CHINA ESQUIRE

Review time again as usual. Most interesting business article for the week comes from Seeking Alpha entitled “Progress or Pipe Dreams? Private Equity / Venture Capital in China.” ( h/t to China Law Blog) Well, its not really an article: it is a panel discussion from some people who know the industry better than most others. Here is what Dan Harris at China Law Blog said:

Project Alpha just posted the transcript from a very enlightening panel discussion on private equity/venture capital in China. The discussion was at JP Morgan’s recent China conference in Beijing. I attended this discussion and found it very informative.

Shaun Rein (Managing Director, China Market Research Group) did an excellent job moderating the discussion between Robert Theleen (CEO, ChinaVest); Joel Kellman (Managing Partner, Granite Global Ventures), and Brandon Lin (Partner, SAIF Partners).

If Dan thinks its a must-read, it probably is. Here are some excerpts I found interesting from the discussion:

Bob Theleen: At local, municipal and regional level, government is very much supportive of the PE industry. At national level things become more complex for the reasons you mention.

On the other hand the contradiction is there is not a mayor or a governor that I have ever met that does not say, my city needs capital; it needs growth capital and I want to support local entrepreneurs. Since the covenant of Beijing with regional government is you are more on your own, that regional government has to fend for itself. I think you will find that contradiction, that Beijing has to accommodate local government and it has to accommodate and support the PE industry, but how do you separate that out from issues like controlling the aggregate capital in a high-inflation market? That is a problem that China faces.

* * *

Shaun Rein: Is it hard right now for entrepreneurs to get capital?

Bob Theleen: I think it is very hard. It is harder because of credit tightening.

The good news is that our regional city banks are providing more and more debt. The aggregate savings of China, pools of RMB are accessible today through trust companies, through other financing sources. But that is an important component of making all of those kinds of business strategies effective.

Good stuff and worth a read. It reads pretty quickly.

CNN World Business ran an article this past week that states that food exports have dropped by 30% to Japan, which is a key market for Chinese food products.  I am not sure that I actually feel too badly for China in this case, but let me explain after the article:

China’s food exports to Japan, a key market, plunged 30 percent in February, hurt by a scare over poisoned Chinese-made dumplings, according to data reported Friday.

Japan is the third-largest market for Chinese exporters of fish, dumplings and other processed food, and the drop in sales is a severe blow to the fast-growing industry.

China’s food exports to Japan in February totaled 186,000 tons, down 30 percent from the same month in 2007, the General Administration of Customs reported.

Exports from Shandong, the eastern province that is the base for food processors serving Japan, fell 60 percent, the official Xinhua News Agency said.

“Influenced by such things as the `poisoned dumpling incident,’ our country’s food exports to Japan fell one after the other,” said a customs agency statement.

Chinese-made dumplings were pulled from Japanese supermarkets in December after traces of a banned insecticide were found in the dumplings and in the vomit of people who fell ill after eating them.

Bad Chinese products are nothing new.  And it is not all too surprising considering that China is become the world’s manufacturer, not just America’s sourcing base.  And as expected, there are issues of quality fade, lack of quality control, and lack of repeat due diligence.  So sometimes I actually think its a miracle that there aren’t more Chinese products issues on a regular basis.  Thankfully, most issues are not lethal, like the glycerin that Panama bought some time back for cough syrup.

But why do I say that China has no one to blame but itself?  Because it often takes the stance that it’s importing country’s responsibility to check out product issues, not the exporter’s.  The Chinese SFDA did that when it came with pharmaceuticals here (and I covered this topic in this post):

But the SFDA said that based on international practice, “safeguarding the legality, safety and quality of raw materials imported for use in pharmaceuticals is the responsibility of the importing country.”

This was the official policy regarding pharmaceuticals, so I know it’s not quite the same thing.  But it is my belief that this has been China’s stance toward food and other exported products as well.  Here was China’s response:

Chinese authorities say their investigation has found the poisoning probably was an isolated, deliberate case. They say there is little chance it happened in China and have accused Japanese police of failing to cooperate with them.

Sure, but if China is trying to implement domestic food safety standards, then it must know that there are food export issues as well.  As long as the government refuses to tackle this issue head on, and expend some serious capital and resources to deal with it, then China really has no one to blame if Japan or other countries decide to start consuming less food products from China.  That’s pretty logical actually.  And I am not trying to be cruel.  In the end, China can only blame itself if the market for Chinese exports, particularly food exports, drops.

This is a good opportunity for the government to get involved in regulating its exports.  It doesn’t need to massively regulate.  But more regulation, though costly, will be welcome.  And ultimately, it may cost China less if other countries can learn to trust Chinese exports again.

The Los Angeles Times recently published an article entitled “Chinese Firms Bargain Hunting in U.S.” ( h/t to CDT).  Ironically, I had just posted an article recently about western companies going into China because the U.S. economy was faltering.  ( here)  And while I had also written about China’s growing economic muscle ( here), the LA Times article puts two and two together: Chinese companies are setting up shop in the U.S. because it is actually cheaper or almost cheaper to set up shop here.  Scary thought.  But the more the west goes to China and drives up costs (particularly raw materials and HR costs), the more that China might be tempted to bring more of that capital here.

