A panel on smart contracts with industry developers and educators

Earlier today I participated in a virtual panel covering smart contracts called, “Let’s Talk Smart Contracts.”

The panel included: Adam Krellenstein (Counterparty), Oleg Andreev (CoreBitcoin), Pamela Morgan (Empowered Law), Stefan Thomas (Codius, Ripple Labs), Stephan Tual (Ethereum), Tim Swanson (Of Numbers), Yurii Rashkovskii (Trustatom) and it was moderated by Roman Snitko with Straight.

Below are some transcribed notes of my own statements.

Introduction starting at 09:06:

Hey guys, great to be here.  Thanks for the invite, thanks for organizing this.  So I’m here because you guys needed another white guy from Europe or something like that (that’s a joke).  So the definition I have of smart contracts, I have written a couple books in this space, and the definition I use is a smart contract is “a proposed tool to automate human interactions: it is a computer protocol – an algorithm – that can self-execute, self-enforce, self-verify, and self-constrain the performance of a contract.”  I think I got most of that definition from Nick Szabo’s work.  For those of you who are familiar with him, look up some of his past writings.  I think that the primary work he is known for is the paper, “Formalizing and Securing Relationships on Public Networks.”  And he is basically considered the [intellectual] grandfather of this space.  I’m here basically to provide education and maybe some trolling.

From 22:02 -> 24:15

I think I see eye-to-eye with Adam here.  Basically the idea of how we have a system that is open to interpretation, you do have reversibility, you do have nebulousness.   These are things that Nick Szabo actually discussed in an article of his called “Wet code and dry” back in 2008.  If you look back at some of the earlier works of these “cypherpunks” back in the ’90s, they talked about some of these core issues that Oleg talked about in terms of being able to mitigate these trusted parties.  In fact, if you look at the Bitcoin whitepaper alone, the first section has the word “reverse” or “reversibility” around 5 times and the word “trust” or “trusted” appears 11 times in the body of the work.  This was something that whoever created Bitcoin was really interested in trying to mitigate the need for any kind of centralized or third party involved in the process of transactions to reduce the mediation costs and so forth.

But I suppose my biggest criticism in this space, it is not pointed to anyone here in particular, is how we have a lot of “cryptocurrency cosplay.”  Like Mary Sue Bitcoin.  I’m not sure if you guys are familiar with who Mary Sue is: she is this archetype who is this kind of idealized type of super hero in a sense.  So what happens with Bitcoin and smart contracts is that you have this “Golden Age” [of Comics] where you had the limited ideas of what it could do.  Like Superman for example, when he first came out he could only jump over a building and later he was pushed to be able to fly because it looks better in a cartoon.  You have only a limited amount of space [time] and it takes too long to jump across the map.  So that’s kind of what I see with Bitcoin and smart contracts.  We can talk about that a little bit later, just how they have evolved to encompass these attributes that they’re probably not particularly good at.  Not because of lack of trying but just because of the mechanisms of how they work in terms of incentives for running mining equipment and so on.  So, again we can talk about that later but I think Adam and Oleg have already mentioned the things that are pretty important at this point.

40:18 -> 41:43

I’m the token cynic, huh?  So actually before I say anything, I would like to mention to the audience other projects that you might be interested in looking at: BitHalo; NotaryChains is a new project that encompasses some of these ideas of Proof of Existence created by Manuel Araoz, he is the one who did POE.  NotaryChains is a new project I think that sits on top of Mastercoin.  The issue that people should consider is that proof of existence/proof of signature: these are just really hi-tech forms of certification.  Whether or not they’re smart contracts I guess is a matter of debate.

There is another project: Pebble, Hyperledger, Tezos, Tendermint, Nimblecoin.  With Dogethereum their project is called Eris which apparently is the first DAO ever.  A DAO for the audience is a decentralized autonomous organization, it’s a thing apparently. SKUChain is a start-up in Palo Alto, I talk about them in chapter 16.  They have this interesting idea of what they call a PurchaseChain which is a real use-case for kind of updating the process from getting a Letter of Credit to a Bill of Lading and trying to cut out time and mediation costs in that process.  There are a few others in stealth mode.  So I really don’t have a whole lot to add with cynicism at this point, we can go on and come back to me in a little bit.

59:41 -> 1:02:35

The go to deficiency guy, huh?  They’re not really saying anything particularly controversial, these things are fundamentally — at least from an engineering perspective — could be done.  The problem though I think runs into is what Richard Boase discussed in — if listeners are interested — he went to Kenya and he did a podcast a few weeks ago on Let’s Talk Bitcoin #133.  I really recommend people listen to it.  In it he basically talks about all of these real world issues that run into this idealized system that the developers are building.  And as a result, he ended up seeing all of these adoption hurdles, whether it was education or for example tablets: people were taking these tablets with bitcoin, and they could just simply resell it on a market, the tablet itself was worth more than they make in a year basically; significant more money.  He talked about a few issues like P2P giving, lending and charity and how that doesn’t probably work like we think it does.

I guess the biggest issue that is facing this space, if you want issues, is just the cost benefit analysis of running these systems.  There is a cost somewhere to run this stuff on many different servers, there is different ways to come up with consensus for this: for example, Ripple, Stellar, Hyperledger, they’re all using consensus ledgers which require a lot less capital expenditures.  But when you end up building something that requires some kind of mining process itself, that costs money.  So I think fundamentally in the long-run it won’t be so much what it can do but what can it economically do.

So when you hear this mantra of let’s decentralize everything, sure that’s fine and dandy but that’s kind of like Solutionism: a solution looking for a problem.  Let’s decentralize my hair — proof of follicle — there is a certain reductio ad absurdum which you come to with this decentralization.  Do you want to actually make something that people are actually going to use in a way that is cheaper than an existing system or we just going to make it and throw it out there and think they’re going to use it because we designed [wanted] it that way.  So I think education is going to be an issue and there are some people doing that right now: Primavera De Fiillipi, she’s over at Harvard’s Berkman Center — she’s got something called the Common Accord program.  And also Mike Hearn; listeners if you’re interested he’s made about 7 or 8 use-cases using the existing Bitcoin blockchain including assurance contracts — not insurance contracts — assurance contracts.  And he’s got a program called Lighthouse which hopes to build this onto the actual chain itself.  So there are things to keep in mind, I’m sure I’ll get yelled at in a minute here.

1:23:58 -> 1:28:10

Anyone listening to this wanting to get involved with smart contracts: hire a lawyer, that’s my immediate advice.  I will preface by saying I don’t necessarily agree with policies that exist and so on; I don’t personally like the status quo but there is no reason to be a martyr for some crusade led by guys in IRC, in their little caves and stuff like that.  That’s not towards anyone here in this particular chat but you see this a lot with “we’re going to destroy The Fed” or “destroy the state” and the reality is that’s probably not going to happen.  But not because of lack of trying but because that’s not how reality works.

Cases right now are for example: DPR, Shavers with the SEC, Shrem now with the federal government, Karpeles [Mt. Gox] went bankrupt.  What’s ended up happening is in 2009, with Bitcoin for example, you started with a system that obviated the need of having trusted third parties but as users started adopting it you ended up having scams, stolen coins, people losing coins so you ended up having an organic growth of people wanting to have insurance or some way to mediate these transactions or some way to make these things more efficient.  And I think that it will probably happen — since we’re guessing, this is speculative — I think that this will kind of happen with smart contracts too.  That’s not to say smart contracts will fail or anything like that.  I’m just saying that there will probably just be a few niche cases initially especially since we don’t have much today, aside I guess from Bitcoin — if you want to call it a smart contract.

What has ironically happened, is that we have created — in order to get rid of the middlemen it looks like you’ve got to reintroduce middlemen.  I’m not saying it will always be the case.  In empirical counter-factual it looks like that’s where things are heading and again obviously not everyone will agree with me on that and they’ll call me a shill and so on.  But that’s kind of where I see things heading.

I have a whole chapter in a book, chapter 17.  I interviewed 4 or 5 lawyers including Pamela [Morgan] of different reasons why this could take place.  For example, accredited investor — for those who are unfamiliar just look up ‘accredited investor.’  If you’re in the US, in order to buy certain securities that are public, you need to have gone through certain procedure to be considered a ‘sophisticated investor.’  This is one of the reasons why people do crowdsales outside of the US — Ethereum — because you don’t want to have to interact with the current legal system in the US.  The reason I mention that is because you end up opening yourselves to lawsuit because chains — like SWARM — cannot necessarily indemnify users.  That’s legal terminology for being able to protect your users from lawsuits from third parties; they just do not have the money, the revenue to support that kind of legal defense.  Unlicensed practice of law (UPL) is another issue.  If you end up putting up contracts on a network one of the issues could be, at least in the US, are bar associations.  Bar associations want to protect their monopoly so they go after people who practice law without a license.  I’m not saying it will happen but it could happen.

