietary Technology
Many SMEs are not able to commit substantial financial and human resources to a China
engagement. However, besides the sales approach described above, high-tech companies have
the opportunity to exploit their existing know -how in the Chinese market – often referred to as
“pure technology transfer”.
Tangible items of “pure technology” include technical blueprints, manuals, patent rights on
products and processes or documented process knowledge, just to give a few examples.
Intangible elements are implicit knowledge and experience which are embedded in the people
who handle or develop the technology. To ensure successful technology transfer, these
“knowledge carriers” should be involved in the transfer process.
113

The most common vehicles for commercial transfer of pure technology are various forms of
“technology sale”. These forms differ mainly in the payment methods agreed upon. Another
vehicle of “pure technology transfer” are training courses offered to Chinese technicians.
They are often a mandatory element within a larger contract, e.g. when complicated
equipment has been sold for which operators and maintenance staff need instruction. Training
as stand-alone vehicle for technology transfer is rare as it is resource intensive and as there is
no immediate need on the Chinese side without equipment purchase. Large companies
organise seminars on their technology and products, but this is rather a marketing instrument.
Chinese buyers and involved engineers are invited to these events which are held in China or
even overseas.
3.3.2.3 Objective 3: Exploiting Comparative Cost Advantages
Cost effective production mainly for export purposes is usually a step up the ladder in terms
of resource requirements. SMEs who have the intention to use lower factor costs to reduce
production cost have several options, but should consider that costs incurred for other than
low-skilled manual labour are often as high or even higher than in many Western countries.
Possible vehicles include contract production (questionable if in the case of high-tech
products quality requirements can be met by the subcontractor), equity and co-operative joint
ve ntures and wholly owned foreign enterprises.
3.3.2.4 Objective 4: Providing After Sales Service and Maintenance
Sooner or later a high-tech SME may be confronted with the need to service equipment and
products sold to China. Servicing from the home base is a suitable option as long as response
times are acceptable and as long technicians have to visit the Chinese customers only once in
a while. With increasing stock of equipment sold to China, the ongoing service requirements
grow and with them the need for local responsiveness. The reorganisation of the SME’s
service and maintenance strategy in China may become necessary.
However, setting up a service and maintenance organisation in China is not as straightforward
as in most other countries. Representative offices are limited to a mere representation function
by law, wholly foreign owned enterprises (WOFEs) cannot be set up as service -only
companies because the Chinese government restricts full ownership of a company to
manufacturing enterprises. However, it is possible that a manufacturing WOFE also provides
service and maintenance for products produced and sold in China. Two legal possibilities
remain: the foundation of a Chinese-foreign joint venture to carry out service and
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maintenance or the use of established trading companies who are allowed to offer technical
service and maintenance. The first option means to share substantial technical knowledge with
a Chinese partner, the second option may not offer the same quality of service because
technicians employed by the trading house are rarely specialists for one particular machine,
they have to service a whole range of technical equipment.
3.3.2.5 Objective 5: Research and Development
Little is known about companies venturing into China to benefit from the scientific resources
and to carry out R&D. It might be an option in very specific circumstances, where a Chinese
partner, be it a University, a state-run research laboratory or a private research organisation,
possesses technology that is of interest to a foreign SME. Cases with MNC involvement are
known in the field of biotechnological research and in the aerospace industry.
A German-Chinese office for the co-ordination of joint fundamental and applied research is
currently in the planning stage but negotiations with the Chinese side are lengthy and
difficult; it will be funded by the German federal ministry for research and technology and
acts on behalf of major German public and private research organisations.
3.3.3 Assessment of Bargaining Situations for SMEs
Understanding the “Bargaining Position”
In the short run neither internal nor external determinants can be influenced and altered by the
SME. They are fixed given facts which determine the choice of the market entry vehicle.
However, the decision on the entry mode is made by a human being; thus all determinants are
subject to interpretation. Correct interpretation requires good understanding of all
determinants, especially of the role of advanced technology in the Chinese context.
Understanding alone is not sufficient: the responsible manager must draw conclusions from
the set of dete rminants, he must anticipate opportunities and risks. Knowledge about potential
“bargaining partners” such as for example local Chinese governments or potential joint
venture partners and the position of the own company in negotiations with these partners,
knowledge about its strengths and weaknesses and the sources of bargaining power, are
imperative to make the best possible choice.
Interpreting the determinants, drawing conclusions and understanding the bargaining position
of the partner are a matter of preparation. This is a difficult task for a manager with limited
time and no or little experience in the Chinese business environment.
115

Knowledge about the own position in a bargaining situation, about own strengths and
weaknesses in negotiations and about the sources of bargaining power are a prerequisite to
use the available “assets” to their fullest benefit.
This section aims to help SMEs to understand their position in a “bargaining situation” in the
Chinese context. First, the importance of every bargaining constellation such as for example
SME – local banks in case of direct export or SME – Chinese Customer in case of a
service/maintenance joint venture is rated. Second, interesting bargaining relations, i.e.
situations where a SME is expected to have at least some bargaining power, are analysed.
The following chart gives an overview of possible relations between a SME and its bargaining
partners. Every intersection of rows and columns represents one possible bargaining situation.
Depending on the SME’s intention and the chosen entry vehicle, the bargaining arenas differ
widely in respect to bargaining partners and the relevance of the relation with them. While the
relation with Chinese customers, for example, are highly relevant if the product is targeting
the Chinese market, this relation does not exist in the case of “exploiting cost advantages” and
producing for export only. According to the importance of a relation, intersections of rows
and a columns are marked with X (low), XX (medium) or XXX (high). An intersection
marked with a 0 denotes that in this constelation no significant relation exists, i.e. the two
parties can act without influencing each other.
116