Here are excerpts of the article:

Liu Keli couldn’t tell you much about South Carolina, not even where it is in the United States. It’s as obscure to him as his home region, Shanxi province, is to most Americans.

But Liu is investing $10 million in the Palmetto State, building a printing-plate factory that will open this fall and hire 120 workers. His main aim is to tap the large American market, but when his finance staff penciled out the costs, he was stunned to learn how they compared with those in China.

Liu spent about $500,000 for seven acres in Spartanburg — less than one-fourth what it would cost to buy the same amount of land in Dongguan, a city in southeast China where he runs three plants. U.S. electricity rates are about 75% lower, and in South Carolina, Liu doesn’t have to put up with frequent blackouts.

About the only major thing that’s more expensive in Spartanburg is labor. Liu is looking to offer $12 to $13 an hour there, versus about $2 an hour in Dongguan, not including room and board. But Liu expects to offset some of the higher labor costs with a payroll tax credit of $1,500 per employee from South Carolina.

Liu is part of a growing wave of Chinese entrepreneurs expanding into the U.S. From Spartanburg to Los Angeles they are building factories, buying companies and investing in business and real estate.

For years, investment between the U.S. and China flowed one way, with American firms spending billions in the Asian nation. But the Beijing government’s $5-billion stake in Morgan Stanley and $3-billion investment in the private equity firm Blackstone Group brought China’s overall investments in U.S. firms to $9.8 billion in 2007, up from $36 million the year before, according to Thomson Financial.

“It’s a lot of pressure going to the largest market in the world,” Liu said. But he thinks it’s certain to help his business become more competitive. “That’s one of the real benefits from this expansion.”

(emphasis added in bold)  We all know that the dollar has been weakening and that international players are finding bargains here.  It’s just an interesting surprise to discover its not just the CNOOC’s and the Blackstone’s that are coming to the west–it’s even smaller Chinese operations quietly coming in. It isn’t terribly surprising once I think about it a little–because it does make a lot of sense.  It’s just that I wouldn’t normally put two and two together in this sort of way.

What does this mean for corporate attorneys?  Or more specifically, for U.S. corporate attorneys?  The large M&A market is sputtering in the U.S. according to a recent article in the Recorder.  ( here, subscription required)  However, the mid-level deals are still alive and kicking according to the article.  These Chinese businessmen bringing business to the U.S. will be mid-level deals at best.  And more likely, need corporate attorneys who can help them set up shop: entity formation, real estate transactions, employment agreements.  In other words, basic corporate lawyers.  This is a bit of good news in a rather slow economy.

And for those M&A, LBO, and structured finance folks who are out of work with the spate of layoffs, maybe its a good time to do entity formation work.  Here’s a start for retraining:

whither the c-corp, s-corp, llc, lp, etc.?

Maybe I will get around to doing that analysis of different U.S. corporate entity types once my work slows down.

CNN Money ran an article the other day with a title that made me want to read it: “You Have 7 Years to Learn Mandarin”. Oh really? Why so you might ask? My original thinking is because the Chinese business (and therefore legal) market would become too saturated with ex-pats and half-pats to break in. I was wrong. Instead, the article talks about a prediction that China will be the world’s economic superpower by… 2015. 2015? You got to be joking. But that’s what CNN is peddling to an unsuspecting public:

Back in 2001 when the International Olympic Committee chose Beijing as the site of this summer’s games, the event was meant to mark China’s debut as a player on the global economic stage. But a recent study by the economist Angus Maddison projects that China will become the world’s dominant economic superpower much sooner than expected - not in 2050, but in 2015.

While short-term investors are already cashing in on China’s growth by playing the global commodities boom, smart long-term thinkers are contemplating what happens when China matures from an exporter of cheap goods to a competitor in sectors where the U.S. is dominant - technology, brand building, finance. China has almost wiped U.S. makers of low-value items like toys and socks, but by 2015 it may threaten Apple (AAPL, Fortune 500), J.P. Morgan Chase (JPM, Fortune 500), and Procter & Gamble (PG, Fortune 500). It will increasingly influence the S&P 500 and the mutual funds in our 401(k)s. So it’s worth looking at how that will happen, what it means, and what anyone can do in the seven years before the baton is passed.

Just using the exchange rate to convert China’s GDP into dollars isn’t helpful in comparing the two economies, because China controls its exchange rate; by that method, China’s economy might not pass America’s for decades. Exchange rates apply only to tradable products and services; they aren’t very useful in valuing nontradable goods in a country like China that is much poorer than the United States. So we need some way to compare the real value of China’s economic output with America’s, and economists have developed one. It is called purchasing power parity.

Angus Maddison’s forecast (which uses purchasing power parity) isn’t built on outlandish assumptions. He assumes China’s growth will slow way down year by year, and America’s will average about 2.6% annually, which seems reasonable. But because China has grown so stupendously during the past decade, it should still be able to take the crown in just seven more years.

If that happens, America will close out a 125-year run as the No. 1 economy. We assumed the title in 1890 from - guess who. Britain? France? No. The world’s largest economy until 1890 was China’s. That’s why Maddison says he expects China to “resume its natural role as the world’s largest economy by 2015.” That scenario makes sense.

