PICPA Spring 2013 : Page 24
China: A Huge Country with Vast Opportunity By Cory Ng, CPA, CGMA, and James Chan, PhD 24 Pennsylvania CPA Journal | Spring 2013 | www.picpa.org
China: A Huge Country with Vast Opportunity
Cory Ng, CPA, CGMA, and James Chan, PhD
Ninety-six percent of the world's population lives outside of the United States, so if you work with business owners or professional service providers who are looking to reach new customers, you may want to think outside Pennsylvania's borders . . . way outside Pennsylvania's borders.
One of the hottest markets right now is China. It is the world's most populous nation with one-fifth of the world's population (1.3 billion people) and is the world's second largest economy.1 Many companies, however, never consider expanding into foreign markets, despite the widely accepted benefits of exporting, including increased sales, diversification of market risks, and extended shelf life of existing products.2 This article will explore the benefits and challenges of Pennsylvania-based businesses entering the China market.
The People's Republic of China has experienced unprecedented economic growth over the past three decades. As measured by gross domestic product (GDP), China's economy grew 9.2 percent in 2011 and was expected to grow 8.25 percent in 2012.3
China is a vast country with a complex market that requires careful consideration of its governmental structure, legal system, regulatory environment, taxes, and cultural differences. Because China is a single-party, state-controlled communist country, there are unique challenges compared with those faced by businesses in the United States. For example, there is no private ownership of land by individuals or corporations in China – all land is owned by the state or local government. As such, businesses that need to use land in China must be granted land-use rights by land management authorities. In addition, China's legal and regulatory systems have been described as "opaque, inconsistent, and often arbitrary."4
The appropriate business structure for conducting business in China is critical. Foreign enterprises have several options: representative office, joint venture, wholly foreign-owned enterprise, and foreign-invested commercial enterprise. A representative office would be established to carry out limited activities in China, such as market research and liaison activities. This structure is prohibited from engaging in any revenue-generating activities, and it is not a legal entity. In addition, the U.S. parent entity must have been in existence for two years prior to establishing a representative office. A joint venture is a legal entity formed by a foreign investor that requires a Chinese company serving as a partner. Under a joint venture arrangement, the foreign and Chinese partners distribute profits and losses in proportion to equity interests or in accordance with contractual provisions. The most popular choice by foreign investors is the wholly foreign- owned enterprise, a legal entity that allows 100 percent foreign ownership and control. Wholly foreign-owned enterprises must be established with funds paid only by the foreign investor and are subject to strict currency controls. Finally, a foreign-invested commercial enterprise is a wholly foreign-owned enterprise or a joint venture established to carry out import-export activities as well as domestic wholesale within China.
Pennsylvania companies exported $3.5 billion worth of products to China in 2011.5 Looking ahead, there are five areas in which Pennsylvania companies could enjoy export advantages.
Precision-engineered industrial parts and components – When China opened to trading with the United States in 1979, it imported complete machine sets to feed its hungry, nascent heavy and light manufacturing industries. By the 1990s, Chinese industrial corporations learned how to make their own complete sets of equipment so that they could reduce their reliance on imports. Many industrial enterprises, however, are still behind in making high-quality, precision-engineered parts and components such as valves, seals, and specialized bearings.6 In fact, four of the top 10 American-made exports to China are made up of precision-engineered parts and components in power generation (10 percent of total U.S. exports to China by value), heavy electrical machinery (7 percent), vehicles (6 percent), aircraft and aerospace (6 percent), and medical equipment and optical devices (5 percent).7
Scientific products and information services – The United States still enjoys its edge in scientific and technological products, including software systems, scientific publications, and web-based information databases. The quality of Chinese science, while improving, has yet to rival that of the United States, and this is where opportunities for Pennsylvania companies lie.
Professional services – As China progresses economically, its service sector will become more important. China no longer wants to be the world's factory for low-value, low-margin consumer products based on low-wage labor. It wants to elevate its industrial stature and become a nation of innovators, inventors, and original designers. For this reason, China is awakening to the critical importance of professional services. Over the past five years, more Chinese companies have engaged American companies for services in industrial design, engineering, architecture, accounting, finance, tourism, hospitality, mergers and acquisitions, corporate management, franchising, licensing, art, and others. The United States exports nearly $25 billion of private commercial services to China, and maintains a trade surplus that will likely continue for years to come.8
Agricultural and natural resources and packaged food products – China imports a large amount of agricultural and grain products from the United States, as well as industrial resources. It is no wonder that pulp and paperboard, copper, and organic chemicals are among the leading U.S. exports to China. Pennsylvania maintains an advantage in this regard. Chinese consumers also want and need safe and quality packaged-food products, including milk products, baby food, and canned goods.
