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Establishing the right presence

Given China’s sheer size, complex and changing business environment, as well as culture and language barriers, it is not an easy market to enter and exit with a quick win. To succeed in China requires careful business planning and execution. Foreign companies need to take time to build up their business network and credentials and to demonstrate their commitment. Often this requires some sort of presence in the marketplace, whether directly through your own business operation, or indirectly, working through a strategic partnership such as an agent or distributor.

 

Agents and distributors

An agent is a company’s direct representative in a market and is paid commission, while a distributor sells products on to customers after buying them from the manufacturer – their income comes from the profits they make on the difference.

Market entry through working with an agent or distributor can have several advantages, such as reducing time and costs to market entry as well as gaining the local knowledge and network of the agent.

However, there are some drawbacks to this approach. Employing a third party results in an additional cost to your products and you may also lose some control and visibility over sales/ marketing. It also has implications for intellectual property rights protection, increasing the risk of your product being copied or counterfeited.

Given the above considerations, companies need to select agents and distributors carefully. Some of the frequently asked questions are in the following checklist. You should also conduct due diligence to verify this information:

  • Background

    • Company size, history and ownership (private or state owned)

    • Quality and quantity of the sales force

    • Customer feedback and trade/bank references

 

  • Distribution channels

    • Regional coverage

    • Types of outlets covered and frequency of calling

    • Transportation and warehousing facilities

 

  • Are they right for you?

    • Does the agent/distributor have a genuine interest in representing your product?

    • Can they benefit from actively promoting your interests (is it a win-win)?

    • Do they also represent any competing companies/products?

    • Can you communicate effectively with your counterpart?

Once a working relationship is established, the agent/distributor needs to be managed actively; this may be achieved by the following:

  • Visiting as regularly as is practicable at a senior management level – this shows interest in, and commitment to, the agent and the market. This will also provide you with an opportunity to learn about conditions in the market and see how your products are faring.

  • Working closely with the agent to show them how they can profit from your products.

  • Helping to prepare marketing and sales plans for the agent.

  • Provide regular training for the sales staff and after-sales training for the technical staff in the UK.

  • Linking performance to incentives and agreeing milestone targets.

 

Exporting Directly to Retailers

British exporters can alternatively send their products directly to retailers without distribution partners in China. However, goods can only be imported through a company that has an import/export license under Chinese laws. Only the biggest retailers tend to have the relevant licences; hence, other companies must use a licensed intermediary.

Exporting directly not only makes it possible to generate better margins, it is also an opportunity to more closely understand the retail system in China and receive feedback on sales volumes and consumer preferences. However, it may be difficult to justify logistical and freight costs to retailers unless large volumes are guaranteed. Even if a company decides not to export directly to retailers, CBBC recommends that companies should schedule meetings with retailers when they visit China. This can increase interest in your products via product introductions, which can later be harnessed by your local business partners and representatives.

 

Exporting Via UK-Based Consolidators/Exporters

Another option for any UK business can be to use a British or European Consolidation company, who can handle the exports for you from the UK. This option may seem to be the most straightforward, but the non-Chinese consolidator will often either lack the know-how for the Chinese market and/or need to use local agents and distributors in China anyway, which will increase costs. It will also become difficult to control customer relationships, or your pricing and brand image in China.

 

Using your Own Distribution Network

This option gives you full control over logistics, branding, marketing and customer relationships, but it is an expensive option, usually only open to the big players.

 

E-Commerce

E-commerce is rapidly growing in China, with 240 million e-shoppers. It is an attractive option to those with little experience of China, who wish to test their product with Chinese customers before entering the market through other means.

Chinese consumers are less familiar with international e-commerce websites and many do not understand English or use international credit cards. Some Chinese platforms do not require a company to be registered in China to sell products on their website, allowing easy purchase by Chinese consumers.

However, using e-commerce without a presence in China can have complications in the order process, local logistics and after-sales services, which may necessitate extra Chinese partners for delivery. See the e-commerce section later in this guide, which provides a more complete introduction to e-commerce in China.

 

Licensing and Franchising

Licensing and franchising (which have strong similarities in China) can be appealing business models for international brands seeking to expand their Chinese activities. The franchiser, who owns the enterprise, lends their trademark and/or business model to the franchisee, who often pays initial and royalty fees for this right. Franchisers are normally involved in initial training, site approval, branding and advertising. It is sometimes the case that brands will only license certain categories to the franchisee, allowing them to use designs and produce and/or distribute products under their trademark.

Fashion retailers have been among the most prevalent users of franchising. It is relatively low-cost, low-risk and can be a quick way to test consumer demand in an unfamiliar and complicated market like China.

There are brand management specialist companies that are active in franchising, especially in the fashion sector. These companies generally demand exclusive sales rights in the Chinese market in order to secure a return for financial investment.

A major concern for franchisers is the lack of control involved, especially if they value brand identity and customer experience as key factors. There may also be problems due to the franchisee’s relative lack of capital, their business ambition and vision and even protection of Intellectual Property. Increasingly, several international brands that initially used the franchising model to enter the market have changed their business model to become Wholly Foreign-Owned Enterprises (WFOEs).

 

Business Incubator Services

If business trips are proving to be financially onerous or time-consuming, there are other methods to have someone represent you in China without incorporating a company locally. A medium-term option is to use a business incubator service; this allows you to have a year-round representative on the ground.

Establishing a presence through the CBBC Launchpad scheme

Launchpad provides a simple, cost-effective, low-risk and legal means of having a presence in China before you set up your own office there.