China was the largest economy for centuries because everyone had the same type of economy - subsistence - and so the country with the most people would be economically biggest. Then the Industrial Revolution sent the West on a more prosperous path. Now the world is returning to a common economy, this time technology- and information-based, so once again population triumphs.

Where do I even begin? I think the 2015 number is built on a number that heavily favors anyone who wants to make grand declarations about China catching up quickly. In fact, last I remember, when Rich Brubaker at All Roads posted that China would catch up by 2028, we all took that number with quite a bit of skepticism. Sure, you can choose one particular figure to represent your claim? But this sort of economics… well, it seems more sensationalistic to me than realistic. Nor will it reflect reality. I doubt in 7 years that value-added industries, the service professions, will be ceded over to China. Hardly–that’s exactly what the U.S., EU, and other Asian Tigers will try to specialize in. So I think the 2015 stats were more shock value than anything else.

I also doubt that China have companies that can play along to the tune of Apple or JP Morgan. Or even Samsung. Not that China doesn’t have some successful companies, or some that have catchet like Lenovo. (okay, Lenovo didn’t have it… they bought it from IBM when they took over the Thinkpad series, which had serious cachet) The Chinese economy isn’t built on innovation and product advancement in the same way that other economies are. The educational system doesn’t embrace such thinking yet. So I doubt that we’ll see that. We will see SOE’s flexing their muscles more. I expect that. But I really don’t think a Chinese computer company will over take Apple in terms of computer and culture maker. Not by 2015.

The global economy is not a subsistence economy. It’s different. It’s more like a pyramid scheme in terms of value added industries. There is a reason why the west dominates in consulting still–because white collar professions, which are services and about “value”, have existed far longer there than in China. And it will be that pyramid for some time still, I am not saying that the Chinese services industry and other higher food chain type businesses won’t evolve. They will. They just won’t overtake the world by 2015.

I think that’s where the conclusion of the CNN Money article is going:

For companies: Focus on getting better at your highest-value activities. Just because the Chinese will be fighting you in the same industries doesn’t mean you’ll lose.

For individuals: You can avoid competition with Chinese workers by doing place-based work, which ranges in value from highly skilled (emergency-room surgery) to menial (pouring concrete). But the many people who do information-based work, which is most subject to competition, will have to get dramatically better to be worth what they cost.

I agree with the advice for companies. It’s a global food chain or pyramid more than a subsistence economy. I disagree slightly for individuals. Why? Because I don’t think information services will require that the west gets dramatically better. It just needs to stay a few steps ahead.

The American Chamber of Commerce recently published its “2008 White Paper on American Business in China”, which can be found here. ( h/t to Chinese Law Prof Blog) It is a very helpful overview of issues that American businesses will face coming into and doing business in China. The usual suspects are there: IPR enforcement (or lack thereof), human resources problems (the talent pool market), visa issues.

But there are a few encouraging trends in Part I of the report in terms of the way businesses perceive issues:

• Management level HR constraints is the top reported problem for 2008. (37%, up from 29% the year below). Again, I don’t think there is anything particularly new about this. This will be a problem for some time to come, especially in places like Beijing and Shanghai. I expect that this will be more and more of an issue as the 2nd and 3rd tier cities expand as well.
• Lack of transparency is fourth top problem for 2008, cited by 28% of respondents. It sounds pretty common-sensical. However, it ought be noted that this is down from 41% during 2007. That is a big difference in my mind. Especially from the Chinese government, where things aren’t always as transparent as western standards would prefer, this is a big thing. Very encouraging.
• Intellectual property rights infringements is not a newcomer to this list. However, it is the 6th top problem at 21%. And this is down from 26% the year before. I have been saying for the past few weeks that Chinese IP enforcement is getting better. This just validates this in my mind: even American businesses are taking notice, in spite of the rhetoric of the U.S. government at the WTO level.

Everything has gone down. Even bureacracy. (which places 5th) Except for the Human resources problem. I would note that there are some very good resources out there about this. I would start with Andrew Hupert’s China Solved Blog, which I follow and sometimes refer to on this blog. In fact, Andrew had an interesting post on point a few days ago. Other than, be warned that you will face stiff competition (to the point of the absurd at times) for good talent in major cities. Expect this.

So why the blog title? Because Am-Cham is so predictably American in their recommendations. I don’t disagree with any of them. However, it is urging the Chinese government to become more like our own government in how things are run. It won’t be easy. And sometimes, I think it well nigh impossible… at least, in this generation. These changes take time.

For example, the suggestions that Am-Cham came up with the following regarding how to fix deal with the HR problem:

Begin steps to reform the education system to encourage greater creative thinking, problem solving and teamwork. Courses should emphasize curricula that are more project-based and that encourage collaborative learning, which are vital skills in the workplace.

Reduce emphasis on one standardized college entrance examination and focus more on assessing individuals based on various abilities and skills that are applicable to the workplace. This includes team problem-solving, practical innovation and public service.