Government
Central
Exploiting Sales Opportunities
Local Government
Venture Partner
Chinese-Joint
Rep. Office XX X 0 XXX 0 0 0 X X
Direct Export X 0 0 XXX 0 0 XXX X XX
Indirect Export 0 0 0 X 0 0 X 0 0
Exploiting existing know-how / IP trade
Licensing X XX 0 0 XXX 0 0 X 0
IP Sale X XX 0 0 XXX 0 0 X X
Training courses X X 0 0 XX 0 0 0 X
Exploiting comparative cost advantages
Contract
Production
Chinese Customer
0 X XXX 0 0 XX 0 X X
EJV, CJV XX XXX XXX 0 0 XXX 0 XXX XX
WOFE XX XXX 0 0 0 XXX 0 X XXX
Getting a long term strategic foothold in the Chinese market
Rep. Office X X 0 X 0 X 0 X X
EJV, CJV XX XXX XXX XXX 0 X 0 XXX XX
WOFE XX XXX 0 XXX 0 X 0 X XXX
Following a major customer
Licensing X X XX 0 0 0 0 0 0
EJV, CJV X XX XXX X 0 X 0 XXX XX
WOFE X XX 0 X 0 X 0 X XXX
Providing service and maintenance
EJV, CJV XX XX XXX XX 0 0 0 XXX XXX
Licensing 0 X XX 0 0 0 0 0 0
TABLE 3-13: Relations between a SME and its bargaining partners
Recipient
Technology
Customer
Home Country
Distributor
Trading House /
Local Banks
Foreign Banks
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This evaluation does not rate SMEs’ bargaining power; it rather shows the importance of the
relation for SMEs’ operations. Not all of the identified relations are real bargaining relations.
The SME may be in such a weak position, that it is forced into compliance with the given
environment and existing rules. This is particularly true for all relations with the central
government and financial institutions. In terms of bargaining power a single SME is a
lightweight against these “partners” and most likely has to comply with the rules.
This section will shed some light onto four of the more promising and interesting bargaining
situations, i.e. relations where SMEs are expected to have at least some bargaining power: 1)
SME – local Chinese authorities, 2) SME – Chinese joint venture partner, 3) SME – trading
house/distributor and 4) SME – technology recipient. First, the interests of both bargaining
partners are briefly summarised for each of the given situations. Second, conflicting interests
are identified. In a third step an estimation is given about the relative bargain ing strength of
the SME. To come up with a reasonable estimate it is imperative to understand the sources of
bargaining power.
3.3.3.1 Bargaining Situation I: SME – Local Chinese Authorities
High-Tech SME Local Chinese Authorities
• Efficient authorities, fast approval procedures
• Adequate infrastructure
• Free choice of legal vehicle
• Protection of technology, e.g. long license periods
• No export quota
• Free repatriation of profit
• Attracting high-tech companies into the province
• Ensure absorption of high tech � joint ventures
preferred
• Personal benefits such as gifts and international
travel
• Comply with central government’s rules
• Tax collection
TABLE 3-14: Interests, objectives and expectations between High-Tech SMEs and
Chinese Authorities
As local authorities are empowered to approve investment projects below 30 million US$,
they are in charge of most applications made by SMEs. To speed up approval procedures in
the special economic zones, there are tight review deadlines for the approving authorities. If
they cannot come up with an decision in time, the application is automatically considered
approved. Growing competition among local government in their attempt to lure FDI into
their province lead to this streamlined approval process (Foreign Investment Administration,
1995). However, issuing the required business license still may take many months.
Local governments, especially in the coastal provinces have realised that high tech companies
have special requirements in terms of physical infrastructure. Beside the industrial parks
which usually provide a good infrastructure, specialised “high-tech parks” are currently set up
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in the most advanced provinces and municipalities. Only technology based companies are
eligible to set up operations in such privileged areas. In these parks which are often foreign
planned and sometimes administered 115 with foreign help, power supply, water quality and
telecommunications facilities are on par with Western standards.
Everything seems to be nicely set up for foreign SMEs, but conflicting interests exist when it
comes to the question of technology transfer. On the one hand SMEs tend to be secretive
about their proprietary knowledge and are reluctant to share it with a partner. On the other
hand that is exactly one major goal of the Chinese side: full and rapid assimilation of the
technology. Therefore, joint ventures are clearly favoured by the Chinese side because
technology transfer to the Chinese Partner is inevitable. License periods are limited by law to
a maximum of ten years, Chinese workers must be given compulsory training (Chen, 1993),
extensive guarantees by the SME are specified in a technology transfer contract.
The technology offered is by far the single most important source of power during
negotiations. The more a SME is willing to share, the better is its position in negotiations. As
the competition among regional governments is fierce, many questions are negotiable.
Although the preferred legal vehicle is the joint venture, it is no problem to set up a company
as WOFE. High-tech companies are usually able to negotiate a 0% export quota regardless of
the legal form chosen (Foreign Investment Administration, 1995) 116 . Longer license periods
have been granted in some instances and repatriation of profit made in China is partly
possible. Ample time for negotiations, high profile negotiation teams, flexibility and a clever
way to deal with unofficial requests (gifts, international travel) are other elements that
strengthen the SME’s negotiation power. To sum up, SMEs have a relatively good position in
dealing with local authorities, provided they offer genuine high-tech, that has a high priority
on China’s “technology shopping list”.
115
Example: Suzhou Industrial Park, a Singapore – China joint venture, jointly run but planned by
Singapore’s Economic Development Board.
116
Companies with foreign held equity usually have to export a certain percentage of their production,
depending on the type of product and the legal form.
119

3.3.3.2 Bargaining Situation II: SME – Chinese Joint Venture Partner
High-Tech SME Chinese Joint Venture Partner
• Cheap production for export or
• Long term foothold or
• Service & maintenance
• Technology as equity
• Keep control of operations
• Getting access to distribution networks
• Short term focus
• Get rid off own excess staff
• Personal motives: travel, etc.
• Upgrade of product and process technologies
• Getting access to foreign markets
TABLE 3-15: Interests, objectives and expectations between High-Tech SMEs and
Chinese JV Partners
When a SME considers a joint venture as entry vehicle, be it for export oriented production,
getting a long term foothold in the market or to provide service and maintenance for its
products, its goal is usually for a stable and long lasting presence in China. Eventual profits
are often reinvested to support the future growth of the joint venture. Chinese companies tend
to have a short term focus; in many cases the goal is to make profit and extract from the
operation as much as possible instead of reinvesting the profit. Conflicts are difficult to avoid
because the different time horizons lead to different business strategies. Equity Joint Ventures
(EJV) where both parties hold an equity share are generally more stable than Contractual Joint
Ventures (CJV) where co-operation is based on a contract without strict equity requirements.
To minimise problems, special attention has to be given to a careful partner selection.
One of the biggest problems is the valuation of assets brought into the joint venture as equity
by the parties. Machinery, technology and hard currency is usually contributed by the SME
while the Chinese partner provides land, eventually buildings, a sales organisation and
manpower. Equity contribution in form of technology (know -how, patent rights, etc.) is
restricted by law to 20% of the total equity. Often land and buildings are evaluated much too
high so that the Chinese side gets the desired equity stake which is relevant for profit
distribution and control of the joint venture. SMEs and MNCs alike usually have to make
concessions in this question.
Overstaffing is a serious problem in many Chinese companies. Getting rid of excess staff
might be a motive to form a joint venture. Like in the equity issue, concessions to the Chinese
side are often necessary. Both issues are hard to solve and are a common reason for the failure
of JV negotiations.
One important, if not the most important reason for a SME to opt for the joint venture solution
is the expectation that the Chinese partner has a lot of “guanxi” and a well developed sales
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network through which the products of the joint venture can be sold. Reality often does not
meet expectations: it is almost impossible to evaluate the quality of guanxi or the efficiency of
the sales network. China is a huge country and it is unlikely that a joint venture partner has a
strong presence in all provinces. Those who have, are large enterprises but these have most
likely already been picked as partners by the foreign MNCs who were first in China. If the
sales network is a major reason to form the joint venture, the partner must have at least sales
experience with similar products. While the foreign SME wants to get access to the Chinese
market, the Chinese partner may have in mind to improve product qua lity through new
technology and then attack foreign markets with competitive products: Again, a potential
source for conflicts.
Personal motives of Chinese managers to form a joint venture are among the most dangerous
because they are mostly of egoistic nature. One objective may be to benefit through gifts and
business travel in the short run but the well being of the joint venture is not a prime issue. If
there is no genuine business interest from the Chinese side, the joint venture is doomed to fail.
To asses the source of SMEs’ bargaining power in respect to the joint venture partner, two
situations are distinguished: 1) JV negotiations and 2) JV operation.
1. Again, the technology offered is one of the major sources of power. It is also the main
reason for which the SME becomes an interesting partner for a Chinese company. The actual
situation depends on how urgently the technology is needed, if the technology is unique or
available from other companies. In the latter case it is important if the Chinese company has
eventually sufficient funds to buy or license the technology from a third party. A high profile
delegation, sufficient time and a careful preparation with contingency plans improve the
bargaining situation considerably.
2. Once the joint venture is in operation, the actual bargaining power is very much a function
of the equity stake hold by the SME. However, this is not a linear function! Whoever has the
majority usually dictates the business strategy and has control over important decisions. This
does not necessarily mean that once a SME holds the majority everything is fine: a good
relation to the JV’s management is equally important, no matter from which side it is
appointed. Regular visits are necessary to create and maintain such a relationship.
Fast moving technologies bear an intrinsic source of bargaining power: updates and
improvements that are developed at the SME’s home location are often desirable to be
implemented in the joint venture – but new technology has its price! The possession of the
latest technology is always a power factor in negotiations with Chinese.
121