Investment and joint ventures – China is becoming an investor in the United States. Chinese corporations have begun to set up factories in the United States, and those Pennsylvania companies that have leverage in what they make will be winners in forming partnerships with Chinese firms. Direct investment within the United States is in its infancy, but it will grow over time. Currently, Chinese investment in Pennsylvania amounts to about $40 million over the last two years: industrial machinery ($29 million), electronics and IT ($8 million), fossil fuels and chemicals ($1 million), and metals and minerals ($1 million). Nationwide, Chinese investment totaled nearly $21 billion distributed through 591 deals from 2000 to the end of the second quarter of 2012.9
Opportunities for CPAs
Pennsylvania businesses that decide to pursue exporting to China will need a variety of professional services, including those provided by CPAs. CPAs who provide consulting services can assist clients with market evaluations and business planning strategies. Also, firms seeking export financing from the Small Business Association will need to provide financial statements and tax returns that a CPA can prepare.
Once operating in China, Chinese tax authorities require entities with foreign ownership to submit annual audited financial statements. Local Chinese auditors have been criticized for not providing the same level of due diligence during audits as required in the United States. Recently, China has lessened restrictions on the accounting and auditing market by allowing overseas accounting firms to set up offices to carry out audits in China.10
Services for Trade Opportunities
The United States Department of Commerce, International Trade Administration, is a federal resource that promotes U.S. exports, particularly by small- and medium-sized enterprises, and provides commercial diplomacy support for U.S. business interests around the world.11 The U.S. Commercial Service is the trade promotion arm of the International Trade Administration. Commercial Service trade professionals in more than 100 U.S. cities and more than 75 countries help U.S. companies get started in exporting or increasing sales to new global markets. The Commercial Service has international offices in Beijing, Chengdu, Guangzhou, Shanghai and Shenyang.12
The Pennsylvania Department of Community and Economic Development has more trade offices than any other U.S. state, and it offers Pennsylvania businesses an opportunity to take an online Export Assessment Quiz.13 After completing the questionnaire, assessment results can range from "You are on the right track but have a long way to go" to "You are ready to export."
In addition, there are Regional Export Network Partners (RENPs) that serve businesses in different regions throughout Pennsylvania.14 These organizations provide membership opportunities with the goal of supporting international trade.
Pennsylvania firms thinking about exports should also consider joining trade organizations such as the American Association of Exporters and Importers, the Federation of International Trade Associations, and the International Chamber of Commerce.
Success in China: A Case Study
Success in marketing Pennsylvania products and services to China depends not only on taking the right steps from the outset, but also on having long-term commitment from the business owner.
In the spring of 1984, the vice president of sales and general manager of an industrial component manufacturer contacted Asia Marketing and Management (AMM) to discuss how his company could market its high-ticket, custom-designed industrial equipment to China. The vice president said, "We know that it takes time to succeed in marketing to China. We give ourselves 15 years, and we don't expect immediate results." It did not take the company 15 years to make a lot of money in the market, but it did take about seven years before it received its first big order from China's leading original equipment manufacturer.
Since 1991, the manufacturer has received orders on a regular basis from both existing customers and new customers. One customer alone bought so much of the client's components it entered the client's list of top 10 customers, a significant achievement considering the company's long history. China has been a very profitable market for this company because the owner of the business was willing to be patient and to persevere in the beginning years, when results seemed almost impossible.
Despite having AMM and an agent on the ground in China, the company's executives and top technical and sales managers travel to China each year. There is no shortcut to seeing customers in China. It is important to customers to see that their trading partner is real. By showing up, the executives prove that they are not phantom personnel conjured up by an agent. The more often you see the same people in China, the more they trust you. Any company that wants to sell to China but is unwilling to commit the right personnel to visit Chinese customers is destined to fail.
Despite the enormous export potential of China, there are risks too. The Chinese government recently imposed a 50 percent social benefits tax on all foreigners working in China, requiring them to participate in the country's social insurance programs.15 In addition, obtaining the proper visa can be an onerous process, and police may deport expatriates that do not carry passports, visas, and resident permits at all times.16
Intellectual property rights (IPR) is another major area of concern for businesses operating in China. As the law firm of Pinsent Masons notes, "China has a well-deserved reputation as a hotbed of intellectual property rights infringement."17 Businesses operating in China should take steps to protect IPR, including trade names, copyrights, patentable inventions, and trade secrets. An IPR strategy should be considered early, then it should be implemented and monitored on a continuing basis.