Re-evaluate the “985 Project” and “211 Project” aimed at strengthening the top universities and improving the curricula in order to propel the top universities to world class institutions in the next 10-20 years. Although we support the Chinese Government’s efforts to increase investment and standards in post-secondary education, these projects should include more cooperation and input from the business community to help ensure that students are learning the skills required to succeed in the labor market.

Relax hukou restrictions for qualified technical or managerial candidates and consider expanding the “Blue Stamp” system to other areas in China beyond Shanghai and Shenzhen.

Creative-thinking? Problem-solving? These are not fundamentally Chinese strengths. And in the current education system which emphasizes rote memorization and regurgitation, they will not be for a long time. So I don’t see these happening. Also, is this something China really wants? From a government level, I would want citizens who are hard working and listen to orders. That’s a cooperative citizenship. Second, where has America gone with its creative-thinking, teamwork oriented approaches? The math and science skills of children have plumetted. Sure, our youth are now great at teamwork–which is good practice for business and other services oriented industries. But even my high school teachers made fun of these “new” and “innovative” teaching methods. Why? Because they often produce poor students with no self-motivation and mental toughness.

I also don’t see the college entrance system changing anytime soon. It’s not just a China thing–it’s present in other Asian countries. It works. I don’t think Chinese college administrations will be ready for an American application system because of the sheer scope of the undertaking. There are going to be far more applicants in China due to its population. Really, this can kill resources in the universities like no other. I also question whether the American obsession with being an A+ student with high SAT scores and a varsity athlete and a humanitarian volunteer and being a participant of many clubs and <insert here> really helps anyone. There is a business for people in America who provide college admissions counseling. And I don’t mean in public high schools. The wealthy actually hire people to help their kids write their essays (”revise” the essay so they say), give guidance as to classes and extracurricular activities, etc. That isn’t really much better.

While I do agree that many of the suggestions would be helpful to American businesses, I want to caveat that they need to be taken with a grain of salt because the ideas are very American. Not that we expected any different.

While I am still talking about intellectual property and IPR enforcement, I thought I would highlight an article I read recently. The Associated Press recently published an article entitled “While upset about piracy, EU is more serene about China than US”. The article reads:

Compared to Washington, the European Union has been serene about piracy in China of its trademarks, copyright and patents. Can that last?

The EU estimates pirated goods cost EU businesses €21 billion (US$33.3 billion) in lost trade annually — about a third of current EU exports to China. But unlike the United States, it has to date not pursued any Chinese piracy cases in the World Trade Organization.

Still, the EU has put China in the category of worst violators of intellectual property. It is the only country in that category because its anti-piracy efforts are so weak that 80 percent of counterfeit goods imported into the 27-nation bloc are Chinese-made.

Again, I would like to know how that figure of 21 billion euros is calculated. As I mentioned before: if it wasn’t for piracy, I really doubt the figures many times.

I also think it can last. Why do all the dirty work of calling China out when America is already more than willing to do that? I think its the best policy.

Mandelson has repeatedly criticized blatant sales of fake goods throughout China that cost European and U.S. businesses dearly. To counter this he has nudged China into a 2007-2011 venture designed to boost enforcement of Chinese piracy laws by providing expertise and training.

“It is important to offer the Chinese all possibilities to put their house in order,” says Luc Devigne, head of intellectual property issues at the European Commission’s trade directorate. “We are not always convinced there is a willingness to stamp out piracy.”

That’s as tough as the piracy language gets at the EU.

I disagree. I think China has done a pretty good of trying to stamp out piracy. It’s true: China has not taken a zero tolerance policy, as evidenced by street vendors continuing to sell pirated products and fly-by-night stores that sell counterfeit goods. But I think the numbers are pretty good: 10% drop in software piracy in years; 76 million discs and other goods confiscated, 13,000 businesses shut down in 1 year (see here); 1.3 billion illegal publications over 20 years (though not all piracy related) (see here). Court cases being won regarding trademark, copyright, and patent. Realistically, there isn’t all that much that China has not already done in my book.

“In America, there are strong feelings of protectionism in the Congress. And the U.S.-China relationship is much more complex, more interdependent. There is America’s huge trade deficit with China. China has leverage over the U.S. because it holds significant amounts of U.S. Treasury debt. And there are security issues like Taiwan and North Korea.”

By comparison, says Innis, Europe “is much more in an appeasement mode with China.”

That is “a bad thing,” says Stuart Newman, head of the Brussels-based Foreign Trade Association whose 100 members include Europe’s biggest supermarket groups and textile importers. “We should be going after China in a tough way on intellectual property rights violations.”

While he favors legal action through the WTO, Newman does not underestimate the job of eradicating piracy in China.

I also disagree. I think the appeasement mode works better. Here’s why: (1) America will be the bad cop, while the EU can be the good cop. Good cop/bad cop works pretty well actually. And I think the EU will end up having a better image for it. Piracy will go down. America is hated. The EU is loved. That’s a win-win if I ever saw one. (2) That is how the Chinese prefer to negotiate. The government knows that IP is a problem. And the government knows that IP enforcement will be important to China’s economy in the future. China is not naive. But to throw that into their face like America does makes China defensive. And it makes China amp up the rhetoric as well. It’s just unproductive. But if the EU can dialog with China and do things in a less-blatant fashion, I think it will encourage the Chinese government to want to work with the EU. I know it sounds so offensive and ridiculous to westerners, but let the Chinese save face where you can. Really, it works.

