Chapter 8 – Sports

[Note: below is Chapter 8 from Great Wall of Numbers]

In 2011 I was teaching at a college in Zhongshan, Guangdong – a mid-sized city in the Pearl River Delta manufacturing region of southern China.  During lunch I would regularly eat at the campus cafeteria.  The faculty dining area was in a separate room connected with the main student dining area.  Throughout the month of June, the students – typically men but also women – would pack their dining area to catch a glimpse of the NBA playoffs on TV’s hanging from the ceiling (and also because it was one of the few rooms with reliable air conditioning – unfortunately their dormitories only had fans).  For nearly an entire month the area was crowded almost shoulder-to-shoulder, even during final exams.  And on numerous occasions, my students, including one named Jason Xu from Dongguan, asked me repeatedly to bring back basketball ‘high tops’ whenever I traveled back to the US.  This task typically involved looking through Eastbay catalogs with them and listening to their dreams of one day wearing “authentic” NBA apparel.

Is this just an isolated group of NBA fans?  No, according to sport consultant Matt Beyer, “the NBA has close to 30 official corporate partnerships specific to China.”1 Thus while you may see Chinese apparel companies advertising in the background during an NBA game – if the student body at the college in Zhongshan is any indication – there is a similarly large potential for US brands to advertise in the Chinese Basketball Association (CBA) as well.

In fact, commissioner David Stern estimated that the NBA’s revenue generated from China will reach $150 million in 2012 (based on television and digital broadcast rights).  And according to Stern, “NBA viewership in China rose 18 percent last year [2011]” and will grow 10% a year for the foreseeable future.2 Furthermore, CCTV 5, a state-owned TV station that focuses on sports recently signed a new agreement with the NBA to increase its live-coverage, programming and analysis based on content “produced exclusively for China.”3 The NBA’s relationship with CCTV 5 dates back to 1987 when the All-Star game was broadcast on the mainland.4

What kind of sponsorships takes place in this cultural-sport trade?

For instance, while Yao Ming has a $10 million contract with Reebok, in 2006, Shaquille O’Neal signed a five-year sponsorship deal worth $1.25 million with Li-Ning (and later expanded to $6.2 million and again to $10 million).56 Li-Ning is one of the largest sports shoe and apparel companies in China, with $1.4 billion in revenue for 2011.7 Similarly, O’Neal’s teammate, Dwayne Wade recently cancelled his sponsorship with Nike and signed for a percentage of equity stake with Li-Ning.8 Yet for comparison, Nike did more business in China alone in 2011 ($2.1 billion) than Li-Ning’s total global revenue.910 And for perspective, according to Boston Consulting Group, the apparel market in China is expected to generate $204 billion by 2020 (triple from 2010).11

How popular is basketball on the mainland?  According to Ying Wushanley, a professor at Millersville University:

It is estimated that more than 300 million people play basketball throughout China; NBA games are watched by more than 30 million viewers per week; retail stores are saturated with NBA merchandise; NBA.com/China has become the most popular single sports website in China; and NBA is consistently the most searched sports term on China’s top search engine Baidu.com.12

The Chinese Basketball Association (CBA) is the top professional league in China.  It has been around since 1995 but has had its share of growing pains.  According to FORTUNE magazine, the league incurred a loss of nearly $17 million in the 2008-2009 season because a significant portion of the expenses go towards recruiting overseas talent.13 For example, in October 2012 Tracy McGrady, a seven-time All-Star for the Houston Rockets signed a $1 million annual contract with the Qingdao Eagles of the CBA.14 Two weeks later he was greeted at the airport by a huge fanbase, which itself attracted media coverage.15 Even non-CBA players are sometimes hot commodities.  For example, this past summer, Jeremy Lin (林书豪 of ‘Linsanity’) signed a two-year sponsorship agreement with KFC, both of whom have huge followings on the mainland (see Chapter 16).1617

And while the domestic league continues to grow and recruit global talent (of note, in the 2009-2010 season, 19 of the top 20 scorers were foreigners18 ), this is not the only sport being played on the mainland.1920

Kicking and skating

While Yao Ming is probably the best known Chinese athlete abroad, the domestic basketball industry – while large (according to both FORTUNE and Ying, more than 300 million play it) – is just one of several sport markets.  As I discuss below, in addition to soccer and tennis, both badminton and table tennis, while seemingly pedestrian in the West, are each have the potential to become multibillion dollar sports in China.