My point with this is, users, anyone listening to this should definitely do your due diligence, do your education.  If you plan to get involved with this space either as an investor or developer or so on, definitely at least talk to a lawyer that has some inkling of of an idea [on this].  The ones I recommend, in addition to Pamela here are: Ryan Straus, he is a Seattle-based attorney with Riddell Williams; Austin Brister and James Duchenne they’re with a program called Satoshi Legal; and then Preston Byrne, who’s out in London and he’s with Norton Rose Fulbright.

1:52:20 -> 1:54:43

Guys look, I understand that sounds cool in theory and it’s great to have everything in the background, but the reason you have to see these “shrink wrapped” EULAs [end user license agreements] and TOSs [terms of service] is because people were hiding stuff inside those agreements.  So if you hide what’s actually taking place in the contract you end up making someone liable for something they might not actually agree to.  So I’m not sure, I think it’s completely debatable at this point.  If we’re trying to be transparent, then you’re going to have to be transparent with the terms of agreement.

I should point out by the way, check out Mintchalk.com, it’s run by guys named James and Aaron in Palo Alto, they’re doing contract building.  ACTUS is a program from the Stevens Institute, they’re trying to come with codified language for contracts.  Mark S. Miller, he’s got a program over at Google, he does something with e-rights.

I mention all of this because, we already have a form of “polycentric law” if you will in terms of internationally with 200 different jurisdictions vying for basically jurisdiction arbitrage.  Ireland and the Netherlands have a tax agreement that Facebook, Google, Pfizer they take advantage of.  It’s this Double Irish With a Dutch Sandwich.  In fact my own corporation is incorporated in Delaware because of the legal arbitrage [opportunities].  Obviously smart contracts might add some sort of new wrinkle to that, but people who are listening to this, don’t expect to be living in some Galt’s Gulch tomorrow or something like that.

For example, when you have something that is stolen, there is something called Coinprism which is a colored coin project.  They can issue dividends on stock.  The cool thing with that is, “hey, you get to decentralize that.”  The double-edged side of that is if that when that get’s stolen: people steal stuff like bitcoins and so forth, what happens to the performance of that dividend?  If the company continues paying that dividend in knowing that the person had been stolen from: if somebody stole from me and I tell the company, “hey, it was stolen” and they continue paying, then I can sue them for continuing to pay a thief.  If they stop paying then it defeats the purpose of decentralization because anonymity is given up, identity has taken place.  Obviously this moves into another area called “nemo dat” it’s another legal term talking about what can be returned to the rightful owner, that’s where the term “bona fide” comes from.  Anyways, I wanted to get that out there.  Be wary of disappearing EULAs, those have a purpose because people were being sued for hiding stuff in there.

2:10:05 -> 2:12:23

So I think everybody and all these projects are well-intentioned and have noble goals but they’re probably over-hyped in the short-run, just like the Segway was.  It eventually leads to some kind of burnout, or over-promise and under-delivering.  I’m not saying this will happen, I’m just saying it could happen.  I actually think the immediate future will be relatively mundane, such as wills and trusts kind of like Pamela was talking about.

One particular program is in Kenya there is something called Wagenitech which is run by Robin Nyaosi and he is wanting to help farmers move, manage and track produce to market to bypass the middleman.  That doesn’t seem like something really “sexy,” that doesn’t seem like the “Singularity” kind of thing that everyone likes to talk about.  But that is needed for maybe that particular area and I think we might see more of that along with PurchaseChain, NotaryChains, some of these things that we already do with a lot of the paperwork.

Again, blockchains and distributed ledgers are pretty good at certain things, but not everything.  It has real limitations that vocal adopters on the subreddit of Bitcoin like to project their own philosophical views onto it and I think that it does it a very big disservice to this technology long-term.  For example, LEGO’s can be used to make a car but you wouldn’t want to go driving around in one.  A laptop could be used as a paper weight but it’s not particularly cost effective to do that.  And so what I think we’ll end up running into a tautology with smart contracts, it’s going to be used by people who need to use them.  Just like bitcoin is.  So what we’re going to have is a divergence between what can happen, this “Superman” version of Bitcoin and smart contracts, versus the actual reality.

So for example, people say it’s [Bitcoin] going to end war.  You had the War of Spanish Succession, there was a Battle of Denain, a quarter million people fought that in 1712 and it was gold-based [financed by specie].  Everyone that says bitcoin is going to destroy fiat, if the state exists as it does today there’s always going to be these institutions and types of aggression.  I do think smart contracts do add collateral and arbitration competition and it does take away the problem of having trust in the system itself, but the edges are the kryptonite.  And always will be.  So we need to focus on education and creating solutions to real actual problems today with the actual technology and not just some hypothetical “Type 2” civilization where we are using [harvesting] the Sun for all of our energy.

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On the ground relevant data and knowledge on the mainland

Shanghaiist recently did a must-read interview with Shaun Rein.  I had the fortune of interviewing him for my book (see Ch 4 & 13), but this new interview is even better/more detailed in my opinion.

He’s one of the few laowai that truly understands what is going on here, approaching the business atmosphere with a very balanced mindset.  Check out his book and if you’re looking for a consumer research firm, he happens to manage one (CMR) as well.

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Mark DeWeaver: Why China Invests in Windfarms It Can’t Use

Yesterday, Mark DeWeaver did an interview with U.S. News & World Reports regarding his recently published book on China: Animal Spirits with Chinese Characteristics.

Mark wrote the Foreword to my book and is the founder of Quantrarian Capital Management, a fund in DC.

Below is the interview:

Also viewable at Google Hangout.

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An Interview with Kenneth Walker, founder of Bubba’s Texas-Style BBQ

bubbas-sitelogoOn March 25, 2013 I took a taxi out to Hongqiao, a western district in Shanghai, to visit Bubba’s Texas-Style BBQ (now one of three locations).  Having grown up in the Lone Star state it is always interesting to meet fellow Texans in East Asia (there are not many of us… we do not have a reputation for being globe-trotters) and as it so happens the founder of Bubba’s is Kenneth Walker, from South Austin.

Kenneth has spent the last 16 years in Asia, 8 in Hong Kong and 8 now in Shanghai.  Prior to Asia he also had an 8 year stint in New York City, working as a PR specialist for Weber Shandwick, a large global PR firm.  And as he explained it to me, although he enjoyed cooking BBQ as a hobby throughout high school, it was not his intention to create his own barbecue joint in China, rather it was a matter of happenstance.

According to him, “While I was doing PR work in New York and Hong Kong, creating a BBQ restaurant was not something that I had really thought about.  It was not until much later, after I had arrived in Shanghai and sampled the local so-called “BBQ” that I realized there was an unmet market opportunity and I began putting together a business plan.  One of the initial challenges for me then and one of the challenges that all restaurant start-ups today must face in this city is finding a location.  When I finally decided to give this idea a try, I originally tried scouting locations whose tenants were already out of business.  The problem for me was two-fold: the first is that I had actually only been in the metro for less than a year, so I did not have a lot of connections throughout the city.  The second is that in contrast to other parts of the world, after a business closes shop, the ideal time to lease the real estate is not after it is fully closed down.  By then it is too late, as someone else always manages to make arrangements before you do – as I found time and again.  So I changed my strategy to look for establishments that were on their way down – that had seen better days.  The original Bubba’s here, was just that – a woman’s bar called Dragon Bar that was run by a couple of expat women.  A friend noticed the place and informed me about it.  So I stopped by one day and spoke to the lady who was thrilled to hear about the buyout idea.”

Kenneth was able to finally check something off the list: found the location.  And as I mention in Chapter 3, in busy areas like Raffles City (来福士广场), one of the most popular shopping malls in Shanghai, space may cost more than 15 RMB per square meter per day (a rate, which for the typical sit-down restaurant footprint can amount to several million RMB a year).  As a consequence several notable restaurants have closed this past year including Purple Onion, Funky Chicken, Public and The Fat Olive (yes those are real names, visit SmartShanghai for more).