My take: the EU should stay the course. The EU will benefit from America’s aggressiveness and still get what it wants, while maintaining the favor of the Chinese government and people.

Matthew DeFlorio published an article with the ABA International Law Section’s International Law News. It doesn’t directly relate to China, but I think its tips are very applicable. A number of his suggestions are based not only in common sense, but quite a bit of experience as well. However, a number of them are not cheap… and so it’s up to you to decide whether its worth it to protect your IPR. I am going to get the answer will be “yes” in a number of cases.

The article, entitled “Supply Chain Security and Its Impact on IPR” reads in part:

Protecting IPR through supply chain security can occur in a number of ways, either through tangible investments or as intangible process changes. . . . Developing new or improving existing processes for business partner selection and internal communications and data flow represent typical intangible enhancements that can provide additional security. Owners have improved their IPR protections by emplying some or all of the following options.

Visibility. Making assets and products more visible throughout the supply chain can protect against cargo theft and damage and prevent products from becoming instruments of illegal trade. Companies achieve this by investing in satellite tracking systems such as GPS, product protection technology such as EPC, or RFID. These systems provide real-time location status and tamper evidence that enables their use greater control over a shipment’s chain of custody from production to point of purchase.

No argument here. However, I just want to note that these sort of systems will cost more. Not a big revelation. But when profit margins are getting thinner by the day, a number of businesses–likely SMEs–won’t want to pay for these costs. At that point, you need to think about just how valuable your IP is and make a proper business decision.

Physical protection. Businesses protect building structures and cargo handling areas by installing fences and video surveillance equipment, and by controlling access to sensitive areas by employees and visits. These measures benefit IPR by protecting product and shipment integrity while discouraging access by unauthorized personnel.

Again, no argument. However, this needs to be strictly done at all levels. Including, your Chinese manufacturers/suppliers. Sourcing from China is likely a weak link in your chain. How many factories are going to protect in this way? Not many. So be careful and make sure you trust your suppliers. I really expect most companies, even SMEs, to be doing some of these things… but only in the US and not overseas.

Standards. Many companies will benchmark processes and activities, thereby establishing minimum performance requirements . . . . Specific methods for reporting fraud and illegal pursuits have become commonplace and are required for public companies under Sarbanes-Oxley. Such process discipline leads to quicker, more assured compliance while reducing confusion and inefficiency in the movement of goods through the supply chain.

Note that this is true for companies under SOX. In other words, U.S. publicly traded companies. Not your Chinese manufacturers. Reporting requirements and processes are not easily implemented in China. It’s not the same as doing it in the U.S. or even Japan. Chinese work culture is very different. Trying to convince your satellite office employees in China to do so… that’s going to be directly related to the effectiveness of your local manager.

Business Partners. Increased scrutiny of current and potential business partners leads companies to investigate beyond financial soundness and into the previous business conduct and security measures undertaken by the potential partner. Due diligence with this investigation will ensure a secure supply of materials, prevention of unauthorized characters tainting your supply chain, and enable early detection of security breaches due to enriched communication and collaboration. . . . IPR owners benefit through cost avoidance; smoother transit means quicker time to market, allowing for decreased inventory levels and the redirecting of funds previously earmarked to compensate for potential criminal activity.

I cannot reiterate this point enough. First, due diligence–thoroughly done–is your friend, even if it costs time and resources. Do it. And of course, do it regularly… check up on your suppliers on a routine basis. Quality fade isn’t the only problem if you are trying to protect your IP. Really, intellectual property is as valuable as your weakest link. So make sure your partners are doing a good job. Drop in unannounced regularly. Second, it also means that you can’t just go onto Alibaba and expect that this is good enough. It isn’t. Don’t think you can just find someone off a directory listing or at some trade even… it’s never that simple. Whoever you go to, do your due diligence.

And of course, as many people have reiterated time and again… Register your IP in China. (Thanks Dan!)

There were a pair of articles last week at the Financial Times that talked about how companies are investing in the Asian M&A market while the western markets (American and European) aren’t do so well. The West’s pain will ultimately be China’s gain it seems.

The first article is entitled, “Asia’s M&A market shows its mettle” and it reads:

The mergers and acquisition market in Asia is holding up better than in Europe and North America, underlining easier access to funds in the region and the global expansion drive by Chinese and Indian companies, according to bankers.

Since the start of January, M&A transactions in Asia-Pacific have amounted to $236.5bn, a fall of 5.8 per cent from a year earlier, according to data from Dealogic. By comparison, the M&A declines in Europe and North America are respectively 31.8 per cent and 37 per cent.

Chinese and other Asian investors are injecting capital into Western financial services companies that have been hit by the collapse of the US subprime market.

Of course, this should come as no surprise to people who know that the Asian market is still growing… at least, it is in China, where “ slow growth” is the catch phrase.