The Chinese Super League (CSL) is the highest level of professional soccer in China has been around since 2004.  While its ticket gate revenue is relatively low, at an estimated $33 million a year, its 17,651 in average attendance is the highest in Asia.21 Soccer, as I note below, is a popular sport played by large portions of the population through pick-up games and several organized leagues (especially in high school and college).

As part of a new 10-year deal with CCTV (the state broadcasting company), in 2012 IMG (one of the largest sports and media firms in the world) was brought in to help market, brand, develop and manage the CSL into a topflight global league.22 Similarly, in March 2013, it was announced that David Beckham will be paid several million euros to become the new CSL Ambassador in an effort to bolster the CSL image overseas.23 Yet despite having a poor national soccer team (plagued by scandals) that has failed to qualify for the World Cup all but once (2002), an estimated 700 million Chinese watched the 2006 World Cup and 24 million Chinese fans watched the 2010 match between Greece and South Korea.2425 The 2004 Asian Cup final between China and Japan drew 250 million viewers in China, making it the “most watched single sports event in the history of Chinese television.”26 Thus US brand awareness firms on Madison Avenue (such as IMG) have a potentially large audience with which they can position their clients’ products.

Sport agents could look at the CSL market as a new venue for their clients.  Guangzhou’s Evergrande team hired Marcello Lippi of Italy for $12.5 million, the third highest ever for a coach.  And Shanghai’s Senghua team signed Nicolas Anelka for $13.3 million, coincidentally the third highest for a player.  All told, “forty three percent of the [league’s] revenue goes to foreign players.”27 Similarly if you are a Western trainer or coach, you may find large monetary incentives to train and coach Chinese athletes.  China’s meteoric rise in the Olympic swimming events is in large part due to Australian coaches who were lured over in part by financial incentives.  For example, Ken Wood noted that China pays four times the amount he would get in Australia.282930

Other non-traditional sports have begun to make inroads as well.  Skateboarding, for instance, has begun to spread throughout the larger cities of China and as of 2009, there are between 40-50,000 active skateboarders.31 At 12,000 square meters, SMP Skatepark in Shanghai is purportedly the largest skate park in the world and home to around 2,000 members.3233

Playing without nets

My first apartment in China was next to the outdoor basketball courts at the college I was teaching at.  During the daytime there were relatively few students on the courts.  But after 5pm, all 20 hoops were roughly jam packed with mostly young Chinese men (and sometimes women).  Just next to the courts was a soccer field, also filled with several soccer teams comprised of a similar demographic distribution.

Yet despite the popularity of soccer and football, at dusk many students, faculty and families would take to the campus streets and play badminton just like a scene out of The Sandlot, sans James Earl Jones.  Hours after sunset, up and down these streets the groups continued to play – until the mosquitoes became too much to bear.  And they did it all without nets.

With similar enthusiasm, the numerous ping pong tables at the student union and faculty centers were continuously occupied by both young and old alike.  None of the equipment was new, or the best – it simply was good enough as Voltaire might say.  And nearly identical recreation patterns are found across the entire country.  As a consequence Chinese athletes have dominated the medal table at nearly ever badminton and table tennis event over the past decade at the summer Olympics and World Games.

For example, Lin Dan is a household name and the first person to ever win the Super Grand Slam in badminton (winning all 9 major badminton events).  His image now graces the cover of numerous marketing campaigns – from Red Bull to Gillette – netting him at least $1.9 million in sponsorships annually (and ranking him the 33rd “most marketable athlete”).34

Table tennis (ping pong) is the national sport of China and the Chinese Table Tennis Association manages the largest professional table tennis league, China Table Tennis Super League (CTTSL).3536 Zhang Jike, currently the reigning Olympic and World champion, is sponsored by Coca-Cola (his image actually appears on the cans).  Domestically Jike is sponsored by Yanjing Beer Group (netting a $70,000 bonus for his Olympic win) and State Grid.37

In tennis, Li Na became the first Chinese national to win a grand slam tournament.  She won the 2011 French Open and subsequently signed 10 sponsorship deals including those with Hagen-Daz, Rolex and Nike as well as a three-year contract with Mercedes Benz and is on track to be the highest earning female athlete globally.38 And in swimming, Sun Yang broke an Olympic record in London last year and has signed 10 million RMB ($1.6 million) worth of sponsorship agreements including those with Yili Dairy, 361 Degrees (a sports manufacture) and Coca Cola.39 The 361 Degree deal was purportedly for 1 million RMB ($157,000).