The bargaining power of a SME in relation to that of a Chinese partner cannot be generalised.
It is determined by many factors, not only by the technology and its availability but also by
the size of the partner, its financial strength, the experience of the negotiation team, among
many others. It may range from very strong to almost insignificant.
3.3.3.3 Bargaining Situation III: SME – Trading House / Distributor
High-Tech SME Trading House / Distributor
• Wide geographical coverage, preferably whole of
China
• Excellent service and maintenance for products
• Committed marketing
• Brand name
• High margin
• High volume sales
• 1st priority: established customers
• SME only if product has excellent market potential,
competitive product
TABLE 3-16: Interests, objectives and expectations between High-Tech SMEs and
distributors
As outlined in a previous paper, large foreign trading houses who cover many provinces
usually have a long track record of activities in China. They have stable long term
relationships with the companies which they represent, often large MNCs with well known
brand names. Usually they are reluctant to take SMEs as new clients. Only under special
circumstances: when the SME’s product complements the existing product mix or when the
product has an especially high market potential in China, new applicants will be considered 117 .
Still then, SMEs will often be only second league clients in terms of marketing effort or
service and maintenance support.
In general, smaller trading houses are willing to take new clients, provided the products fit
into their existing product portfolio. Although new SMEs may be along with others equal
“first league clients”, the small trading house may not have the resources to do an efficient
marketing or to give appropriate service support to the customer. They are unlikely to cover
the whole of China but focus a geographic region.
Sources of bargaining power vis a vis a large trading house are obvious: the greater the
market potential of the product (as estimated by the trading house), the more likely the trading
house will give appropriate attention to the product (marketing effort and customer service).
The same is true for excellent price competitiveness, meaning the trading house can realise
high margins. Although SMEs do not have well known brand names such as for example
117 Presentation at Sieber Hegner Trading, Shanghai, 17.04.1997.
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Siemens or Motorola, they may have a reputation and a well known brand name in their niche
market – a fact that should help in negotiations with a trading house. To sum up briefly,
unless an SME’s product has not an extraordinary market potential, the bargaining position of
SMEs in respect to large well established trading houses is rather weak.
3.3.3.4 Bargaining Relation IV: SME – Chinese Technology Recipient
High-Tech SME Chinese Technology Recipient
• Appropriate price for technology
• Free choice of business model (licensing, sale,
royalties)
• Delivery of appropriate technology to avoid
problems
• Protection of technology
• Low cost upgrading of process and product
technology, new products
• Complete disclosure of technology
• Extensive guarantees
• Most advanced technology
• Training
• No tie-in contracts
• No restriction on sales region and no min. sales
price
TABLE 3-17: Interests, objectives and expectations between High-Tech SMEs and
Chinese Technology Recipient
Regardless of the form of payment, SMEs expect an adequate financial compensation for
technology transfer. This leads to a first set of problems (Guo / Akroyd, 1996): Chinese
technology buyers are very cost sensitive, yet routinely request the most advanced and
sophisticated technology, even though they may lack of foreign exchange, adequate
infrastructure to utilise complex technology and trained personnel (Chen, 1993).
There is no tradition of commercial technology transfer in China, previously technology was
transferred between the state owned conglomerates free of charge. In the end the price is
us ually the decisive factor, given the technology fulfils the basic requirements. Flexible
pricing strategies, such as modular pricing of individual components are a good method to
make the deal transparent for the Chinese and give them options to chose from. Still, the value
of a technology is often hotly debated in negotiations.
Asking for the most advanced technology is understandable from the Chinese point of view –
catching up with the first league industrialised countries as fast as possible is an implicit goal
in many actions. However, in many cases leading front end technology is inappropriate and
only a second best solution. Technology providers face the problem that they have to give
guarantees concerning the performance of the technology although they do not ha ve control
over the quality of material inputs or correct handling of the process. They are trapped in a
dilemma, knowing that a more mature technology suits better for the purpose while the
123

Chinese insist on cutting edge technology. If the technology proves to be too advanced for the
Chinese recipient, employees may mishandle the equipment due to lack of sufficient training,
which could badly damage the foreign suppliers reputation.
According to Confucian philosophy copying is a legitimate and clever way of learning; moral
scruples do not exist. For an SME whose major asset is proprietary technology, it is
imperative to control and to protect its technology from unauthorised use, copying and
dissemination. Holding back key components (delivering them as bla ck box) is one defensive
strategy. SMEs involved with rapidly evolving high-technology face probably less risk when
transferring their top end technology to China. Once the Chinese fully master this technology,
a succeeding technology generation has already been developed. Thus the risk of creating a
competitor is minimal.
Although Chinese Patent and Licensing Laws are of Western standard, law enforcement is
still very weak (Kloth 1996). Dissemination of delivered technology is almost beyond control
of a foreign SME; it happens that a process technology license is given for one manufacturing
plant, that fees for this plant are paid regularly but that the technology is used in similar
facilities without gratification and notification of the licensor.
The risk of creating a competitor on the world market is inherent to process and product
technology transfer. Chinese Licensing Laws do not permit any geographical restriction of the
sales area of the products deriving from licensed or bought technology. Minimum sales prices
are forbidden, giving the Chinese way to conquer established markets with dumping price
strategies. However, it seems that only the largest Chinese firms have the experience and
management resources to become a serious competitor on the world market.
As Paul reflected on his China venture, he realised the wisdom of Mr. Zheng in his dealings
with the Chinese partner. Mr. Zheng’s good business relationships with the Chinese partners
involved not only the provision of a foreign market for Chinese goods, but also the essential
help and advice which he gives to them in terms of improvement to the products as well as the
introduction of various appropriate technologies to the Chinese partner. When appropriate,
Mr. Zheng has even helped the Chinese partners source for technology in Europe. Paul began
to realise the reasons for the strengths and depths of Mr. Zheng’s relationships with his
124

Chinese partners. He also began to realise why he could not seem to make any headway with
his Chinese partners once Mr. Zheng is gone. Without extra “technology service” which Mr.
Zheng is providing, the strategic partnership may not be too attractive to the Chinese partners.
“Technology service” was never part of the formal agreement to co-operate in the existing
trading arrangements. Similarly, the often necessary inspection and assembly activities
relating to the trading activities were also never specified in any written agreement with
Chinese partners. These anomalies according to Paul’s past perception would now appear to
be central to the business relationships Mr. Zheng had developed and critical to their
maintenance over the longer term.
Paul continued to read on about the cultural factors relating to the negotiations for a Joint
Venture in China. Brigitta Joho and Jürgen Müller wrote:
3.4 Negotiating for a Joint Venture: Strategic Considerations (by Brigitta Joho
and Jürgen Müller)
For many people in the West, China is not only geographically but also culturally very far
away. Although modern communication technology gave us a closer link to the Asian world,
this region still seems further away than for example Australia. The completely different
culture is one major aspect. It is therefore no wonder that companies use Joint Ventures as a
first step to enter the Chinese market. The way to a successful Joint Venture is long and full of
problems. The missing language ability is certainly not the biggest obstacle, but the lack of
intercultural competence, social and economic knowledge and experience.
The keys to a successful European–Chinese Joint Venture lie in a very good preparation for
the Chinese culture and for any problem which could await the investor, as well as the ability
to use the opportunities provided by an intercultural partnership. This paper tries to highlight
the main differences between German and Swiss values and customs on one side, and Chinese
on the other.
To illustrate these differences we proceed in the following way: In a first step we build the
foundation for our paper, by giving a rough overview about the meaning of culture in its three
different levels and their functions. In the next section we present a more theoretical approach
to the Chinese way of doing business, and in the last part we summarise the experiences
gathered through the inte rviews with different companies. Finally, we would give some
recommendations on how to do business in China.
125