What about supplies and decorations?  For anyone that has lived abroad for any long-term period, it can be difficult to find a number of creature comforts from back home.  And as is the case of football, to the chagrin of North American fans, sport memorabilia can be hard to find.  Yet walking around in Bubba’s, North Americans would feel at home with dozens of sport pennants and authentic jersey’s attached to the wall and even a trophy case with autographed footballs (including one from Tony Dorsett and Mack Brown).

Where did he get these?

“It started with a Michigan State fan a few years ago.  He gave me a Spartan pennant that I hung up on the wall.  And after other patrons saw this, they became riled up.  So I made it an open policy: if you bring it, I’ll hang it.  BYOB: bring your own banner.  So little by little I began to accrue what you see before you today.  Prior to this ambiance, all I had initially brought were a few of things I had with me: a flag of Texas, saddles and a golf club whose Tom Kite autograph was accidentally rubbed off later by a cleaning crew.”

Again, for disclosure purposes I will note that I do not own any equity in his firm.  I even paid for my own baby back ribs.  But as I later told my friends, these were the most authentic tasting Texas ribs I have eaten in this time zone and this is coming from a guy who growing up, regularly ate at Spring Creek and Dickies.  How did he do this?

“As I said, I had sampled the food of other local restaurants and what I found did not meet the standards I was used to back home.  And to make good BBQ you need to actually smoke the meat.  So I began looking for a smoker to import.  I had never done this before and I was unfamiliar with the import laws.  I did find a company in the US called Southern Pride who told me they could sell me one for $15,000 and that they had sold them abroad before.  After hearing they had exported 15 smokers to Asia back in the ‘90s, I then began trying to track down the one that ended up in Shanghai.  Somewhere in this city was a real smoker.  And as luck would have it, I found out that Hard Rock Cafe were the owners of the smoker – and that they closed the restaurant a few years earlier.  I got a hold of their previous GM and he told me that all of the store equipment was now in storage out by the airport and that it was all about to be removed in the next month.  So I drove out to this storage site, climbed around for a couple of hours with a flashlight in my hands and after crawling around old chairs, tables, automobiles and motorcycles, I found the smoker.  While it had been used as a rotisserie oven for chicken, it had never been used as a smoker, so fortunately it did not have any of the old smoker smell stained into it.  I was able to buy it for $2,000 and with the help of about 10 Chinese mover guys we put it onto a flatbed  truck and brought it to the now gutted Dragon Bar.”

While you may not be as fortunate as Kenneth was in acquiring kitchenware for your own restaurant, today would-be entrepreneurs have websites like Craigslist, Shanghai Expat and Delta Bridges to talk with others (both locals and laowai) to find equipment and potential store locations.

So Kenneth has found a location, a smoker and has a team to work with.  How did he turn it into the real deal?

“The next hurdle is finding some type of wood to smoke with.  Any fruit wood would work just fine, and I knew that apple wood was available as some of the Beijing duck restaurants were using it to smoke their ducks.   I found a local duck restaurant that used Applewood to smoke their ducks, and while they gave me a few sample pieces of wood, they would not divulge the supplier name or contact.  Later however, a friend I had placed in charge of logistics tracked down a company in Beijing that sells Applewood by the ton.  I was not very sure what a ton of wood looked like and was told they would deliver it in a 6-ton truck.  Thus I had a dilemma because I did not want to waste the storage capacity either.  At the same time I did not want to scare the neighbors or the authorities, if they saw a new business opening with piles of wood, what would they think?  So while I initially ordered a full 6 tons, at the last moment I cancelled half of the order.  When the truck finally arrived and we unloaded the wood, all 3 tons that were delivered ended up taking up half of the restaurant.  I got lucky because if I had ordered all 6, there would be no room in the restaurant.  Afterwards we manually moved each cord out behind the restaurant wall and this supply lasted for two-and-a-half years.”

Is the rest history?  Not quite, after all, even with everything in place you still need to cook a produce customers are willing to buy.

“Even though I knew how to cook BBQ, the first 3 months were hard.  I was here from 5am to midnight each day.  I eventually taught some local hires how to properly smoke meat and our initial menu included chicken, ribs and potato salad.  Sometimes, for recipes like a breakfast sausage that tastes like Jimmy Dean sausage for instance, I would do a lot of trial and error before finding the right combination of flavors that the customer was used to and wanted.  The restaurant also features my own secret barbecue cause and dry rub.  Later we expanded the menu to include burgers, pizza, seafood and Cajun style fish& chips.  We did have some Mexican food at one point but felt the menu was getting too cluttered so we culled it.  We might expand the menu again though, due to changing customer demand.”

What are some expansion possibilities and opportunities?

“I opened up the first Texas BBQ in all of China.  Because of my professional background I have done a lot of branding for merchandise like t-shirts and now social media.  I also organize an annual chili cookoff and an annual BBQ cookoff with multiple teams made up of local cooks around the metro.  Because the chili cookoff is an officially sanctioned event by CASI, the top 3 finishers earn automatic bids to the world championship held in Terlingua, Texas.  In addition, we have live bands at these events and more than 1,000 people attend, with about an 80% – 20% demographic split (80% foreigners, 20% local), which is about the same demographic customer base at Bubba’s locations.  We even work with Crown Relocations services to help manage the logistics of the chili teams, by picking up the kitchen equipment the day before and setting it up at the event grounds.”

CASI is the Chili Appreciation Society International and all Texans born north of the Guadalupe River are legally required to belong to it.   Crown Relocations services is 45 years old and according to its official FAQ, generates $766 million in annual revenue.

What are some of the challenges that business owners face?

“This can still be a challenging business culture because of the need to maintain guanxi, to maintain relationships with suppliers and various governmental bodies.  But larger cities like Shanghai, Beijing and Guangzhou have become increasingly business friendly.  There is a formal structure with forms and permits that have been streamlined over the years.  Potential business owners should also make sure to set-up a WFOE because it can be very risky creating a JV with a local partner like a friend or wife.  Too many risks associated with that.”

For more about guanxi Chapter 1 and WFOE (Wholly Foreign Owned Enterprise) see Chapter 10.

And other opportunities?

“While it will vary from location to location, but the team that gutted and renovated our first restaurant did so brick by brick.  They used the wood paneling from the bar to construct a ladder and reused the bricks to create a new wall in a different location.  This kind of resourcefulness occurs throughout many other construction sites all throughout the country.  And because of time saving methods like this, we were able to gut and then reopen the restaurant in about 3 months – a process which probably would have taken longer in other cities in the US.  Other opportunities that I see are a “dive” steak restaurant.  It is hard to find a really good steak for a decent price in this city.  When I was working in New York there were a couple of very inelegant restaurants that had nothing but graffiti on the walls, no frills or ambiance whatsoever.  The money you paid for the meat was used to buy the best meat for the money, so you got a great product, a delicious steak.  I think there is room for several of these “dive” restaurants throughout China, especially in bigger cities.  In addition, there are these pop-up trailers that are popular in certain cities of the US.  They are mobile units that cook ethnic food like from Vietnam and I have yet to see them here on the mainland, but could see them being very popular late at night and early in the morning near bars and clubs.”

For a review of these pop-up mobile food trailers in Austin see: Scrumptious Chef

With varnished bar stools hovering around wooden tables, a flat-screen TV with sports on in the background, sport pennants and white walls (as opposed to the pink and black décor of Dragon Bar), Bubba’s illustrates how a simple idea and bit of tenacity and luck can create a successful business in China.

For more info about Kenneth and Bubba’s BBQ see: Shanghai’s First Annual BBQ Cookoff: What’s Bubba got to say about it? from ShanghaiExpat and Austinite who introduced Shanghai to Texas barbecue to compete in Terlingua from Austin360

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Chapter 3 – Food and beverage

[Note: below is Chapter 3 from Great Wall of Numbers]

There is a famous proverb in Chinese called min yi shi wei tian (民以食为天) – eating is as important as the sky.1 Despite regional differences in dialects, in regulations and in climate, one universal rule on the mainland is that eating is one of the most important activities of the day.  While this may sound like a fortune cookie truism (which by the way, do not exist in China – I have yet to see one), with recent memories of plagues and famines in their mind, many Chinese residents pay close attention to what their next meal will be.  And how it will be cooked and increasingly, where it was grown.