Thus along with a social media strategy that I outline later in Chapter 12, if you or your company plans to sell goods and services to consumers on the mainland, it is important to look at potential sponsorship deals with popular athletes in leagues across the country.  And once again, if you do not, your competitors (both US and Chinese) could very well be looking to sign the next Yao Ming or Lin Dan.40

Professional know-how

What other services could you provide that are not available or are in scarce supply in China?

In his book Red Flags, Matt Garner notes that because Westerners – and specifically Americans – are exposed to the best advertising campaigns, the most concerted marketing efforts and the most methodical media plans, Westerners are by-and-large the most sophisticated and savvy consumers on the planet.

How can you use this to your advantage?

Colin Colenso is an Australian businessman who illustrates how Garner’s “saviness” can be put into practice.  He is the CEO of Human Action Media and with no qualifications or work experience in marketing, media or event managing, within 18 months of pursuing his dream to start a business in Shanghai running billiards events, Colenso’s small company – aided by two English speaking Chinese friends – managed the first nationally televised snooker event in China with a western multinational brand as sponsor.4142

In an October 2012 interview I had with Colenso, he noted that “this national snooker event was actually presented to me by the government officials as they hadn’t the marketing or public relations skills or resources to sell sponsorship packages to professional westernized companies in China.  Such gaps in skills and knowledge in sports and many other aspects of China are numerous, as services and products adapt to a growing and freer market.  This market phenomenon occurs everywhere, but the gaps in China’s rapid evolution to a market economy have been wider and deeper than in developed countries where such obvious opportunities had been snatched up long ago.”

So where does this leave a sport marketing expert in the developed world?  Is there a way you can translate your experience to the Chinese market?  Or is it too late?

I asked Colenso these same questions and he advised that while, “the development of sports business in China has been rapid, particularly in the last decade, so the gaps may be narrower and shallower for beginners.  Thus opportunities may not be obvious or easy to discover.  But in a market of dozens of cities with millions of residents whom have a growing desire and capacity to procure sports entertainment and products, I have no doubt Chinese sports will be grabbing headlines around the world in years to come, not just in athletic performances, but in business developments related to sports.  In fact, sports, as well as other markets are maturing to the point that they are more capable of providing opportunities for experienced professionals and companies from the West.  Snooker provides but one example of this, as China has become a key ally in World Snooker’s strategy for international expansion.  I’m sure the same is true for golf and various other sports, as the various organizations and companies involved have evolved.”43

And remember, just because you might not know who Lin Dan or Li Na are does not mean that Chinese consumers are equally unaware.  For perspective consider that the English Premier League generates almost the same revenue as the NBA ($3.5 billion versus $4.3 billion)44 yet it would be foolish to ignore the marketing potential of sponsoring teams like Manchester United or players like Wayne Roonie (the League’s highest paid player) just because you did not like the sport.  In fact, due in part to its large fan base on the mainland, Manchester United recently signed a 3-year sponsorship deal with China Construction Bank and Wahaha, the largest soft drink producer in China.45 Could your firm or clients find similar opportunities?