3.4.1 Culture
Culture influences both economic behaviour and performance. In the Asian-Pacific region,
several cultural and religious traditions exist: Confucianism, Taoism, Buddhism, Hinduism,
Islam and Christianity. Additionally, Western attitudes like Liberalism and Communism have
also influenced this region. 118
Corporate
culture
business culture
national culture
FIGURE 3-19: Three levels of culture
When we talk about culture in this context, we have to differentiate between three stages: the
national culture, the business culture and the corporate culture. These different levels cannot
be separated, they interact.
3.4.1.1 National Culture
National culture provides the basis for our behaviour, way of thinking, customs, etc. We are
socialised into our culture and we learn through culturally defined symbols which have
specific meanings. Through socialisation people gain shared understandin g in a society to
allow adequately for predictable and co-ordinated social activities. 119 In essence, this
constituted our cultural background, and is the main reason why people from other societies
are different from us. Culture does have its basic functions like division of labour, providing
social controls against deviant behaviour, distribution of power, and providing a sense of
priorities and values. 120
At this point it is important to make a distinction between ‘nation’ and ‘country’. It is
common to say that a nation, e.g. the Germans, live in one country, which is in this case
Germany. But this view is too simplistic, separating different nationalities along country
118 Schütte/Lasserre, 1996, p. 101.
119 Terpstra/David, 1991, p. 20.
120 Phatak, 1992, p. 9.
126

orders. However, a country may also consist of peoples of different nationalities or ethnic
groups, such as former Yugoslavia, the former USSR or Malaysia. 121 There are also
nationalities whose people straddle more than one country, such as the Kurds or the Basks.
3.4.1.2 Business Culture
Business culture is a sub-culture of the national culture. It often requires learning of cultural
knowledge relevant to a person’s participation in the wider social-economic world. Business
culture comprises the effective rules of the game, the boundaries between competition and
unethical behaviour, the codes for conduct in business dealings. 122
We will discuss the differences in business culture between Europe and China in section
Comparison of Business and Culture between Germany/Switzerland and China, later in this
paper.
3.4.1.3 Corporate culture
A business is an organisational entity with its own common and shared values. Characteristics
of a corporate culture are shared values (e.g. ethical values on how to do business, business
ideologies, and ideas of quality, co-operation, tolerance, hierarchy, control, etc.), shared
norms (guidelines, leadership principles, etc.), shared attitudes (attitudes of the employees
towards task, product, colleagues, leadership, company, development, customers, etc.) and
shared artefacts (languages and language rules, behaviour, architecture, conferences and
meetings, parties, rituals and ceremonies, myths and anecdotes, etc.). 123
Just like in the society, sub-cultures can also exist in a company. This could be due to the
different functional, hierarchical, regional, or other affiliations of the members, or due to
differences in their nationalities, sex, age, and other personal characteristics. 124
3.4.2 Comparison of Business and Culture between Germany/Switzerland and
China
What we are going to discuss in this sec tion should give you a general idea of Chinese
business life and its culture. However, it does not guarantee a procedure without any difficulty
121 Stüdlein, 1997, p. 36.
122 Terpstra/David, 1991, p. 20.
123 Stüdlein, 1997, pp. 38.
124 Stüdlein, 1997, p. 39.
127

in negotiations and communication with your Chinese partner. We should always keep in
mind that human beings are individuals all over the world, it doesn’t matter if they come from
Germany, Switzerland, Africa, or China. Each person needs to be treated individually.
3.4.2.1 Understanding of Confucianism
Chinese philosophy and thought have been influenced greatly by Confucianism. Confucius
was born in 551 BC, in what is now called Shandong province, and died in 479 BC. His
ambition was to hold a high government office and reorder society through the administrative
apparatus. The glorification of Confucius began after his death, and during the Han Dynasty,
Confucianism effectively became the state “religion". He aimed to instil a feeling of humanity
towards others and respect for oneself, as well as a sense of dignity of human life. Courtesy,
selflessness, magnanimity, diligence and empathy would naturally follow. His ideal person
was competent, poised, fearless, even-tempered and free of violence and vulgarity. 125
The understanding of Confucianism may help foreigners to understand the Chinese better,
particularly during negotiations:
• Harmony is the highest goal of action and thought, to maintain it, each person has to seek
compromise, not confrontation.
• Stability of society is based on unequal relationships. This involves mutually binding
obligations.
• A family is the prototype of all social organisations. Every person is member of a family or
group.
• A role played by an individual is more important than the individual.
• One must behave in a virtuous manner towards others. Everyone’s “face” must be
maintained. 126
Harmony is in the centre of morality, righteousness, relationships, virtue, sincerity and thrift.
125 Storey, 1994, p. 72.
126 Rubensdörffer, 1997.
128

Germany/Switzerland China
democratic, "mündig" (i.e. mature) respectful, obedient
open-direct communication humble, demeanour-circuitous communication
conflict means to clear issues seeking harmony towards all, tenacity
Performance-motivated ready to learn and to take up
active, self-driven patient, respectable, humble
"have fun" thrift, sincerity
advantage-driven morally, conscientious
analytic-researching seeking synthesis/balance
change: challenge, ego stability, tradition, family
creative self-development self-discipline, self-sacrifice
opinion-oriented evasive-"receiver-oriented"
TABLE 3-18: Comparison of Values and Behaviour
3.4.2.2 Guanxi and the importance of family and friends
For the Chinese, their family, including extended family and friends is the central unit. All
members of the family and friends build a society network which can extend all over the
world. This networ k, also called "guanxi", is based on personal loyalty, trust and
responsibility. It takes a lot of time and patience to develop such a network, which involves
lasting relationships. As a result, members of a network are obliged to each other. If someone
is in trouble, the other members will work together on a solution. This social network is a
major reason why Chinese business people can be so successful: They work together and not
against each other. "Guanxi" is carried into the economic system and has an immense
influence on the Chinese decision-maker. For the Western business partner it means that he
has to be conscious of the resulting restrictions as well as advantages when his Chinese
counterpart belongs to such a network. 127
A foreigner in China can eve ntually become part of a Chinese person’s circle of family and
friends. However, he is expected to accept the traditional Chinese obligations of being a
friend and must be reliable and dependable. Foreigners, who are not used to such a high level
of mutual dependency can feel the Chinese expectations of friendship extremely burdensome.
Moreover, friendship is expected to last throughout a person’s life. 128
3.4.2.3 Self-Presentation
At the first meeting it is very important that you have a positive effect on your Chinese
partner. It is very helpful for further negotiations, if you are seen as competent and
trustworthy.
127 Melchers 1994, p. 66.
129

Good self-presentation in Germany and Switzerland requires one to show the difference of
one’s own person, the company, the offer and the product compared to others. In China, good
self-preparation requires the presentation of one’s own personality which is ready to match
the partners' interests and his existing relationships. The search for common interests, to show
one’s own social position as well as to confirm respect for the potential partner, are central
elements of the Chinese self-presentation. This kind of presentation aims at building trust and
confirm trustworthiness. To build trust with someone means in China to be ready to confirm
respect to the partner, to occupy oneself with his interests and to be ready to do business with
him. 129
Germany/Switzerland: China:
self-confident Respected
Successful know important people
Competent influential
experienced Educated
Modern have luck and be happy
political and cultural interested Experienced
have a clear opinion Modern
be able to afford something have a status
Dynamic, energetic keep conventions
Determined Helpful
Emancipated polite and pleasant
Unordinary to belong to an important family or company
TABLE 3-19: Presentation of the own person 130
128 Dunung, 1995, p. 105.
129 Zailiang/Reisch, 1994, p. 8.
130 Zailing/Reisch, 1994, p. 9.
130