And while they may have a reputation for spending some of the highest amounts of their annual income on food (28% in China versus 10% in the US, this is called Engel’s Law)2 and are simultaneously highly elastic (e.g., if food prices increase they will switch over to cheaper substitutes), their perpetual gastronomical vigilance is not unwarranted.3

During the summer of 2008, China was faced with a series of nationwide milk powder scandals in which 300,000 babies and infants were poisoned and six died from a chemical called melamine which local producers had added “to save money.”456 As a consequence, there was a subsequent surge in the importation of milk powder from abroad including New Zealand and Australia.7 All told 80% of imported dairy products were from New Zealand in 2012.8 And in Australia, Victorian dairy farms recorded a record $144 million in exports to China in 2011.9 In fact, China is now the largest powder milk importer globally as many families – out of concern of repeat poisoning – currently place higher value on imported brands.1011 As a consequence, Tmall, the largest e-commerce platform on the mainland, has begun importing baby formula from companies such as Nestle and Danone to be sold directly to Chinese customers.12 And milk is not the only dairy product that Chinese consumers are importing.  For example, despite being a new commodity to the mainland $139 million worth of cheese was imported in 2011.13

And to “secure” these supply lines according to Financial Review, China Investment Corporation (CIC), one of the world’s largest sovereign wealth funds, is actively seeking agriculture investment opportunities in Australia and other countries.14 In fact, the Beidahung Group, the biggest Chinese agricultural conglomerate recently purchased and is leasing 100,000 hectares in Western Australia and plans to invest up to $4 billion in Australian agriculture.15

In addition to the melamine fatalities above there have been scandals involving “gutter oil,” whereby cooking oil is collected and dredged from restaurant drains; clenbuterol and other chemicals are added to meat to “enhance” the taste yet is toxic; arsenic in frozen calamari and even tainted steamed buns crop up throughout the year.16 It is not unsurprising then that according to a 2012 survey conducted by Horizon Research Consultancy, a Beijing-based polling company found that 41% of those surveyed said food safety was a major problem, up from 12% in 2008.17 One residual ramification from this stark rise in concern comes from a 2012 report from Ipsos, a market research company, which found that due to food scandals “more than 60 percent of people would choose foreign brands more often.”1819

At the same time, in 2010 China exported $41 billion in agriculture such as garlic and onions, yet even among some of this purportedly screened produce, there have been food safety issues.  For example, this past summer a batch of strawberries originally grown in Shandong ended up poisoning thousands of German schoolchildren.  While the investigation is ongoing, the initial findings were that some of strawberries may have been contaminated with norovirus.20

Not quite soylent green

In a bid to protect consumers, an independent, private consumer watch-dog group called Zhichuchuangwai was started in 2011 to chronicle all of the nationwide stories involving food and beverage containments.21 In addition, the world’s largest food retailers (hypermarkets) including WalMart, Tesco, Carrefour and Metro have spearheaded an independent non-profit quality assurance consortium called Global Food Safety Initiative to produce food safety guidelines, harmonize food safety standards and create a certification framework for suppliers and distributors.

As China develops and the middle class grows, the demand for higher quality goods – safe goods – has led to an increase in opportunities for foreign brands which are perceived as meeting the highest safety standards.  For example, the USDA trade office in Shanghai reported that “the 82 foreign hypermarkets [in Shanghai] accounted for 78.6% of the total hypermarket sales volume in 2008.”22 These same hypermarkets also contain an increasing amount of food products (60% as of 2009).  Collectively the mainland hypermarkets is a $81 billion industry and growing.23 Yet before you decide to jump in and create yet-another-hypermarket, this area is fraught with nebulous legislation.  For example, in an effort to “protect” small and medium suppliers, on December 19, 2011 five ministries and committees issued a joint regulatory plan whereby they arbitrarily removed hypermarkets from being able to charge delivery fees, slotting fees, holiday fees and several other fees.24 This caused a lot of confusion and as a consequence retailers were essentially forced to resign their previous contracts with local suppliers.  In addition, these foreign “big box” companies face zoning restrictions that prevent them from competing with domestic retailers like Suning or Gome.2526

For perspective in this segment, in 2010 the two largest retailers in China were Vanguard and Lianhua, both of whom are state owned enterprises (SOEs), and they both generated more than $10 billion in revenue.  For comparison, privately run RT Mart (owned by Sun Art), Carrefour and Walmart generated 25-35% less, yet with a fraction of stores compared with their domestic competition.  For instance, Carrefour generated almost $7 billion in revenue from 182 stores compared with Vanguard, who had 3,155 stores.  In addition, not all private companies perform the same.  In 2012 Tesco closed several outlets in August and scaled down its expansion plans and Carrefour’s same store sales declined 6.1% in Q3 2012 yet RT Mart has thrived and plans to open 105 hypermarkets in 2013.27

In my own anecdotal observations, these large foreign-owned hypermarkets are continuously filled by Chinese and expats alike, even though some of the products cost significantly more than locally owned supermarkets are charging.  For example, as I mention later in Chapter 6, I had a bad bout with food poisoning while in China during 2011 and as a consequence both my Chinese and American doctors recommended that it is better to be safe than sorry – better to spend more on safer food now than pay for it later as an in-patient.  So several times a week I shop at a nearby CityShop.28 CityShop is an up-and-coming, locally owned and expat managed supermarket with 10 stores in the Shanghai and Beijing areas.  More than 80% of their products are imported from the US, Germany, Australia and other developed countries.29 And like Walmart and Carrefour, CityShop is packed with shoppers – both Chinese and expats – throughout the day.

In March 2013 I spoke with Lawrence D’souza, customer service director for CityShop.  He is originally from Goa, India and has spent his career managing a variety of supermarket chains around the globe.  For the last three years he has worked on the mainland at his current position and in his view there are a couple of challenges that while not unique to China, can be a hurdle for entrepreneurs.

In D’souza’s words, “one of the issues that all grocery stores face when trying to import goods is changes in duties and clearing customs.  So for example, recently it has become difficult to import certain products like organic foods which require the CCC stamp from the government yet may not be approved for a variety of unstated reasons.  On the other hand, items like organic milk from Australia are typically allowed entry.  So supermarket owners need to keep up-to-date otherwise they will have backlogs in their supply chain.  Another reason this is important to a grocery store like ours has to do with location.  Each of our store locations is placed in a different neighborhood with differing demographics.  So for example, one location may cater to a client base that is comprised entirely of mainland Chinese.  Another location may have a mix of businesspeople from Japan, Hong Kong and Taiwan.  And yet other locations may have 50% of their customers that are expats from the West.  As a result, we have to stock each store with different items that the target market wants, thus the consistency and flow of items is different.  Which brings us back again to keeping up-to-date with changes in the import rules so that way we can remain flexible to the demands of our diverse customer base.”  As mentioned in Chapter 1, CCC stands for China Compulsory Certificate and is required in order to import any item.  Furthermore, import taxes such as those on wine or breakfast cereal can vary throughout the year and the list of which is maintained by the General Administration of Customs (海关总署).  Additionally, all organic foods imported or produced locally needs to be approved by the China Organic Food Certification Center (COFCC).30

At the same time D’souza sees several untapped opportunities in this segment.  According to him, “because of the rapid development in the last several decades and scarcity of shelf space, there is a product gap, a lack of certain flavors and tastes as some of the food that supermarkets import on the mainland may not necessarily be of interest to customers from India, Russia or Southeast Asia.  For instance, there are between 40 to 50,000 Indian businesspeople and traders that work in Shanghai throughout the year, yet finding specific food like basmati rice can be difficult to locate in the metroplex.  One example in our own stores is that based on customer feedback we added avocados and guacamole throughout the year due to the popularity of Mexican food.  So other entrepreneurs could likewise satiate demand from ethnic niches and become successful doing so.  On the other extreme is volume and scale: the bigger the store, the more products you can stock.  Entrepreneurs and managers could try to emulate big-box stores such as Costco which may be able to keep costs low and process bulk orders to cost conscious buyers – but this also has its own share of inherent challenges.”

Another challenge that D’souza and others that I interviewed raised that is not unique to China is fixed capital costs.  Or in other words, leasing real-estate.  In busy areas like Raffles City (来福士广场), one of the most popular shopping malls in Shanghai, space may cost 15 RMB per square meter per day.  It is significantly higher in the case of supermarkets, 10,000 to 15,000 RMB per square meter or up to 50% of the total operating costs may come solely from rent.  Entrepreneurs should also be aware of the gestation period in receiving import permits and licenses.  According to several businesspeople that I spoke with, it may take 6 or more months to have all the paperwork processed and approved (photocopied, translated, verified), especially if it is a new type of food or ingredient that has never been sold in China.