The Great Outdoors

As I discuss later in Chapter 11, according to the China Daily, in 2011 more than 60,000 Chinese children traveled to the US and participated in various summer programs.4647 While educational attainment is the primary motivation, another reason is that some middle class families have begun looking for outdoor activities for their children.  Why?  According to a recent survey, “Chinese kids under six spend less than an hour outdoors every day, only a quarter of the global average.”48 Thus in an effort to educate their children about nature, some are opting for day-trips to nature preserves and even summer camps.  In fact, according to a McKinsey & Company survey, “Chinese consumers who identify “retail-tainment” as a favourite pastime has fallen from more than half a few years ago to about 40 per cent now, and will be less than a third by 2020.”49

This kind of change in consumer behavior could provide an opportunity for both domestic and foreign companies to provide outdoor services and entertainment to children and adults.  For example, two years ago Club Med opened its first ski resort near Beijing.  During the summer it doubles as a golf course and theme park and was built to accommodate 18,000 customers a day.50 And according to one estimate from Justin Downes, a ski resort advisor, “there are about five million ski tourists in the country” – a number he estimates could reach 20 million by 2020 once new ski resorts are built.51  There are even ski resorts in relatively remote Urumqi, in the northwest province of Xinjiang.52 All told there are over 400 ski resorts nationwide and companies like Mountain China Resorts are investing several billion RMB to develop and build additional resorts and hotels to cater to a customer base which is now about 70% Chinese.53 Thus both foreign and domestic turf experts, course and resort designers, and even ski trainers may find a new revenue source.

Yet one area both foreigners and domestic firms and investors should be cautious of is golf courses.  While the ban on golfing was lifted in 1984, construction of new courses has been officially banned since 2004 (e.g., “it is an elitist game” and “uses scarce fertile land”); there has been a cat-and-mouse game of subsequent construction followed by investigations.  To get around this ban, new golf courses typically use other names like “health clubs” or “country clubs.”54 Those that are discovered (typically via satellite imagery) are sometimes dug up.  For example, several years ago the Anji King Valley country club (southwest of Shanghai) received a 10-day visit from bulldozers who subsequently redesigned the landscaping (tore up the turf and sprinkler system).55 Yet there are others that thrive and generate purportedly large sales; the Qinghe Bay club that opened in 2008 charges 880,000 RMB ($141,000) for lifetime membership.56

In fact, one estimate is that the Chinese golfing industry generated nearly $10 billion in revenue in 2008 (from course costs and equipment) and is expected to grow from 700 courses in 2012 to 2,700 in 2015.57 Even Mission Hills, the world’s biggest golf resort operator has opened several courses in the face of legal uncertainties.  Their largest course is the size of Manhattan and is located in Hainan province which is exempt from the ban.  Yet as I mentioned at the beginning: caveat venditor.  This boom may only be temporary.58

Six Minute Abs

As China both ages and develops (see Chapter 6 and 19) the demand for professional recreational facilities may also increase.  For example, water aerobics is generally considered a healthy, physically beneficial activity for elderly consumers in the West.  Yet aquatic facilities do not exist in China at the level as they do in some foreign countries.  And it is not due to a lack of popularity as anyone who has visited a public pool can attest; these facilities can become very crowded.59 Similarly, just as all other developing countries go through growing pains, one literal example that is increasingly relevant is physical stress.60 Or rather, many segments of the mainland do not feel they have enough time to both work hard at work and exercise afterwards.  In fact, according to the World Health Organization, the obesity rate for those 15 years or older in China reached 38.5% in 2010 (up from 25% in 2002) and another study by the General Administration of Sport (国家体育总局) found that “overweight rate among students between the age of 7-22 climbed to a new high.”6162 And as I mentioned in Chapter 6, in terms of overall numbers China is now the capital of diabetes, with 92.3 million or 9.7% of the population suffering from this affliction compared with 11% in the US.63

Part of the predicament leading to this rise in obesity is that quite simply, many students are encouraged and required to study more that in the past.  The increased competitiveness in obtaining academic placement (see Chapter 9) has led to many primary, secondary and even tertiary students to typically attend school from 7:30am to 5pm and then spend an additional 3-4 hours doing homework.  As a consequence they have little time to play or participate in physical activities.64 In fact, according to a recent Global Times report, “[i]n comparison with data collected in 2005, scores in men’s 1,000 meters fell by 3.37 and 3.09 seconds for urban and rural students, while breathing capacity of college students as a general dropped by nearly 10 percent from the 1985 level.”65 According to Qiao Xiaoshan a physical education researcher, “[f]rom 2002 to 2010 in China, more than 40 participants in long-distance running events aged 16 and over died suddenly.”66 In 2012 two more college students died from heart exhaustion after participating in a marathon in Guangdong and another student died in Shanghai while playing basketball.67 This has led to cancellations of running-based tests and competitions across many cities and provinces.  In fact according to Qiao, “more than 30 universities in Xi’an no longer held long-distance races because of the decline in students physical fitness, leading to concerns the students may suffer injury or even death if they took part in intense physical activity.”6869