3.4.2.4 Conversation at the first meeting
Chinese and Swiss/German people touch on different conversational topics at the first
meeting. Europeans like to talk about things which just happened, what they studied or about
their carrier, their own norms, exclusive hobbies, weekend or holiday events or about the
inability of other people. Chinese tell about their own background, what they studied, their
carrier, their stay abroad, food and drinks (very important!), international events, economic
development, help and support offers, social relations and about everything, that is pleasant
and gives a good feeling. 131
There are some topics you should not mention when you get to know your Chinese partner:
• Do not praise yourself or a member of your family. However, it would be nice to praise the
person you are talking to.
• Do not make any critical or debasing remarks on anything.
• Do not mention negative events like illness, misfortune, accident, etc.
• Do not forget to show your positive sympathy and your personal interest for the well-being
and welfare of the person you talk to.
• Do not start controversial discussions.
• Do not try to talk immediately about topics which could end in a conflict.
• Do not get too near to your partner. 132
Germany: China:
Offensive, direct indirect defensive
Active reactive, wait and see
Critical take note of the communication
Purposive purposive, reserved
Analytical, systematically systematically
Innovative, dynamically adaptable, open minded
Emotional, engaged calm, self-controlled
like a good colleague respectful, hierarchically distanced
TABLE 3-20: Communication behaviour at the first meeting 133
In short, it can be said that a German or Swiss tries to distinguish himself positively from
others, that means he tries to present himself to be better than others. He does this by stressing
131 Zailing/Reisch, 1994, p. 10.
132 Zailing/Reisch, 1994, p. 9.
133 Zailing/Reisch, 1994, p. 9.
131

his own norms and qualifications, or even by criticising others. Through these, he presents
himself as very self-confident, competent and wealthy.
The Chinese looks at self -presentation differently. In China somebody is noticed by others
because he gets respect, he belongs to an important family, or he is a member of an influential
group or because he has the support of other people.
A potential conflict exists when the Chinese considers the Europeans’ behaviour as
embarrassing or overdone. On the other hand, the Europeans cannot stand the self-
presentation of the Chinese because they see their status gesture as ridiculous. Moreover they
feel hurt by some topics raised by the Chinese.
3.4.2.5 Negotiation process and its communication problems
There is a clear difference between the European and Chinese communication process.
Europeans are used to explain their final goal, give reasons for it and whenever possible
defend it. From their point of view, it is the business of the negotiating partner to make his
position clear and to give reasons for his target. Both partners have different goals. The final
acceptable result will be somewhere in the middle of the two positions. They reach it by
clarifying the differences, make compromises and concessions to each other. The whole
process is accompanied by relevant and logical arguments. The trick of the whole procedure is
to receive more concessions than to give.
The Chinese do not follow this strategy. For them it is not effective enough, too direct and not
very clever to show at the beginning your own goals to the partner. A Chinese wants to know
his partner first and get an idea of him so that he can assess if he is the right person to work
with. For these reasons the Chinese communication strategy does not start with the building
up of positions and clarifying divergence but starts with agreements where the negotiating
partners have a lot in common. Up to here they try to widen the spectrum of agreements. The
negotiation begins only when there is a subject where the divergence is low and the chance is
high to come to an agreement. The more delicate a subject and the bigger the differences, the
more they will postpone discussion on the subject. The reason is simple. The more time spent
on negotiations, the higher the possibility that the counterpart will agree and make
concessions. Moreover, the longer the negotiations go, the better the Chinese get to know the
partner and his strengths and weaknesses. With this strategy the goals of the Chinese appear
132