However, before you come away thinking that hypermarkets and supermarkets throughout China are filled row-after-row with imported goods, the same USDA report noted that even international retailers “typically carry less than 1% imported SKUs” and that “imports rarely constitute more than 5% of total SKUs” even in high profile stores in large cities like Shanghai and Beijing (an SKU is a stock-keeping unit).  One of the reasons why this is the case is that few of the retailers have been able to build out a distribution network (e.g., cold storage) that they already have in Western countries on the scale that KFC has managed to do (as I note in Chapter 16).  What this means is that by-and-large, these same retailers typically still source their food from local suppliers.  This presents an opportunity to foreign distribution and supply chain management experts – to bridge the wide gulf between an increasingly wealthier consumer that would like to purchase imported products for quality and safety reasons versus the amount of imported goods that retailers are able to continuously stock.

Another opportunity is for cold storage experts as well.  For example, PFS (Preferred Freezer Services) is a joint venture between an American company and a Dalian-based company (Yida Group).  During the next several years they will spend more than 7 billion RMB ($1.1 billion) to build out a cold storage network across China, including a 40,000 ton facility in Shanghai.31 And according to Li Wanqiu, head of Zhongde which is a cold-storage consultancy, “Beijing alone built over 50,000 square meters worth of new cold storage warehouses in 2011.”32 The reason these are needed is that according to Datamonitor, “China’s frozen food market grew 9.9 percent annually between 2004 and 2009.”33  One of the reasons for why this marked increase in consumption has occurred is that as an economic develops and urban residents work longer hours, they have less time to cook.  So the demand for quick, easy-to-make meals such as TV dinners (e.g., Hungry-Man) increases.  Can your firm take advantage of this opportunity?

You don’t need to bet the farm

 In Chapter 16 I discuss the failures and successes of foreign owned and operated restaurants (such as KFC and McDonald’s) but even with their entry there is potential for additional competition.  For example, in October 2012 I interviewed Glenn Wilkinson an Australian who has lived in China for the past 25 years.  He is a Senior Consultant at Beacon Consulting, a Shanghai-based firm that specializes in corporate training and HR staffing.34 In his mind, one of the biggest opportunities for both foreign and local entrepreneurs is in the “food industry,” a very vibrant and dynamic market.

What he means by food for example, are the restaurants I listed above.  One of the reasons this is a vibrant market is that according to the National Bureau of Statistics, the restaurant industry as a whole has been growing 14% annually since 2007 “reaching two trillion Chinese yuan (US $319 billion) in 2011 to account for 11.3% of all revenue in the consumer products category.”35 The food-service industry (e.g., catering) jumped to $99 billion in 2011 also up 14% from a year earlier.36 Furthermore, as noted by Wilkinson and others interviewed, there is a high demand for a quality product due in part to safety concerns and in part because of a growing middle class.  For comparison, retail sales in China have risen an average of 17% for each of the last five years and the luxury goods market (see Chapter 11) is expected to grow 20% a year for the next decade.37

Yet to be even handed, enthusiasm should be tempered due to policy changes from the top.  According to the China Cuisine Association (CCA) that due in large part to Xi Jinping’s (the new President of China) fight to stop waste of public money on extravagant meals, the CCA recently conducted a survey that found, “60 per cent of nearly 100 restaurants saw bookings cancelled recently, with one Beijing-based outlet reporting an 80-per-cent drop in sales.”38 Furthermore, “The survey found that business owners felt pessimistic about the outlook of the industry.  They think it’s necessary to readjust their business models to adapt to the new market conditions.”  Prior to the new national policy, the average monthly failure rate of restaurants was 15% in mid-2012.39 Thus the risks involved in setting up a new food & beverage establishment arguably have changed and that failure rate may increase in the short and medium term.

While each city has different rules regarding local partnerships and minimum registered capital requirements, the restaurant business is relatively open to market participation (e.g., certain districts in Shanghai require a $150,000 minimum in registered capital).40 While you would need to do your own fact-finding exploration to measure the return-on-investment, based on anecdotal evidence, it appears that mainland Chinese are apt to eat foreign food just as voraciously as they eat domestic food.

For example, in 2002, Element Fresh was founded by two foreigners, Scott Minole and Sheldon Habiger, has since opened 13 stores in Shanghai, Beijing and Guangzhou.  While a bit on the expensive side, in my mind the quality of the salads more than make up for the price.   In 1999, Bob Boyce from Montana co-founded Blue Frog with his business partner Kathleen Lau.41 I have visited two of its 9 locations (there are 6 in Shanghai and 3 in Beijing) in part because they have great specials on Monday’s and because the burgers are some of the best in the city.   Also in 1999, John Christensen of Denmark founded Wagas, a delicious sandwich shop that I have personally frequented several dozen times.  There are now 25 and counting Wagas locations in Shanghai alone and one in Beijing.

One of the reasons these Western-style restaurants are finding success is as I note in Chapter 15, you have several million Chinese residents who have lived, studied and worked overseas and some of them now enjoy Western food.  For example, according to one estimate by the government, 186,000 Chinese living abroad moved back to China in 2011.42 According to the China Tourism Agency, 70 million Chinese tourists traveled overseas in 2011 and an estimated 82 million traveled overseas in 2012 (who spent $98 billion).4344 McKinsey & Company estimates this number will climb to 94 million by 2015.45 And by 2020, Boston Consulting Group predicts that “China’s total outbound market [will] likely be three times as big as Japan’s.”46 In addition, nearly one million Chinese students now study overseas, including more than 190,000 in the US alone.47 Thus, the Chinese middle class is increasingly familiar with Western-flavors and styles.  And if my own anecdotal experience is any indication, restaurants like Wagas and Blue Frog, while popular with expats, are also quite popular with locals as well – some nights accounting for 90+% of the customer base.  Perhaps you could create a BBQ or Tex-Mex franchise, both of which there are currently few market participants.

Simultaneously, domestic firms whose management understands these dynamic tastes are not sitting idly by.  For example, the Alibaba Group, the largest ecommerce internet company in China (owner of Taobao, Tmall and Alibaba.com) is developing a new procurement system to bridge consumer demand with foreign, international suppliers.4849 According to its founder, Jack Ma, “Tmall will work with the center to build a database of international suppliers that Chinese consumers are most interested in.  It would then collect orders to make group purchases.”50 The new system is expected to be rolled out within the next two years and part of the domestic plans is to deliver anywhere on the mainland within 24 hours.51

Tastes and flavors from home

In March 2013 I spoke with Charles Zeng, founder of Piro, a restaurant and bar located in Shanghai near Jing’an Temple.  Zeng is originally from New York City and previously worked in the financial industry before moving to Shanghai.  After some cursory research he saw an unmet demand: tasty Western food with a normal price tag.  Thus two years ago he setup shop, teaching himself how to cook, learning as he went.  In his words, “while both of my parents were originally from Shanghai, they moved to the US about 30 years ago.  Yet despite this cultural connection, starting up the restaurants was still difficult for me due to a lack of guanxi and knowledge of the regulatory climate.  The learning curve was steep but based on my research I found that there was not enough American-style food for a price that both expats and locals could afford.  And so despite the hurdles I have turned this project into a profitable business venture and definitely think that there are a wide range of opportunities for more competition in this food and beverage area.”

In his view, obtaining the necessary licenses and permits and meeting the food code regulations are an ongoing challenge that all business owners must face.  Specific opportunities beyond food that he sees are “niches such as micro brews, craft brews – there are currently not many out here despite the enormous consumption of beer and liquor.  More specifically, craft beers that are higher value, top-shelf products.”  In 2011, 50 billion liters of beer were consumed in China compared with 24 billion in the US and 9 billion in Germany.52  With $1 billion in industry profits in 2012, China is the largest beer market by sales and Nomura forecasts that profits will rise to $9 billion in 2021.  Yet according to Accenture, 85% of the domestic beer market is “comprised of low-end domestic beer brands” such as Tsingtao which sells a 330 mL bottle for $.32 (for comparison, a similarly sized Budweiser costs $1).53 Thus, Zeng sees this as an opportunity to serve a niche market that will invariably grow as consumers become more familiar with what the market offers.  Maybe your local microbrew club could find success, like Carlsberg has attempted to do, as it recently bid to takeover Chongqing Brewery Company for $461 million.54

Yet to temper visions of immediate grandeur, consider champagne and chocolate.  In contrast to the large amounts of wine importation (see Chapter 11), the consumption of champagne remains relatively subdued.  Only 1.3 million bottles of champagne were sold in China in 2011 compared with 1.3 billion bottles of red wine during the same year.55 Similarly sales of other red wines to China from areas such as Germany remained muted because of lack of brand awareness (i.e., Chinese consumers are unfamiliar with German brands).56 In other food segments, chocolate consumption also remains low-key on the mainland.  The average Chinese consumes a mere 100g of chocolate a year; in comparison the average Japanese eats 11 times as much, an American eats 44 times as much and a German eats 82 times as much.57

And if you own a farm

Roughly 2% of all American’s work in the most productive agricultural industry in the world; an industry which not only feeds the 3rd largest populace but also grows and exports significant portions of the world’s caloric intake (up to 20%).  In 2011, the US exported a record $137 billion in agricultural products globally and China imported a record $20 billion from the US (surpassing Canada).58 In fact, due to a variety of reasons, in 2011 China became the largest importer of agriculture.59 Among other products, US farms exports soybean, rice, corn, cotton and pork to China.60 And in part because of a variety of domestic policies in China (discussed in Mark DeWeaver’s new book61 ), China is essentially dependent on the US for food security and thus is investing in and buying secure supply channels to improve its livestock.