The other article from FT ( h/t to China Digital Times) is an example of one such company, GE, which got hammered on its earnings due to the faltering U.S. economy. GE is investing 2 billion dollars into Chinese markets, with the hopes of increasing its revenues to $10B by the year 2010. Talk about aggressive:

General Electric plans to invest up to $2bn in acquisitions and other deals in China over the next three years as part of a strategy to double its revenues in the country.

The world’s biggest industrial company, which stunned investors last week when it announced its worst quarter of financial results in five years, is looking to hire a team of 20 “in-house investment bankers” to conduct the deals in China.

The aggressive investment plans, which will include acquisitions and joint ventures, underline GE’s intention to expand its China business rapidly at a time when its domestic operations face a slowing US economy.

GE plans to increase its 2007 revenues in China of $4.4bn to $10bn by 2010, which would require the company to expand more than twice as fast as the economy’s double-digit rate of growth.

“The wider problems in the credit market and the signs of a slowing in the overall global economy have not entered the picture [in China],” said Mr Bertamini.

The comments come just days after GE slashed its full-year earnings forecast because of the effect of the credit crunch.

China Venture News was optimistic about GE’s future in China:

With GE’s good record on clean technology and Beijing’s new emphasis on environmental issues, the company may be able to find its way into some sweet deals in the coming years

While I am not able to really comment on GE’s ability to succeed or fail in its aggressive stance in China, the China M&A market remains as one of the few places for western companies and venture capital/private equity to invest. It makes sense: the western economy isn’t doing well, shift the money to where the economy is doing much better. I don’t think it takes a rocket scientist to figure this out.

I have been hearing that the M&A work at law firms is slowing down. It doesn’t have to be. There are plenty of firms still quite busy because they are doing American or European cross-border M&A into China and other Asian countries. If you aren’t prepared to do Chinese M&A work, then it really is time to learn. There are plenty of resources out there, such as stuff from China Briefing, which can give you a very basic understanding of the law, and numerous conferences. You owe it to yourself to get educated.

This call to go west isn’t just for businesses looking for opportunities: it is siren call for lawyers as well.

Silicon Hutong did a post yesterday about Krispy Kreme’s strategy to break into China–Shenzhen to be specific. And while many China consultants try to model and/or describe best practices, its always helpful to look at bad practices–both as a teaching lesson and to laugh at a little. After all, just because people like Krispy Kreme donuts doesn’t mean they will be successful in China. And if you have a popular product, don’t think you can just traipse into China either.

From the post:

China Economic Review is quoting Krispy Kreme’s HK CEO explaining why the confection pushers are planning to start their invasion of the People’s Republic of China in Shenzhen.

“Shenzhen is a migrant city, many are from the north, and the people are more receptive to fried products.”

Krispy Kreme is doomed in China.

Well, we don’t know that its “doomed” in China yet. But I agree with this idea. Why start a western brand that can easily target ex-pats and then expand? What’s clearly lacking isn’t necessarily common sense. It’s the business plan. In other words, I don’t see one. In fact, CER here seems to indicate that both Dunkin’ Donuts and Mr. Donut have some ideas and direction. I don’t see any from Krispy Kreme. That’s my main problem.

First, any company that would stoop to concocting such a nonsense justification for locating a high-value franchise somewhere is engaged in some high-level self-delusion. I would bet that real reason they’re going to do Shenzhen first is that the HK CEO is getting stuck with the job on the mainland, probably likes his mid-levels flat, and doesn’t want to be flying to Beijing or Shanghai all the time. Shenzhen, on the other hand, is 45 minutes from Central by car.

Second, if Krispy Kreme was really serious about China, they wouldn’t hand the responsibility to a guy in Hong Kong. They would do their research and put a guy on the ground in Shanghai, Beijing, or somewhere else in China to act as representative, get to know the local government, and find local franchisees. Behaving like you need to enter China from Hong Kong, then Shenzhen, is a modus operandi far more appropriate to China’s circumstances circa 1990.

I agree with this. Any company that is serious about doing business in China needs people on the ground. Whether its to manage your business or do your due diligence, you must have someone there locally. If you are a foreign MNC, you need to transfer key people to China to be on the ground: decision makers. Yes, decision makers in China–that seems like a foreign concept. But it’s important. Due diligence and commitment to doing business in China is key.

Third, if Krispy Kreme really understood the way into China, they would start someplace where there are a lot of people who already like donuts, can’t get them, and will form long, slavering lines outside their door each morning. If you’re afraid of Shanghai, go with Beijing. Call me crazy, but tens of thousands of American and Canadian businesspeople, students, diplomats, and families seem like a built-in market for a store or ten, better (especially initially) than a million or two migrant workers and their factory bosses.

Alas, Krispy Kreme appears content to sit in Hong Kong and wait for the franchisees to come to them, and then invade the market slowly.

No debate from me. Don’t do anything half hearted if you plan to go into China. Do it all the way. Be full steam ahead. Because the market is dynamic enough that you will probably get eaten alive by everyone else who is running into China. China is not the place for you to dabble. You can do that at home and be a mom-and-pop shop.