only after a certain time and even then, is made known step by step. 134 If difficulties arise
during the negotiation process and the partners do not come to a solution or when a position is
not acceptable, the Chinese leave the subject aside and go on to the next topic or change the
level of discussion. It might appear to you that Chinese wants to drag out the discussions in
order to wear down your patience gradually. In fact, the decision-making process in China is
often slower than in Europe. The Chinese wants to avoid disharmony and may require inputs
from national, provincial and local levels. 135 This interruption of the discussion does not mean,
that the Chinese is giving up. If the subject is important for them, they will come back to it
again at a later time. Chinese can be very persistent and do not just give up. German and
Swiss mana gers often have problems with this style of negotiation. They are used to discuss a
subject until they get to a result. However, Chinese often change the topic although they did
not find a solution. In their eyes a change in the discussion level helps to relax and can lead to
a better atmosphere, making it easier to make progress in the negotiation. This tactic can be
very stressful for Europeans who are determined and want to come straight to the point. It is
necessary to be patient in negotiations with the Chinese. Fierce outbursts will not earn you
any respect. Patience, flexibility and creativity are the keys in negotiating successfully in
China. Be prepared for tough negotiations. Adhere to your principles and objectives. Maintain
a quiet and dignified manner. If problems develop, you should be firm about your limits and
your willingness to work with your counterparts to find a mutually agreeable solution.
As we can see, Chinese and German or Swiss communication strategies differ considerably.
Both sides have different ideas of clever negotiation. By the respectful toughness and
persistence of the Chinese, European managers get the feeling that they want to pull the wool
over their eyes in a systematic way. However, the Chinese do have visible patterns and rules
in their communication strategy. When these patterns are recognised, it is a lot easier for
Europeans to negotiate with the Chinese. 136 It is advisable to allow your counterpart to set the
tone and level for frankness and to follow his lead. Remember, the friendlier Chinese talk
about a subject the more important it is for them. 137
134 Zailing/Reisch, 1994, p. 85.
135 Dunung, 1995, p. 116.
136 Dunung, 1995, p. 86.
137 Heiniger, 1997, p. 134.
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3.4.2.6 Yes and No
Chinese do not like to say "No" or to be the bearer of negative news. If they do not agree with
something they will hint indirectly by saying something like "It is inconvenient" or they will
raise twice an objection to a subject to show that they do not agree. 138
It is similar with "Yes". Chinese tend to response to nearly everything with "Yes". This could
be an insignificant "Yes" which means "we hear you", a "Yes" which means "we listen to
you", or a "Yes" which really means "Yes". You have to be careful with the interpretation of
the "Yes". It doesn’t always mean an agreement on the Chinese side. If you are not sure of the
meaning of the "Yes" or "No", avoid asking your counterparts directly about the meaning of
the answer. Do not ask embarrassing questions. If an answer is "No" verify it by asking a
question which can be answered positively. 139 It is important that all parties maintain "face".
The big challenge for western people means: learn to guess what has been said even though
nothing seemed to have been said. 140
3.4.2.7 Further Differences between Germany/Switzerland and China
Germany/Switzerland China
functional-objective integrated-intuitive
Analytical Synthetic
Linear non-linear
team hierarchy
refer to things refer to persons
follow principles refer to the situation
individual sense of community
direct approach indirect approach
TABLE 3-21: Manager-thinking: Comparison of Germany/ Switzerland and China 141
Further cultural differences arise with regard to business-partnership. Europeans value
control, results and equal rights. They see business as business, want to strengthen their
position and have a legal attachme nt. Chinese, however, value confidence, human attachment,
equality and process. In their eyes business is also a private matter and in a business
relationship, weakness has to be balanced. 142
138 Dunung, 1995, p. 117.
139 Dunung, 1995, p. 117.
140 Heiniger, 1997, pp. 134.
141 Chung/Sievert, 1995, p. 55.
142 Chung/Sievert, Joint Ventures, p. 56.
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3.4.3 Experiences of European Companies with Joint Ventures in China
A few years ago, when China was still an unknown area for business, not many Europeans
had ever heard anything about intercultural management, and few thought of attending a
training course. Nowadays, some western companies have quite some knowledge about China
and its culture because of their past experiences. They learned from these experiences and as a
result co-operation with a Chinese partner is much easier today. Most Western employees
who plan to go to China, attend a 3-day seminar or something similar, so that they get at least
some ideas of the Chinese culture, but there is no intensive training to prepare them
adequately.
China and its people are still relatively unknown to many Europeans but the companies have
learned to understand the culture and to adapt to it. For this reason, our interview partners
were able to give us a good idea of important factors to build up a good relationship with the
Chinese partner and to be successful in business.
Good intercultural management may not mean trying to find solutions for existing problems
between the partners, but trying to avoid them.
3.4.3.1 Interviewed Companies
Our intention was to interview companies from different industries to see if intercultural
problems come up only because of the collision of two cultures or if it is also a matter of the
industry. The following companies were interviewed:
• Bühler AG, Uzwil, Switzerland
• BASF AG, Ludwigshafen, Germany
• Daniel Swarovski Corporation AG, Feldmeilen, Switzerland
• D. Swarovski & Co., Wattens, Austria
• Georg Fischer AG, Schaffhausen, Switzerland
• Hilti Aktiengesellschaft, Schaan, Fürstentum Liechtenstein
All interviewed companies have had experiences with Joint Ventures in China for several
years. From the interviews, it is clear that intercultural problems do not depend on the
industry a company is in.
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3.4.3.2 Interviews
In the interviews, the companies were asked questions relating to 4 areas:
1. Preparation for their engagement in China, including training courses for employees;
2. Search for and evaluation of the Chinese partner;
3. Negotiation process – the problems, solutions and avoidance of problems;
4. Daily business dealings as well as some general questions relating to doing business in
China.
3.4.3.3 Important Factors
During the interviews we received a lot of information. The most important factors to avoid
intercultural problems and to build up a good relationship with the Chinese partner as well as
to be successful in business are presented in the following section.
Employees and Training
An expatriate who is representing the European part of the Joint Venture, has a very important
and meaningful function. He has a strong influence on the Chinese partner's behaviour and it
is mostly up to him as to whether the Joint Venture partners have a good relationship and
good co-operation. Therefore, the expatriate has to be highly motivated to go to China and he
needs to be very positive and feel good about this decision. It is also absolutely necessary that
he has a general interest in the country and its people. Otherwise his stay in China will
become very stressful and uncomfortable. This again would have a negative influence on his
behaviour.
Professional qualifications of an expatriate is also a prerequisite, but it is not the most
important factor in China. Much more important are social abilities. He has to be very
sensitive and needs a good feeling for people. He has to try to understand what the Chinese
are saying to him and therefore he has to be a person who listens to others. Furthermore he
needs the ability to communicate in a way that nobody is loosing “face”. A rude expatriate
who is not able to adapt to Chinese behaviours would lose his face and also his reputation.
Moreover an intercultural training course is highly recommended. One of the interviewed
companies found in their experience, that people who worked for a few weeks or months in
China and did not attend a training course had much more troubles in adopting to the Chinese
way of life. They were much more annoyed about little things and complained more than the
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ones who atte nded a course. They simply do not have a basic understanding for the different
thinking and values of the Chinese. They expect the Chinese to act like Europeans.
Joint Venture Partner
To be successful in the long run, it is essential to have the right Joint Venture partner, that is
one who is interested in a long-lasting relationship. Therefore it is not unusual for the search
for the right counterpart to take two to three years. It is easy for Chinese to impress Europeans
and to pull the wool over their eyes, because it is quite difficult for investors to check the
information a potential partner gives to them. For this reason it is important to screen each
potential partner carefully.
As a result of early export activities, most of our interviewed companies had already good
relations with China long before their Joint Venture engagement. The advantage of export
partners becoming Joint Venture partners, is that they know and trust each other before they
start their business activities in the Joint Venture.
If no relations to a Chinese company exist, you might get help from the local embassy,
business associations, consulates or of other European companies already doing business in
China. In this case it is best to choose a well established Chinese company as Joint Venture
partner. The company has already successfully built up a reputation in the market and is not
willing to lose this. Therefore, it is likely to act within a Western legal frame. Moreover, the
more similar the business philosophies of the two partners, the bigger the chance of becoming
successful Joint Venture partners in business.
Negotiation process
The negotiation process will last on the average between one and two years. This period was
mentioned by all our interview partners. It is important, that trust in the Chinese partner is a
central point for negotiations. The Chinese partner should, as already mentioned above, be
interested in a long-lasting relationship. This means, that his main target is not to make short-
term profits or misuse the Joint Venture to get access to foreign technology for his own use.
Europeans must take their counterpart serious and must have a fair attitude in order to achieve
a good and friendly negotiation climate. This means, that they have to listen and pay attention
to what their Chinese negotiation partner says. Europeans should try to find a basic
understanding of Chinese values and behaviours. They should stick to their own position and
strategy, but at the same time think also about the Chinese position. One should always
evaluate the Chinese point of view. Good relations at a personal level can help a lot.
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To achieve good personal relations, it is important to meet regularly with the potential
Chinese partners. Continuous contact via telephone, fax and le tters cannot replace the
personal face-to-face meeting. It is also important to have informal meetings besides those at
the negotiation table, such as at a Karaoke bar, at dinner, etc. This was highly recommended
by nearly all of our interview partners. One said, that you have to meet so often at an informal
level and talk about the Joint Venture, that in the end, everybody is saying the same thing and
nobody is losing face. It helps both sides to get to know each other better.
Another important factor, me ntioned by our interview partners, is that the Europeans should
adapt to Chinese’s negotiation tactics. They have to learn the way Chinese do business and
how they negotiate. This learning will take a long time, and is mainly a process of trial and
error, and can hardly be learned before going to China. A recommendation of our
interviewees on how to handle this problem is the following: "Be very flexible at the initial
stage". This sentence is a central statement. The "Letter of Intent" is only used to convince the
governmental institutions, it is not a pre-contract. Here, one can make concessions, but do not
move too far from the final goal.
Despite economic development and opening to the West, the Chinese keep their traditions.
Two main topics in this context are seniority and hierarchical thinking. This means, that the
oldest is the leader of the negotiation team and decides. There are no democratic decisions.
Because of this acceptance of authority, you have to be sure about your goal and strategy. An
example, that illustrates this point, is, that in a Chinese negotiation delegation only one person
is talking, whereas in a German or Swiss delegation, everybody is talking. Chinese are very
analytical and once they recognised that there is no common strategy in the European team,
they will try to use this to their own advantage. Therefore, negotiation meetings have to be
very well prepared for by the Europeans as the Chinese are well prepared. You have to stick
to your strategy, otherwise one single remark can turn the whole negotiation process up-side
down.
During negotiations, Chinese often switch negotiators and the subject. This is not bad at all.
Think of the following, which happened to one of our interview partners: You negotiate e.g. a
whole year without having found a single solution or common level. If now the Chinese
switch the negotiators, it can also be an advantage for you, because with the new team you
can start the discussion again, and the possibility to find a mutual solution could be much
higher.
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Another Chinese tactic is, as mentioned above, to delay decisions. Europeans should not be
too astonished if the first question on their arrival in China is for their flight back. A
preferable answer, in this case, is to say that you stay as long as the negotiations will last. One
interviewee suggested to present a shorter time table or leave the returning flight open. When
the Chinese know the return date, a typical negotiation week may look like this: First half of
the week will be spent on social activities and dinners at the evening. The "friendly banquet"
during the negotiation period is used by the Chinese to get to know the European partner
better. The second half will be general discussion and on the last day the real contract
negotiations will start. That way, Chinese try to force the foreign partner to make more
concessions and accept a less favourable contract. They know that you cannot go back home
without achieving anything.
"The end of a negotiation period is the beginning for further ne gotiations." In China, a
contract is not rigid. It can happen, that after a contract is negotiated and ready for signing, the
Chinese partner wants to discuss the subject again.
Recommendations
There is no general recipe. Nobody has a hundred per cent success formula. However, there
are some recommendations, made by our interview partners, which may help. A Joint Venture
should always be based on partnership. Win their trust and be prepared for compromises. Be
patient, reserve a lot of time and be sure that your goal is not to far away from that of your
partner. A good personal relationship is a very important success factor. Stay in regular
contact, even if there are no problems. This will show your interest. You will have the
opportunity to feel the mood of the employees of the Joint Venture. Take care of your
expatriates. You can use their knowledge of the Joint Venture and China for other employees
and the mother company. Remember, that everything is translated in China. This is one reason
why everything takes longer. In most Joint Ventures of our interview partners, the President is
Chinese, the Vice President is German or Swiss and the General Manager is German or Swiss
and the Vice General Manager is Chinese. This is because Chinese still have the hierarchical
thinking, and a Chinese President knows Chinese business better and can use his influence
and connections for the Joint Venture. The European, as General manager, can contribute the
technical and management knowledge. Hong Kong and overseas Chinese can act as
intermediates and catalysts, because they know both worlds, the Western and the Chinese one.
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3.4.3.4 Evaluation of the Interviews
Companies which stress the human factor have the biggest success in China. During our
research, we found out that companie s which have existing business relations to China,
because of former export activities, and good connections to embassies or politicians have
less problems than the others. The companies which trust their Chinese counterpart and have
no fixed framework are more successful than the others. It should always be kept in mind that
Chinese also want to make profit. Their understanding of profit differs sometimes from that of
the Europeans. Chinese are perceived as being more short-time oriented, whereas German and
Swiss companies want to establish a long-term relationship. If the European companies accept
these differences and offer the Chinese partners a significant share of profit and stay flexible,
they have less difficulties. An aspect which is important but cannot be influenced is luck.
Without it, every preparation and strategy is worthless.
It is not wise to push Chinese straight to the point. A basic understanding, achieved by
training or experience, is highly important. Using European management and negotiation
tactics will lead to a disaster. "It is not a shame to be European, and it is not a shame to make
mistakes." This statement is true, but without any intercultural sensitivity one mistake may
often to be too much.
Reading this paper helped Paul to realise a major perception problem in his relationships with
the Chinese. He just did not understand what this “Guanxi” is all about, which Mr. Zheng had
so dutifully developed for his China Venture. It is a social network involving genuine
relationships of trust, loyalty and responsibility. It has little to do with corruption or
malpractice although to the uninitiated, it may look somewhat like that. Indeed, the Chinese
were so nice to him because they were really giving him the opportunity to develop genuine
relationships (Guanxi) with them. The Chinese are not in the habit of working with someone
they do not know and without such genuine relationships. These thoughts made Paul want to
kick himself for his cultural ignorance and impatience. He should have spent some time trying
to understand his Chinese partners and venture, not just the superficial business and financial
aspects, but more the social relationship aspects on which the venture is grounded.
Paul turned to the final paper on post-entry strategic considerations.
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4. Post-Entry Strategic Considerations
The problem of a China Venture not working well or even stumbling after a successful entry
is a very real problem. Many companies made the mistake of leaving their China Venture to
less experienced managers once it has been successfully set up. Most simply did not realise
the volatility of the ever changing environment and how fast such environmental changes
would demand a re-positioning of their business ventures in China. Clearly, such an
environment is also alien to Paul. He did not realise the dynamics of this environment when
Mr. Zheng was running the business. He did not realise it when he took over the running of
the business. He finally began to realise the problem as he read on in a paper by Klaus
Kukovetz...
4.1 Post-entry Considerations: Need for Re-evaluation and Re-positioning (by
Klaus Kukovetz)
4.1.1 Introduction
The Chinese business environment is characterised by high GDP growth rates and therefore a
fast changing business environment. The regulatory environment is also only emerging, which
makes rapid changes in the political and judicial system possible. Because of its geographical
and cultural distance to Europe, the inner workings of the country, reasons and speed of
change, etc. are often diffic ult to understand for foreign companies.
For all of these reasons, a strategy for the Chinese market has to be flexibly applied according
to changes in the underlying variables. To be able to react in a timely and appropriate way, a
company will need to establish reliable feedback loops to channel information from the field
back to the headquarters.
Information sources for such feedback loops should be plentiful and extend to sources outside
one’s own organisation. Often, managers in the local subsidiary will be biased about specific
bits of information. Censorship might come only too naturally to managers in China. For this
reason, a broad net of business contacts with people, companies, and other organisations
focused on China will be very useful. Such a w eb of inside and outside sources of information
and feedback will provide a better basis for sound decisions.
In addition, a system of constant re-evaluation should be built up, which should be designed
to compare planned developments from actual trends. Not all disparities between plan and
reality are reasons for concern or should initiate structural changes. Due to the unreliability of
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much business data in China and the speed of change and development in the environment.
There, many plans will prove inadequate and unable to reflect actual developments. In this
respect, a large pool of applicable and reliable information from efficient sources will be
particularly helpful, as it helps to differentiate between discrepancies caused by slower
development of an otherwise well designed business and those caused by operational or
strategy related flaws of the company.
An organisational structure for gathering information and feedback together with processes to
periodically re-evaluate the business, should form the basis for post-entry strategic success.
However, these structures and processes can only be utilised to their fullest if they go hand in
hand with the will, determination, and power to actively reposition the Chinese business if
necessary.
The will and determination will have to be achieved by appropriate internal monitoring and
management processes. The power to do so, however, is often won or lost during the initial
phase of negotiations with one’s partners. If the joint venture partner has a significant share in
the ownership of the project, strategic change may be very difficult to achieve. This may
result, as the examples below will show, in outright failure of the whole project and total loss
of the investment. For this reason, the possibility for significant strategic repositioning needs
to be taken into account already in the business formation phase.
The need to reposition one's activities will be larger in China than in a more stable business
environment. The challenges faced in trying to achieve such goals may easily be
underestimated. The following examples and case-studies will show how the need for re-
evaluation and repositioning can arise in reality. Some of the dire consequences of the lack of
planning for exit strategies can surely be avoid ed by openly discussing and accounting for
various developments that might make strategic change necessary.
4.1.2 Case studies
4.1.2.1 Luxury goods company in China (LGC)
LGC is a family owned company supplying highly priced fashion jewellery to a world market.
With around 9200 employees the company generates a turnover of around 1.4 billion CHF. It
operates globally with more than 70 group companies, most of which are sales offices. By the
early 1990s, the company operated two production facilities in Asia. One of them in Thailand
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and the other one in China. The company organised its Asian activities through sales offices
in China, Hong Kong, Indonesia, Japan, Singapore, Taiwan and Thailand.
LGC started the process of building up its joint venture in China already in the mid 1980s. By
doing so it could draw on the 25 years long experience of its Hong Kong office. 50 per cent of
the joint venture was owned by LGC, the rest by two Chinese partners, one of them a
government agency.
The company encountered little problems in starting up production and it also managed to
achieve its goal to stimulate the development of a local fashion industry that would use some
of LGC's core products as raw materials. There were no quality problems with the products as
export goals could be easily met.
However, internal sales did not develop according to plan. The partner company did not meet
LGC's expectations as far as distribution and logistics was concerned. Also, the partner did
not offer the expected network of contacts to relevant business partners. Managerial problems
were caused by a lack of co-operation between the foreign and local partners. Managers
appointed by the Chinese side tried to short cut decision making by LGC's general manager.
This resulted in bad business decisions, among which was the hiring of inappropriate staff.
Internal problems of the company were further worsened by a market which initially proved
smaller than forecast, by problems in exporting to other regions, and by a quickly emerging
competitive environment. Competitors soon managed to offer similar products, albeit at lower
quality, at much cheaper prices.
These trends did not escape the attention of the managers at LGC's headquarters. For a long
time they tried to mend the problems within the existing organisational structure but had
finally realised that a complete re-evaluation and repositioning of the company's activities in
China was necessary.
For this purpose, the management formed a team of specialist at the European headquarters.
This group could draw on information from within China, within the region, most notably
from its regional office in Hong Kong, as well as from outside sources. LGC attributed
enough attention to this repositioning process to invite professional, as well as semi-
professional consultants to join their efforts to reposition the company's strategies. 143
143 One of these groups of outside advisors was headed by the author together with a fellow
researcher, Reza Rahimi. The team also included nine graduate students of the University of St.
Gallen, Switzerland.
143