For example, the New York Times noted this past spring that the US, “exported a record $664 million worth of breeding stock and genetic material like semen in 2011.”62 Who is buying this material?  In 2011, Chinese companies “bought $41 million worth of live breeding animals and genetics.”

Why are they buying this?  The New York Times quoted, Ronald Lemenager, a professor of animal sciences at Purdue University in Indiana, who said, “[w]hen you have a nation’s diet changing as rapidly as China’s, the most efficient way to build up production is to improve your animal genetics. We have the genetics they want.”

Thus, if you own or operate a farm in the US, not only can you export your products to China, but you can probably provide services to improve China’s knowledge base of breeding and husbandry.63

Domestic initiatives in agribusiness 

As I detail later in Chapter 14, NetEase is the 2nd largest tech company in China.  Its founder is William Ding who is investing a significant portion of his personal multi-billion dollar wealth in agriculture.  He along with his company “have set aside $16 million for agricultural investments” such as an organic piggery stocked with 5,000 pigs “raised and sold under conditions that can satisfy health-conscious consumers spooked by China’s many food safety scandals.”64

How large is this organic industry?  According to Du Xiangge, chairman of the China Federation of Organic Agricultural Movements (CFOAM), “Only 1.9 million hectares of land are used for growing organic vegetables in the country, less than 1 percent of all farmable land.  It is possible that the ratio could reach 5 percent over time.”65 Thus there is ripe potential for investors such as SAIF partners a domestic private equity (PE) fund that finances specialty shops like LohaoCity which sells organic health food in Beijing and Tianjin.

And on the other end of the spectrum is Peter Zhang a former-chemical engineer at a large SOE (and an autodidact) who is originally from Heilongjiang in the northeast.  Over the past several years he has retrained and retooled to become an English teacher, yet in an effort to hedge against food safety he has retrained yet again, becoming proficient in agribusiness and has leased several dozen hectares in Southeast Anhui province to grow organic produce, primarily fruits and vegetables, for his friends and family.  Zhang told me in November 2012 that, “I am concerned about food safety issues and have invested my personal savings into growing quality produce for my family and friends.  I belong to the middle class, I should be able to afford the quality of food that previous generations have in the past, yet due to inflation and a number of other macro factors, cannot.  So I have invested our savings into a dozen hectares of crops including carrots, rice, pears, cherries, grapes and even free-range chickens.  And after you get through the inconvenient paperwork, land is relatively cheap to lease outside of urban areas thus making the whole endeavor worthwhile.”  He is leasing roughly 80 acres (around 500 mu or亩) for about 30,000 RMB ($4,800) a year based on a 55-year lease between the government and rural farmers who exchanged the land with him (the typical lease on the mainland is 50-70 years, after which time ownership automatically reverts back to the state).

According to Zhang and others I have spoken to, inflation has pushed the price of chicken past a psychological “100 yuan per pound” line, a price that makes eating high-quality chickens unaffordable to those living, ironically, in larger cities.66 Why have these prices increased?  According to the Ministry of Agriculture, “urban Chinese increased their consumption of chicken 219% per capita from 1983 to 2006.”67 What Zhang is also referring to are consumer price index (CPI) increases which have added transportation and storage costs for farmers that bring poultry and produce from outlying farms due to a nascent supply chain network and cold storage network discussed earlier in the chapter.  For example, while CPI increased at a relatively low 1.7% in October 2012, roughly two years ago in January and February of 2011, CPI in China increased by nearly 5%, led in part by a 10% increase in food costs.6869  Similarly, the CPI index rose 3.2% in February 2013, a 10-month high due to a 6% increase in food costs – more specifically, residents in Beijing pay more per pound than their peers in Boston70 Yet to give you an idea of how this fluctuates and differs according to category, in mid-February the average prices of 21 different vegetables declined 11.2%.71 And since Chinese consumers spend a significantly larger portion of their disposable incomes on food (28% in China versus 10% in the US72 ), even a relatively small increase in price of staple goods is immediately felt.

Zhang also noted that one of the main reasons he and his family have become increasingly vigilante about what they eat is “because our trust and our faith in domestically owned restaurants has been shattered due to milk powder poisoning, gutter oil, fake honey and even moon cake scandals.”  While each region varies, roughly half of all honey currently sold in Shanghai is reportedly fake, comprised of substantially cheaper substitutes made of syrup and gum.73 Moon cakes are a traditional dessert made and given as gifts during Midautumn Festival usually held in September.  Over the past several years, investigations have uncovered several domestic mooncake producers, who in an effort to reduce costs have reused and resold both filling and entire inventories of mooncakes – made from previous years – to customers believing that they were buying newly made desserts.  For example, in 2003 a Shanghai-based company, Guanshengyuan, “was caught making mooncakes with expired and mildewed fillings.”74

He also mentioned that similar scandals have taken place at grocery stores and restaurants that dyed rotten pork to make it look younger and “leaner,” dyed noodles and even sold fake steamed buns.75  He is referring to a scandal in 2011 in which 17 noodle manufacturers in Dongguan added ink and paraffin wax “to give their products the look and texture of more expensive varieties.”76 In addition, while there have been several steam bun scandals, one of the most recent notables cases is the Shanghai Shenglu Food company, which added food coloring to lower costs (e.g., turning corn flour buns into a different color) and repackaged expired buns.77

This is not to say foreign restaurant chains are scandal free.  KFC advertised that its soybean milk was freshly ground, when it was not; and its chicken suppliers in Shandong may have used antibiotics to fatten the chicks faster (same-store sales declined 37% in January 2013 as a result).78 In fact, to alleviate food safety concerns, in February 2013 KFC announced that it was launching a new quality assurance program and cutting out small farmers due to the difficulty in overseeing them.79 Ajisen Ramen (a Japanese noodle restaurant) claimed its soup was made from bone-based broth, which upon further investigation turned out to be highly diluted (e.g., “a concentrate”).80  And a McDonald’s outlet in Shenyang reportedly served laundry detergent instead of a Coca-Cola.81

Yet perhaps by partnering with these entrepreneurs, foreign agriculture companies can establish a foot-hold on the mainland and satiate consumer demand.  And as I discuss later in several other chapters (notably 11 & 12), branding, trust and market perception are distinct advantages that foreign firms typically have when entering the mainland market.  This is in part because of the immense resources invested in quality control programs (e.g. Six Sigma) by foreign brands in order to proactively innovate and prevent any potential quality-based scandals from ruining their company images.  In contrast, this kind of branding issue is not taken as seriously on the mainland as it is elsewhere which itself creates an opportunity for brand marketing consultants.

Changing times

According to China Daily, a substantial portion of businesspeople in Zhejiang have moved away from the low-end, low-margin manufacturing industry to agriculture.82 In fact according to the Zhejiang Provincial Administration for Industry and Commerce, “the average annual amount of money invested in agriculture by Zhejiang businessmen has exceeded 10 billion yuan over the past five years.  The total amount reached 20 billion yuan last year.”83 Could your ag firm work with these businessmen in modernizing their farms?