CBBC members can have their own representative working for them in China, with their own space in one of CBBC’s 13 offices. This is a fast and cost-effective way of enabling companies to test the local market before committing to a permanent presence.

More details of this service can be found on the CBBC website: www.cbbc.org


Establishing a permanent presence

Although it is possible to be represented through agents or distributors, many foreign companies progress to the establishment of a permanent presence in China, as their experience and confidence grow. When confidence in the Chinese market reaches a sufficient level, you may consider setting up a permanent presence in China via a Foreign Invested Enterprise (FIE). Having a permanent presence in-market can provide several possible benefits, including:

  • Market presence – showing commitment

  • Quick and direct access to customers and/or distributors

  • Direct control over corporate strategy and activities

  • Enables trading in local currency and eases the conduct of business transactions

  • Trading in the Chinese currency Renminbi (RMB), which eases business transactions

  • Total control over brand image and distribution in China

There are a number of structures that allow foreign invested enterprises (FIEs) to conduct various business activities. These include representative offices, joint ventures, wholly foreign-owned enterprises, and foreign invested commercial enterprises. Each of these structures has unique advantages, restrictions and drawbacks, and it is essential to choose the option best suited to your business aims.

The rules and regulations regarding foreign direct investment and FIEs have evolved gradually since China began opening up to foreign business activities. Since China’s accession to the World Trade Organisation there have been a number of amendments to regulations, easing market entry for international companies across a range of sectors.

Companies that desire a permanent presence have to set up operations as an appropriate legal entity, depending on the intended business scope, and be compliant with Chinese legal and tax requirements. Under current regulations, foreign companies cannot legally employ Chinese staff unless the company is registered in China. Therefore, if you are ready to make a long-term commitment, the establishment of your own legal presence is the way to go.

However, it is usually more difficult to alter a business structure once a legal entity is incorporated or established, so it is vitally important to seek professional advice on your investment structure during the early stages of planning. You must fully understand your intended business activities in China (for the short and long term), whether they are practicable, any legal and sector barriers to entry, and in turn what the suitable vehicle is for you.

UK Trade & Investment and the China-Britain Business Council can offer dedicated one-to-one consulting and incorporation services to assist UK companies establishing various kinds of permanent presence in China. Please contact one of their offices for more details – see the “Contacts” section of this guide.

 

Model 1: Representative offices
Representative offices (rep offices) are the first step taken by some foreign companies when establishing a permanent presence in China. They are officially liaison offices, and as such they cannot generate income through contracts, tax receipts, invoices or sales activities, but instead are useful for activities such as market research, public and business relations and support. Visiting visas can be obtained more easily through ‘business visits to rep offices’, but only four working visas for foreign staff can be obtained, while all local staff must be hired through a government-approved agency.

This is the least complicated method for a foreign firm to have a legal presence in China and was, at one time, the first choice for foreign companies with little experience in the country. However, due to the limited operational scope mentioned above, WFOEs are typically a better option for entrants seeking to develop their business in the long term in China.

Model 2: Joint Ventures
A joint venture (JV) is an organisation jointly owned by both Chinese and foreign partners. A JV can be formed by way of equity contribution based on each party’s monetary contribution (‘Equity JVs’) or by contractual agreement (‘Cooperative JVs’).

In certain restricted sectors, such as insurance and the automotive industry, JVs are currently the only permitted route for international companies in China.

However, JVs are now becoming less prevalent as Chinese economic reform has gradually opened up new industries to WFOEs. International companies often prefer the autonomy and flexibility that is afforded to them through WFOEs, despite the full business ownership risk.

However, JVs may be beneficial in various ways. Local partners can contribute market knowledge and strong marketing and distribution channels and they may help reduce the costs and risk of market entry.

The common risks associated with entering into partnerships with other companies apply in China and are often exacerbated by cultural differences and business practices. Hence, the right partnership is essential in establishing and running a successful JV. The ability to maintain effective communication, and control where necessary, is also crucial.

It is important that you carry out corporate and financial due diligence before signing up to any partnership. JVs should only be created when both parties have a clear understanding of the business objectives and when appropriate exit strategies have been developed.

Model 3: Wholly foreign-owned enterprises (WFOE)
Wholly Foreign-owned Enterprises (WFOEs) are Chinese-incorporated companies that are fully owned by foreign organisations. They are currently the most popular option for foreign enterprises, as they provide complete control and full profit from operations, alongside limited liability. WFOEs also generally provide greater protection to intellectual property rights compared to JVs and can directly employ local staff, unlike rep offices. However, they do have a minimum investment requirement that is dependent upon the locality and nature of the business.

WFOEs are the appropriate structure for companies whose main activities in China are to manufacture and sell products, or provide services such as R&D or business consulting. A WFOE allows the foreign investor to issue invoices and receive revenues in RMB that can then be converted and repatriated outside of China.

Incorporating in China

In the UK, incorporating a company takes a few days, whereas in China it may take several months and involves a complex process through which the foreign investor must obtain various approvals. Foreign companies will likely require professional support on aspects of business incorporation, including tax planning, legal advice and project management. Foreign companies are required to use a government-certified ‘Filing Agent’ in some regions of China during this process.

CBBC provides detailed guidance on various issues regarding business incorporation in China and offers a managed incorporation service. There are also many professional service firms in the private sector that can help with this process.

 

Mergers and Acquisitions

M&As have become increasingly popular in recent years for foreign investors. There are numerous options for M&A in China, including equity and asset acquisitions as well as mergers. As a form of FDI, the general rules on the establishment of Foreign-Invested Enterprises (FIEs) also apply to M&As.

Source: UKTI and CBBC

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