During the many years of trying to fix problems internally without the means nor will to
enforce major changes, the business environment in China had also changed so dramatically
that LGC had to restart planning from base zero. This meant that after around ten years of
doing business in China with a largely unchanged organisational structure which did not
perform satisfactorily, the company preferred to plan a completely new market entrance rather
than trying to build on its existing organisation. Knowing that the joint venture agreement was
too rigid to allow for major changes, LGC was willing to forfeit most of its investments in the
existing company.
LGC considered its many years of operations in China as a valuable - if costly - learning
phase, which helped the company to now plan a new market entry with a more suitable and
flexible structure. In doing so, LGC developed an aggressive plan of quick market
penetration, which would inte grate all the company's relevant business units. Instead of trying
to accommodate this new strategy with existing structures, it opted to write -off its investments
up to date to avoid further delays in re-structuring and repositioning.
The example of LGC shows clearly that in a fast changing, unstable and very risky business
environment, flexibility is a core virtue. Flexibility to significantly change a company's
strategy in a target market may, however, be forfeited very early on in the market entry
process. In LGC's example, the joint venture agreement did not only suffer from operational
problems but it also made a swift and decisive change in goals, structures and operations
impossible. Realising the need for possible restructuring and repositioning in the future even
before start up is very important and should therefore be taken into considerations in the early
phases of strategic planning for market entry.
4.1.2.2 Consumer goods company in China (CGC) 144
CGC is a continental European SME with around 1000 employees and 150 million CHF
turnover. It produces goods in a variety of industries. Its core competence is coffee roasting
and the manufacture of various coffee-based drinks. Coffee is also the strategic business unit
which CGC chose for market entry into China.
Prior to its market entrance, CGC had gathered some relevant experience through its
marketing of speciality coffee products in Japan. The company had not, however, had any
144 The research for this case study was undertaken by the author in 1997.
144