According to one federal government report, mainland China was the origin of 79 percent of all the goods seized in the United States. "For years, companies active in China have been protecting their IPR by using a reactive, raid-based approach that involves engaging third parties to seek out counterfeiters and coerce action from often less-than-enthusiastic or corrupt law enforcement agencies."18 However, "the raids-based approach doesn't strike at the root of the problem: the initial leak of IP."19 One recommended solution is obtaining the services of an IPR protection company that uses an intelligence-based approach to focus not only on seizing counterfeit items through raids but also identifying the owners of counterfeit operations and the distribution channels used. China has well-developed IPR laws on the books; the main issue is the lack of government enforcement of the existing laws.
Pennsylvania firms also need to carefully consider the location of establishing operations in China during the planning phase. China has vastly different geographic areas that have developed economically at dramatically different rates. Less-developed areas may offer lower costs for wages, but they also tend to have less- advanced infrastructure and access to markets.
Finally, cultural and linguistic differences add complexity to doing business in China. Mandarin, the official language of China, takes years of practice to become fluent.
China represents a tremendous opportunity for Pennsylvania businesses to reach millions of new consumers. Entering the China market, however, requires a long-term commitment of resources, time, and a deep understanding of the differences in culture, business practices, government regulations, and intellectual property concerns. Business owners are encouraged to visit China to gain a firsthand understanding and perspective of its unique business environment and people prior to committing to doing business there. After making the decision to enter the China market, careful planning and consultation with the various organizations discussed here, combined with CPAs, attorneys, and others, can help you navigate a successful operation.
1 V Arora and A. Vamvakidis, "Gauging China's Influence," Finance and Development, International Monetary Fund (December 2010).
2 M. Kogon, "ExportingBasics,"3rdEdition, (April2006). World Trade PA.
3 "China Economic Outlook," International Monetary Fund (Feb. 6, 2012). http://www.imf.org/external/country/CHN/rr/2012/020612.pdf
4 "China Business Handbook, " U.S. Department of Commerce,
U.S. Commercial Service (2011).
5 U.S. Department of Commerce, The U.S.-China Business Council (2012). https://www.uschina.org/public/exports/2000_2011/pennsylvania_2011.pdf
6I. Leybovich, "Q&A: Exporting Pro on Selling U.S. Industrial Goods to China," Industry Market Trends, ThomasNet.com News (Nov. 13, 2012).
7 The US-China Business Council (2012). https://www.uschina.org/statistics/tradetable.html.
8 Office of the United States Trade Representative. http://www.ustr.gov/countries-regions/china.
9 "China Investment Monitor: Tracking Chinese Direct Investment in the U.S., "Rhodium Group (2012).
10 E. Kliegman, "CPAs in China: Fascinating Similarities and Differences, " The CPA Journal, New York State Society of CPAs (August 2005).
11 International Trade Association, November 2012. http://trade. gov/about.asp.
12 "Powering Export Growth, 2011 Annual Report, " U.S. Commercial Service (2012). http://trade.gov/cs/cs_annualreport12.pdf.
13 Pennsylvania Department of Community & Economic Development, November 2012. http://www.newpa.com/business/ exporting.
14 A list of RENPs in Pennsylvania is available at http://exportingpa.org/Resources.aspx.
15 R. Flannery, "China Hits Foreigners and Their Employers with New Social Benefits Tax," Forbes (Sept. 10, 2011).
16 C. Beam, "China Does Not Want You," Bloomberg Businessweek (June 11-17, 2012).
17 "Doing Business in China," Pinsent Masons (December 2011). http://www.pinsentmasons.com/PDF/businessinchina.pdf.
18 T. Lowe and B. Simar "Countering Corruption in Intellectual Property Cases: CFEs Equipped to Deal with IPR Infringement in China, " Fraud Magazine, Vol. 26, No. 1 (January/February 2011).
Cory Ng, CPA, CGMA, is an assistant professor ofaccounting and business programs supervisor at the Community College of Philadelphia and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at email@example.com.
James Chan, PhD, is president of Asia Marketing and Management, a Philadelphiabased consultancy firm. He can be reached at firstname.lastname@example.org.
The authors gratefully acknowledge Douglas P Hepburn, CPA, PFS, CFP, for his assistance in coordinating this article.