Or maybe foreign companies that build or design automated farming equipment (e.g., robotic fruit pickers) can find demand for products in an industry that is still largely based on manual labor.  For example, according to a 2010 statement from China’s Ministry of Agriculture, “in corn production, the mechanization rate for sowing has reached 72.5%, but the mechanization rate for harvesting is only 16.9% and has become the bottleneck for corn production.”84 In 2012 this figure was updated and the new estimates for the overall mechanization rate for corn harvesting is now 38%.85 In contrast, in the US both planting and harvesting of corn are fully mechanized.  In fact, through the use of mechanization and genetically modified crops, an acre of US farmland “yields twice as much corn as in China or Eastern Europe and four times as much as in India.”86 Yet mechanization, as shown in the statistics above, is increasing rapidly on the mainland and according to a recent Reuters report, “[m]ore than half of China’s ploughing, planting and harvesting is carried out by machines, compared with a third a decade ago.”87 In fact, the 2011 harvest yields in Heilongjiang province broke nation-wide records, rising 11% over the previous year due to “bigger and better machinery for threshing and plowing.”88

And according to Der Spiegel, one of the reasons German companies purchased the imported strawberries from Shandong in the first place (see the strawberry story at the beginning of the chapter) was because strawberry picking robots capable of washing and cutting are an unknown variable – hence the relatively cheaper labor costs in China provided a cost advantage that neighboring countries did not have (at the time).89  In fact, because of relatively high labor costs in California, farm companies have begun looking for robotic alternatives such as prototypes from Vision Robotics that while still on the drawing board, have the potential to assist and replace manual human labor.90 Similarly, German and Californian agribusinesses may even be interested in a project unveiled two years ago: Japanese researchers demonstrated a robotic system that can identify the ripeness of a strawberry which enables the machines to “cut harvesting time from 500 hours to 300 hours.”91 Thus if you and your company build the agribusiness machines or software that powers the machines, you may be able to find new revenue sources in China.

Yet there are two sides to every coin.  As one Chinese source recently told me, “the potential for opportunities for foreign firms remains high in the agriculture industry because it is still largely underdeveloped.  Compounding the issue is that much arable land has been seized from farmers for real estate development during the urbanization process, and major labor forces have migrated from the farmlands into the cities, which leads to worries that the current food production capacity may not meet the growing food demand for the populace.”9293 For example, between 1996 and 2008, arable land decreased from 130 million acres to 121 million acres.  Another estimate put the loss at 123 million mu (one mu is about 1/6 of an acre).9495 Thus China must either import food or modernize its agricultural industry to increase production to make up for the food shortage.96 Simultaneously there are regulatory hurdles that sometimes require technology transfers from foreign agriculture firms to Chinese companies.  For example, seed companies like Monsanto must team up with local partners in order to gain market access.  Yet, these provisions have not prevented Monsanto from increasing both earnings and market share – and it plans to further boost investment on the mainland.97

Takeaway: as China develops, its middle class will have more funds and resources to allocate towards food and beverages.  US businesses and entrepreneurs are already providing both products and services in the form of agriculture, knowledge and physical storefronts.  Yet because of the continued growth, there are still opportunities to start new restaurants or even restructure and train a largely non-mechanized agriculture workforce to the industrial-scale agribusiness that is the envy of emerging markets.  Chapter 12 discusses how you can establish a brand in China through its diverse domestic social media networks.


Endnotes:

  1. A Chinese friend suggested that I provide an explanation to this phrase.  The complete phrase is wang zhe yi min wei tian, min yi shi wei tian.  While wang zhe means emperor, according to him the key to this is the last word “tian.”  Tian on its own is literally ‘heaven’ or the sky over our heads.  But this phrase should be better appreciated in the context of its originator, a Minister Guan Zhong of the powerful Qi Kingdom of the Spring Autumn (1st half Eastern Zhou) period, who meant to use tian here as in “tian ming” – the mandate from heaven (to rule over the people).  Properly understood, the five character phrase ending should correctly translate to something like “the government’s mandate (king or prince) to rule is founded upon its ability to feed the people.”  Or, in the more sophisticated form of political advice: “hunger breeds discontentment.” []
  2. See Agriculture Commissioner Todd Staples says that Americans spend less of their disposable income on food than individuals in Mexico, China and Russia from PolitiFact and Meet the 2020 Chinese Consumer from McKinsey & Co. []
  3. Seniors aged 55 to 65 in China’s largest cities spend half their expenditures on food and only 7% on apparel, according to Ogilvy data, while those a decade younger allocate 38% of their spending to food and 13% to apparel.  See Targeting Grandpa: China’s Seniors Hunger for Ads from The Wall Street Journal []
  4. See Chinese figures show fivefold rise in babies sick from contaminated milk from The Guardian, Two get death in tainted milk case from China Daily, Timeline: China milk scandal from BBC, and 毒牛奶事件 from Yunnan News []
  5. China dairy industry whistle-blower dies after assault from South China Morning Post []
  6. Another reason milk powder is in high demand is that milk powder companies have successfully convinced families that powder makes babies more “chubby” and therefore healthier than being breast-fed.  See Breastfeeding faces challenges in China from Xinhua  and Breastfeeding flashmobs: Chinese mothers are abandoning formula from The Telegraph []
  7. See Baby food sails out with Chinese crews from The New Zealand Herald and Dollar falls as tariff raised from The New Zealand Herald []
  8. This trend may not last as Chinese consumers and government officials have began investigating a claim regarding dicyandiamide, or DCD that has purportedly contaminated some milk powder from New Zealand.  See Ministry acts on dairy safety from China Daily []
  9. Farmers to milk China’s taste for cheese from The Australian []
  10. Hopes wane for China whole milk imports from agrimoney []
  11. 美赞臣等洋奶粉仍热销 国产奶粉再沦陷消费者失去信心 from Qbaobei []
  12. Tmall announces cooperation with foreign baby formula companies from Xinhua []
  13. Foreign cheese firms eye big slice of China’s market from China Daily []
  14. China targets dairy industry from Financial Review []
  15. Chinese buy farms for food from The Western Australia []
  16. See The Shandong Oilman from Caixin and Maggots in the Pasta: Europe Screens Tainted Chinese Food from The New York Times []
  17. See Survey: Half of Chinese like US ideas on democracy from Associated Press and McDonald’s says food giveaway not tied to China’s TV show on Corporate Shame from South China Morning Post []
  18. The consuming challenge of food safety from China Daily []
  19. For an illustration of why and which foreign items are purchased in China see this excellent infographic: Why Do Chinese Consumers Pay So Much for Foreign Brands? from East-West Connect []
  20. See The Hidden Price of Food from China from Der Spiegel and No contamination found on China-exported strawberries: watchdog from Xinhua []
  21. The consumer report site is Zhichuchuangwai []
  22. China Retail Report from the US Department of Agriculture Trade Office in Shanghai []
  23. Sea Bass With Barbie Dolls Challenge Wal-Mart in China from Bloomberg []
  24. China Retail Report from the US Department of Agriculture Trade Office in Shanghai []
  25. Chinese retailers give global giants run for money from The Hindu []
  26. Walmart, Tesco, Carrefour finding it tough to do business in China from The Economic Times []
  27. Sea Bass With Barbie Dolls Challenge Wal-Mart in China from Bloomberg []
  28. This is not an endorsement of their services as there are other chains that provide high-quality imported food as well, such as Ole’ – which is owned by CR Vanguard (華潤萬家), the largest grocery company on the mainland.  Another competitor is Metro (麦德龙), a German-owned chain. []
  29. CityShop []
  30. China Organic Food Certification Center (中绿华夏) []
  31. Cold storage industry sees a hot market in mainland from China Daily []
  32. In Beijing, cool profits from sub-zero storage from smartplanet []
  33. Ibid []
  34. Beacon Consultancy []
  35. China’s restaurant industry shows strong growth potential from Want China Times []
  36. This double digit increase is expected to decline due to a maturing market and a crackdown on government banquets in 2013.  See New Bureaucratic Diet Takes Bite Out of Restaurants, Hotels from The Wall Street Journal []
  37. Chocolate-makers seek to whet China’s appetite from Asia One []
  38. Mainland restaurant takings plummet as party order cadres to tighten belts from South China Morning Post []
  39. Ibid []
  40. For a step-by-step guide on forming an WFOE see China’s Approval Process for Inbound Foreign Direct Investment from the US Chamber of Commerce.  See also Forming A China WFOE. How Long Will That Be Going On? from China Law Blog and Selling In And Into China. Four Good Tips And Mine. from China Law Blog []
  41. Interview: Bob Boyce, owner of Blue Frog and KABB from Shanghaiist []
  42. Reverse brain drain: China engineers incentives for “brain gain” from Christian Science Monitor []
  43. See Demystifying the Chinese traveler from CNN and Chinese rush overseas for holiday from China Daily []
  44. While Chinese consumers typically trust foreign brands (as shown in Chapter 3) they are increasingly vigilant against scams and cons as well, especially while traveling abroad.  See Tourist: We were conned from The New Zealand Herald []
  45. Chinese Choosing Prada Over Louvre Boost Luxury Shares from Bloomberg []
  46. Chinese check-ins from The Economist []
  47. In 2011, the US embassy in China issued more than 160,000 student visas for Chinese students to study at American schools.  Yet a November 2012 report from Open Doors notes that the actual number is even higher, 194,029.  See Ten Years of Rapid Development of China-US Relations from Xinhua and Students from China add $5b to US economy from China Daily []
  48. The goal Sales at Tmall and Taobao combined to reach $157 billion in December 2012, a new record.  See RMB 1 TRILLION: Alibaba Shopping Sites Hit a Sales Milestone from Alizila []
  49. According to a recent Morgan Stanley research note, Alibaba is worth between $66-128 billion and Alibaba continues to diversify into other areas of e-commerce including notably a new search engine through its Aliyun brand.  See Morgan Stanley’s Latest Alibaba Estimates Suggest It’s Worth $66 – 128 Billion from Forbes and China’s E-Commerce Giant Now Has a Search Engine to Take on Baidu and Google from Tech In Asia []
  50. Tmall Plans to Link China’s Consumers with Foreign Goods from Caixin []
  51. The plans are being rolled out together however the domestic 24-hour delivery service is expected to be completed within 1 year.  See 马云1000亿建电商物流 目标全国任何地区24小时内送达from ifeng. []
  52. China beer consumption hits the 50 billion litre mark for first time in 2011 from Mintel []
  53. In the battle for China’s beer drinkers, the $0.32 brew is still king from Quartz []
  54. Carlsberg launches take-over offer for Chinese brewer from Reuters []
  55. Putting some fizz into the wine market from China Daily []
  56. German winemakers seek to win over the Chinese from Deutsche Welle []
  57. Chocolate-makers seek to whet China’s appetite from AsiaOne []
  58. See US agricultural exports to China become costly in times of drought from Global Post and U.S. chief agricultural negotiator sees bright future for exports from the Agricultural Communication Services []
  59. China Overtakes U.S. as Largest Crop Importer, WTO Data Show from Bloomberg []
  60. Chinese farmers produced 50 million tons of pork in 2012, more than half of the world’s total.  See How China’s love affair with pork is creating a pollution problem from The Guardian []
  61. Animals Spirits with Chinese Characteristics by Mark DeWeaver []
  62. From the U.S., a Future Supply of Livestock for China from The New York Times []
  63. According to one estimate at the US Department of Agriculture that I spoke with, building a new corn or soybean farm in the US may be profitable with current prices, especially since both of these crops are in high demand from China. []
  64. Game Boy: Billionaire William Ding Lei Has A Few Fantasies Of His Own from Forbes []
  65. Backed by Profit-hungry Investors, New Approach to Farming Takes Root from Caixin []
  66. This is not to say all produce has increased in costs.  For example, there has been a cabbage glut that has put many farmers in northern China in a bind.  The cost of cabbage harvest and transportation costs more than what could be made selling the produce at the market.  Thus some farms have allowed the public to gather cabbages for free and in some cases even let the cabbage rot in the fields.  See Cabbage price drop hurts growers, wholesalers, grocers from China Daily []
  67. Cheap food may be a thing of the past in U.S. from Los Angeles Times []
  68. See China’s food inflation leaving a bad taste from Globe & Mail and China’s inflation eases to 1.7 percent in October, giving room for more stimulus from Washington Post []
  69. China CPI in December 2012 rose to 2.5% and has spurred interest in looking for ways to reduce farm distribution costs.  See China moves to cut farm produce distribution costs from Xinhua []
  70. Meat prices add to China’s inflation, policy risks from Reuters []
  71. China’s farm produce prices down from China Daily []
  72. See Agriculture Commissioner Todd Staples says that Americans spend less of their disposable income on food than individuals in Mexico, China and Russia from PolitiFact and Meet the 2020 Chinese Consumer from McKinsey & Co. []
  73. Fake honey sales called rampant, hard to detect from Shanghai Daily []
  74. Bad moon rising: China’s mooncakes won’t keep from Want China Times []
  75. From Milk to Peas, a Chinese Food-Safety Mess from International Health Tribune []
  76. See China wrestles with food safety problems from Los Angeles Times and Noodle makers in hot water from China Daily []
  77. 3 arrested over Shanghai steamed bun scandal from China Daily []
  78. See Yum stumbles badly in China, warns on profit from Reuters, ‘Kentucky Fried China’ no more? from Reuters, Yum’s Yuck Factor in China from The Wall Street Journal, Yum’s chicken in China contained excessive levels of drugs from Reuters, CCTV report says KFC chickens are being fattened with illegal drugs from South China Morning Post and China Chicken Probe Hurts Profit as KFC Ends Deal: Liuhe from Bloomberg []
  79. Yum Makes Cuts to Supply Chain in China from The Wall Street Journal []
  80. Some foreign fast food is harder to swallow from China Daily []
  81. Shenyang McDonald’s apologizes after woman served detergent from Want China Times []
  82. Manufacturing, mining and construction represent approximately 45-48% of China’s GDP; in contrast, services accounted for 44.6% of China’s GDP in 2012.  While there are and will continue to be opportunities for manufacturing, the service industry continues to grow at a fast clip.  Yet as a number of the people I interviewed noted, services are intangible, physical goods are much more tangible so it can be a lot of hard work educating consumers about the value proposition in paying for something less concrete than they are used to.  How long will it take to educate them to appreciate this quality?  How to differentiate your company from local competitors like Newegg tried to do?  See Chinese Graduates Say No Thanks to Factory Jobs from The New York Times and Served in China from The Economist []
  83. Entrepreneurs turn to the land for profit from China Daily []
  84. Another innovation that may assist in the merging, acquisition and development of agricultural land is satellite imagery which is now being used as part of a land reform project being piloted in Anhui.  See China’s big step in rural reform; mapping tiny plots of farm land from Reuters, 加快推进玉米收获机械化 力争2015年玉米主产区机收水平超过50% from the Ministry of Agriculture and All About Corn by Cathy Gao Jing []
  85. 农业部:全国“三秋”农业机械化生产迅速展开 from The Central People’s Government of the People’s Republic of China []
  86. Monsanto Needs to Put Doubts to Rest from The Wall Street Journal []
  87. Analysis: China turns to machines as farmers seek fresh fields from Reuters []
  88. Ibid []
  89. The Hidden Price of Food from China from Der Spiegel []
  90. Farms Fund Robots to Replace Migrant Fruit Pickers from Wired []
  91. Strawberry-picking robot knows when they’re ripe from c|net []
  92. This is not to say similar “eminent domain” cases do not take place in other countries.  See China’s cabinet warns of rural land expropriation from Xinhua, China’s giant, deserted malls wait for reluctant consumers from The Globe & Mail and Henan city refuses to stop clearance of graves to make farmland from South China Morning Post []
  93. This is not suggesting that China is facing a looming plague or food shortage as a whole.  Yet despite a record grain output of 589 million tons in 2012, according to Xinhua, China throws away enough food to feed 200 million people each year.  Another estimate from China Agricultural University states that 50 million tons of food is wasted annually (10% of China’s annual grain output) due to poor storage techniques and rot during transportation.  These statistics have become talking points recently during a government crackdown on waste and corruption targeted at government banquets where food is often left uneaten.  For comparison, according to the Food and Agriculture Organization (FAO), one third of all food grown globally is lost or wasted each year (amounting to approximately $1 trillion).  Another recent report from the Institution of Mechanical Engineers states that as much as half of all food produced in the world ends up wasted each year.  See Curbing food waste from Xinhua, China’s anti-waste campaign revives frugal spirit from Xinhua, Grain supplies still not secure from China Daily, Assuring Chinese Finish Their Live Lobster Sashimi from Bloomberg and Almost half of the world’s food thrown away, report finds from The Guardian []
  94. Shortage of farms and water threatens grain output targets from China Daily []
  95. Shrinking arable land threatens grain security from China Daily []
  96. This is called a “grain security” issue that Chinese policy makers and analysts have been increasingly discussing over the past several years.  Some have noted this is equivalent to the “Western dependence” on Middle East petroleum.  See Keep a red line for arable land from China Daily and Grain supplies still not secure from China Daily []
  97. See Monsanto Sees Greater China Investment on Par With Brazil from Bloomberg and Monsanto Needs to Put Doubts to Rest from The Wall Street Journal []
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