experience in operating production facilities outside Europe before it entered into joint
venture negotiations in China.
Planning for the foundation of a production joint venture started in 1993 and progressed
rapidly, even though CGC's management did not have any relevant experience of doing
business or negotiating in China. The goals of the company were straight forward. It wanted
to penetrate the market quickly, starting with sales in China's most promising city, Shanghai.
Plans were short-term with expectations of breaking even in the second year of operations.
During the planning and build up phase, no consideration was given to the eventuality of a
failure. No exit strategy was therefore discussed.
The company decided quickly to enter the market via a joint venture agreement with a local
partner. Negotiations were swift as both partners wanted to start doing business quickly. The
contract was considered very favourable to CGC, giving it 60% of voting rights, as well as
management authority. The partner, a state -owned business, contributed land and buildings.
During the negotiations the partner had insisted that the joint venture would take on people
from the partner company if they had appropriate experience for their new jobs.
The newly formed joint venture company achieved a satisfactory product quality very quickly
through the utilisation of European machinery. Even more successful were the marketing
efforts of the company. According to their own estimation, CGC achieved a brand recognition
rate in Shanghai of over 90% within two years of operation.
These marketing efforts and successes, however, were not mirrored in similarly impressive
sales figures. This was mainly true because distribution did not work at all. Like what
happened to so many other foreign companies, CGC's partner did not live up to expectations.
At the beginning, the joint venture company relied mostly on the partner's distribution
channels which proved to be so inadequate, that demand could not even be met in the city of
Shanghai. Further expansion to other regions seemed completely beyond the capability of the
company.
Apart from distribution, the company also faced major cost problems. Production turned out
to be much more expensive than originally planned. Personnel costs were much higher than
forecast. The reason for the high personnel costs could be traced bac k to the hiring of too
many and too inefficient workers from the partner company. CGC hoped that changing the
general manager, who had the ultimate authority over hiring people, would cure the problem.
However, the partner company continued to exert pressure on the new general manager to hire
more and more employees.
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The apparent policy of the partner company to channel workers to the joint venture affected
also for the distribution system as the partner would sabotage the initially successful efforts to
outsource distribution to a third party.
Problems like these are reported by many companies operating in China. Many of these
problems will not be totally avoidable. It is crucial, however, how a company can react in face
of such problems and challenges.
CGC's management was well aware of the problems at an early stage on. After the initial
phase of joint venture foundation was completed, the management's interest in their China
project did not diminish. This was due to the significance of the venture for the relatively
small and internationally inexperienced company. For this reason as well as the short term
goals of the joint venture, CGC realised very early on that a re -evaluation and subsequent
repositioning of the joint venture was necessary.
There were enough ideas for such a repositioning, ranging from a stop to new employees, to
the outsourcing of distribution. The company had also hoped that its contract, capital
majority, and management authority would allow it to alter operational strategy relatively
easily. CGC had to realise, however, that a repositioning within the current structure could not
be achieved. It had not talked with its partner about eventualities that would make massive
changes of the operations of the company necessary. More importantly, CGC realised only
later on that there existed a mismatch of goals between the foreign and Chinese partner, who
seemed to be mostly concerned with cutting down its own work force.
Therefore, any drive for change met with fierce opposition. Combined with a certain lack of
understanding of local procedures, the working climate deteriorated massively, until CGC had
to realise that the venture had failed entirely. CGC ultimately had lost all of its capital.
Just as in the case of LGC, also CGC failed to provide for the possibility of massive
restructuring and repositioning in the early phases of market entry planning. In their
evaluation of market entry methods, both companies did not give enough weight to the
flexibility that a wholly owned, or de -facto wholly owned company would provide for the
foreign investor. Both companies might have chosen a joint venture agreement even if they
had taken such possibilities into consideration. But by ignoring the possibility of the necessity
of major changes in operational and strategic direction, the companies did not plan their
market entrance in an optimal way.
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In these two cases, the companies may well have never had a fair chance to succeed. It is
possible, however, to learn from these two case studies that complete failure of one's
investment projects might be avoidable through the creation of a very flexible organisational
structure. This could either be achieved alone or with one’s partners. In the latter case, a
potential investor would have to evaluate in an early stage of the planning process, the
reaction of the partner to significant strategic changes due to problems or massive variations
in the competitive environment. It can be concluded that post-entry considerations must be
taken into consideration during the early stages of market entry planning.
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Epilogue
Finally, Paul has finished reading the set of China papers. There is little doubt that China is
not too perplexing anymore. Indeed, his China Venture has succeeded under Mr. Zheng
because Mr. Zheng knew his business well and the operating environment in China well. He
also knew his partners and business collaborators well enough to know how to set up and
maintain a long term mutually beneficial relationship with them. He wished he had not let Mr.
Zheng go.
As Paul sat and pondered about his China Venture, he could envisage how he too would have
succeeded without Mr. Zheng. There is so much more that could have been done. After all, he
certainly was lucky to have so many former business partners who have proved their
reliability through past dealings. This is a far cry from the many often heard complaints of
foreign businessmen in China. He had the right contacts and yet, he seemed to have lost them
all. He wished he had read these papers earlier, but then it may still not be too late. Should he
not go back to China and try to revive his China Venture? Will his former partners and
collaborators in China accept him again? Can he start again? These questions continued to
occupy his mind as he slumped on his easy chair and fell deep asleep.
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5. References
Aharoni, Y. (1966):
The Foreign Investment Decision Approach. Boston, Mass., Graduate School of Business
Administration, Harvard University.
Alexander, G. / Sharpe, W. / Bailey, J. (1993):
Fundamentals of Investments , Englewood Cliffs.
Angang, Hu (1995):
China’s Environmental Issues. In: Harris, Stuart/Klintworth, Gary (1995):China as a Great
Power. Myths, Realities and Challenges in the Asia -Pacific Region.St. Martin’s Press, New
York.
Arthur Andersen (Ed.) (1996):
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6. Appendix
6.1 Fact Sheet People’s Republic of China 145
Capital: Beijing
Population: 1.22 bn
Regions: 22 provinces; 3 municipalities (Beijing, Shanghai and Tianjin);
5 autonomous regions (Guanxi, Inner Mongolia, Ningxia,
Xinjiang and Tibet)
Key Cities: Shanghai (13m), Beijing (10.7m), Chengdu (9.7m), Tianjin
(8.9m)
Ethnic Groups: Han (91.96%), Zhuang (1.37%), Manchu (0.87%)
Religions: Daoism (Taoism), Buddhism, Muslim 2%-3%, Christian 1%;
officially atheist, but traditionally pragmatic and eclectic
Languages: Mandarin and various dialects
Land Area: 9'562'000 square kilometers; arable land: 10%
145 Compare: http://www.odci.gov/cia/publications/factbook/ch.html and Business Monitor International,
China & North Asia, No 8, August 1998.
159

Natural resources: coal, iron ore, petroleum, mercury, tin, tungsten, antimony,
manganese, molybdenum, vanadium, magnetite, aluminum,
lead, zinc, uranium, hydropower potential (world's largest)
GDP: consumption by sector: Agriculture 20%, Industry 49%,
Services 31%
GDP: real growth rate: 1995: 10.5%, 1996:9.7%, 1997: 8.5%, 1998:
7.8%
Consumer price inflation: 1995: 101%, 1996: 6.8%, 1997: 3% (est.)
160