So if you plan to go in to China: (1) have a business plan. A good one. One that you believe in. But just have one. (2) have people on the ground. Move them there if you have to. Hire trusted consultants there if you have to. Make sure there is local decision making power and authority. (3) be aggressive. This isn’t the market to “test”. This is a place when you either kill or be killed.

The Hutong concludes:

Fortune in China usually tends to favor the brave and the wise. Be both.

I couldn’t agree more.

An article that was sitting in my mailbox that was just waiting for comment was entitled “EU and US team up on Chinese toys” from BBC News. It’s a little old, but since the news was not covered on any of the blogs I frequent, I thought I would talk about it:

The EU and the United States have agreed to work closely to persuade Chinese toy-makers to improve the safety of their products.

Millions of Chinese-made toys were recalled in 2007 after safety concerns about lead paint or detachable magnets.

EU commissioner Meglena Kuneva said, after talks with her US counterpart, Nancy Nord, that the world’s two major economies had to speak with one voice.

“We are pro-open markets, [but] not compromising on safety,” she said.

China has pledged to step up the way it monitors products.

Ms Nord, chair of the US Consumer Product Safety Commission, said she wanted the EU to agree to a global set of product safety standards.

Bringing the two systems together would be “for the benefit of consumers; it is certainly for the benefit of product manufacturers”, she said.

Currently, the EU uses a CE mark but European consumer groups have called for a stricter standard awarded by an independent regulator.

First off, how will the EU and the US “persuade” Chinese toy makers to improve their safety? They won’t. That is more or less an impossibility. Chinese toy makers are in this business because they want to make money, and because they sell to larger multinational companies, I don’t see how western governments are going to persuade anyone in China to do anything. So this is actually a mislabeling in my mind.

That’s not to say the EU and the US have no power. They have power on businesses sourcing from China but based in the U.S. or other countries in the west. In other words, your business. In the U.S., civil and criminal liability are already deterrences against harmful products. Add regulatory penalties to the list. That’s not too much of a threat, but just having to deal with government inspections, the time wasted on such a process, and sheer nuisance value does make this a possibility.

And so I will continue to preach quality control and due diligence. Especially quality control because quality fade is still very real. (think Greek Olympians)

My other thought is regarding a “global” standard. Who determines this? I have a hard time seeing a real consensus here. And of course, what effect can it have on consumers? A lot. If other countries raise the ceiling ridiculously high (which is desirable), then imagine the increase in costs for products worldwide. Do you think China as the world’s manufacturer will help the pinched consumer in America who fears a recession? No. I like the independent regulator idea. But I just can’t see this working out in a beneficial way for most people.

And of course, we go back to the quality fade problem.  You have a regulator certify a product.  You have some random, but not-too-often type of inspections.  You are asking for quality fade.  And Chinese suppliers will give you in a heartbeat.  QC and due diligence can only do so much against economic realities.  So watch out.

Ultimately, it’s probably so that the EU and America can wring their hands when problems arise and say “I am innocent”.

It is still review time today, and my favorite blog post all week comes from Silicon Hutong, which is a responsive posting to an article from the China Economic Review / Business Week (re-print). I try not to reprint posts without commentary, but this one was so well done that I don’t think I need to really comment. Something I had to share with my readers (though I believe there is very little non-overlap) and also just to save for the future. It is a mixture of some facts and a lot personal experience, which is quite effective.

The post, entitled “ Selling Hong Kong” reads: (note, I have posted most but not all of it)

Hong Kong began and grew as a trade entrepot, and for many years after 1949 was a busy center for manufacturing as well. Reforming and opening of the mainland have sucked most of the manufacturing upriver and inland, and (as today’s story underscores) Hong Kong’s importance as a center of transshipment declines as its picturesque harbor is pinched by reclamation and development - not to mention rising property values, growing pollution restrictions, and the climbing cost of labor.

In spite of all of this, Hong Kong’s port will continue to prosper for a time. But to rely on the port for growth or economic vitality is growing less practical. Even the city’s major port operators are betting on investments in faraway quays and harbors for their long term prosperity. Clearly, physical logistics is not the basis on which the SAR’s leaders can or should build a vision for the future.

(Nor, for that matter, is some well-intentioned belief that the city is a great place to build online businesses - many of those industries are highly labor, power, and real-estate intensive, and the back rooms of Shenzhen, Hangzhou, Beijing, and Dalian are arguably better suited to become multimedia centers.)

More than Ports and Property

But I believe in Hong Kong, and feel that if the SAR could understand what it offers - and what it doesn’t - it need not decline to become a lesser light than Shanghai and Singapore, a path it appears to be treading.

Where Hong Kong excels is in services. It remains perhaps the easiest city in all of Asia to get a lot of stuff done in a very little time. Every time I go to Hong Kong I am amazed at how many things I can knock off my list in the space of a morning or a single day. My company is domiciled there. My lawyers, travel agent, and accountant are all there, as are my bank, my tailor, my computer store, and my dive shop. What is more, I can get to every single one of those places in a single day, with time left over for lunch and some random shopping.

It remains the best place in the region to hold meetings, attend conventions, or run training programs. Setting up - and operating - a company there is about as easy as it gets. It is simpler and faster in Hong Kong than Singapore, Beijing, Shanghai, or Tokyo to do my banking, send a parcel (or myself) anywhere on the planet, buy a mobile phone, shop for just about anything, get a suit made, watch a movie, find a wi-fi hotspot, eat a meal, rent an office, buy a CD, or find a Moleskine notebook.

Where else is there a higher density of every business craft or profession? Law firms, accounting firms, advertising agencies, investment banks, venture capitalists, and head hunters abound in such profusion that you could probably get your needs met in any given office tower in Central.

It’s the Services, Guys

If I were doing a campaign for Hong Kong, the tagline would be simple:

Hong Kong. At Your Service.

Forget real estate and shipping. If I were Donald Tsang or any of his staff, I would be giving a lot of thought to how to shift the SAR’s industrial policy and external marketing toward highlighting - and growing - Hong Kong’s role as the service entrepot of - if not Asia - certainly of Greater China.

Getting Serious about Service

To make that happen, the SAR government needs to get itself a laser-focus on becoming the place where stuff that is unnecessarily difficult to do elsewhere is utterly simple to do in Hong Kong.

That means a policy focus aimed at encouraging - even subsidizing - companies who are genuine innovators in services. You have a better way to do something for people? This is where you want to be.

The great part of all of this is that Hong Kong is already half way there. Services dominate the economy. Hong Kong’s major brands - Cathay Pacific, HSBC, A.S. Watson, Hutchinson, Shangri-La - are almost all service brands.

The greatest problem is one of positioning: Hong Kong has never articulated these strengths well. That needs to change. Now.

Otherwise the city is doomed to become a sad provincial shadow of itself, a narrow stretch of water surrounded by expensive real estate and the effluent of the Pear River estuary.

‘Nuff said.

I have been thinking a lot about the Chinese mindset vs. the American mindset. Being a Chinese American, I find myself smack in the middle a lot: appreciating western principles, culture and ideology, and yet, raised by those who were culturally very Chinese, and all that it entails about trust for others, ideology, and principles. The two mindsets are vastly different.

This has become even more clear as I dialogue with Chinese friends about Tibet. [note: I am not posting anything on this blog about that topic for two reasons: (1) I like being able to get through the great firewall and (2) it is hard work to maintain any sense of neutrality about the subject, and I prefer taking a neutral stance wherever possible.] Inevitably, I find myself having to defend the western viewpoint to some degree because the two are just so different. So many of the grievances on both ends could be addressed just by understanding the other perspective.

So what triggered this post? An interesting article about international arbitration in a supplement to The Recorder entitled “Going Global” by Alexandre de Gramont at Crowell & Moring. In the article, he discusses how in the past, American companies approached international arbitration like American arbitration/litigation: hire a slick attorney who is a litigation super star, and let him dazzle the panel. Well, this article talks about how this utterly failed for American companies. And large firms were forced to develop international arbitration practices that dealt with many of the cultural and international aspects of arbitration. I only want to highlight a few portions because I need to actually type them:

A foreign company brings a high-stakes international arbitration against a U.S. company. The U.S. Company turns to a star outside litigator, an American attorney, to handle the matter. Although he has never handled an international arbitration before, the litigator has an unparalleled track record of winning bet-the-company cases in state and federal courts around the country. His performance in domestic arbitration is equally superb. . . . Why go elsewhere . . . .

The litigator no doubt feels the same way, that is, until the arbitration gets under way. With an experienced international arbitration specialist on the other side, the parties begin by selecting a tribunal of three arbitrators. The specialist seems to be on personal terms with nearly all of the available international arbitrators. Indeed, she has even served as an arbitrator with some of them.

In the meantime, many of the witnesses just don’t seem to warm to the U.S. litigator and his team, who don’t understand the witness’ language or culture and who have to communicate with witnesses through interpreters (whereby much is lost in translation). Even the translating service selected by the U.S. team has missed some of the critically important legal subtleties in the key exhibits.

As might be expected, this particular adventure does not end happily for the star U.S. litigator–and his client.

Moral of the story: what works in America and what works for you now won’t necessarily work on a global, international scale. Or in China for that matter. “When in Rome…” seems to make good sense because you need to learn to what works in China rather than making the assumption that you already know. You (or your client trying to go into China) may be dead wrong if you don’t.

I found the article interesting because it shows that American biglaw firms are gaining enough sensitivity and sophistication to know that things don’t work the same internationally as they do in America. (and trust me, large law firms are hardly the model of cultural sensitivity) And though American large corporations have discovered this going into China, it is imperative that smaller enterprises (SMEs) understand Chinese culture and ways of doing business first. It is very different. So before you go on Alibaba, plunk down a lot of money, and wait for disaster to happen, you should educate yourself. China blogs such as China Law Blog, This is China!, All Roads Lead to China, and others (hopefully including my own) will give you a start. My blogroll has a number of these.

You can and should read, read, and read some more. It doesn’t mean you will fully understand the Chinese culture and mindset. But at least you’ll have a much better idea and grasp of it. Really, resources and capital are only half the battle to doing international business. Common sense, respect, savvyness, and the ability to understand another culture are equally important.