In other cases, the consumer may not feel comfortable at existing facilities.  For example, in my own anecdotal experience at participating in gyms in China, one common concern I have heard by female patrons is that they would prefer to work out in their own women-only gym so they can receive train in a more supportive, focused environment.  Thus foreign, women-oriented firms such as Curves may find opportunities to cater to niche clientele.70 Similarly, specialty gyms like CrossFit may be able to capitalize on its status as a non-traditional, unconventional training program that could market itself towards the insatiable demand for wushu (e.g., Shaolin kung fu) which similarly involves training in creative ways and carrying, throwing, contorting and kicking unusual apparatus.71 However, all told, by one estimate, the penetration rate for fitness facilities is a mere 0.3% on the mainland compared with 16% in the US and 13% in the UK.72

For perspective, in 2011, there were 29,365 fitness-related businesses providing 43.6 million gym memberships in the US.73  Yet just because there is potential in one country does not mean there is instant success in another.  For instance, Bally’s Total Fitness has actually reduced its fitness centers in China from 44 in 2008 to less than 30 today.  And 24-Hour Fitness sold its centers to a local Chinese group (Ansa) in August 2012.  Why?  Because according to Walter MacDonald, a wellness management consultant, “[a]ll the ideas that work in the West mostly don’t work here.  Fitness is not like fast food chains that can easily change the menu according to local taste.”74  Similarly Theo Hendriks, the CEO of Sports and Leisure Group explains that “[t]he international clubs that have a difficult time in China are franchises, and they just have one concept for their gyms in different countries and cultures.”75

And again for those willing to stick with the mainland, the revenue potential could be rewarding.  According to Walter Macdonald, in terms of market size only $11 billion is spent on fitness in Asia compared to $21 to 25 billion in the US.76 For example, Hosa Fitness Clubs is one of the largest on the mainland with more than 500,000 members and plans to increase its centers “from the current 82 to 300 by the end of 2013.”77 Thus perhaps if foreign firms can figure out how to localize and cater fitness to specific consumer behavior (e.g., group based activities like tai chi, yoga, cycling) instead of the traditional Western model commonly tried they may be able emulate Hosa’s success.7879

In my conversation with Kirt Greenburg (see Chapter 1), he also noted that foreign firms should conduct research to specifically discover consumer behavior patterns regarding scheduling preferences at the gym.  For example, based on his cursory research he has found that many local gyms do not cater to consumers who prefer to work out in the morning, that gyms are typically only open beginning at 8:00 am.  According to him, “because the gym itself and formal fitness culture have not been established in most urban regions, customers and entrepreneurs are still adjusting and learning how to utilize and cater to peak hours.  The idea that you can take your work clothes to the gym, workout, shower and then head straight to work is still not fully embraced by urban workforces.”  Thus it may take some long-term planning and even education to cater to this new segment of time-conscious customers.

Takeaway: China’s sports base and sport development continue to create world-class athletes.  Professional leagues are beginning to mature and have attracted significant fan bases.  As a consequence, sponsorship and advertising revenues continue to climb both for sport franchises and athletes.  If you plan to sell your products and services in China you should also consider looking for potential athletes and sports – even those seemingly unpopular in the US such as badminton or table tennis – because if you do not take the opportunity to sign them, your competitors (both Chinese and American) very well might.


Endnotes:

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  1. China reaches for the big leagues from The National []
  2. NBA China Revenue to Increase at Least 10% Annually, Stern Says from Bloomberg []
  3. NBA, CCTV to boost basketball coverage in China from Variety []
  4. NBA, CCTV to expand partnership from China Daily []
  5. Yao Gives Reebok An Assist in China from The Wall Street Journal []
  6. O’Neal the real deal as Li-Ning goes global from People’s Daily []
  7. 2012 was a relatively difficult year financially and strategically for Li Ning and it may not exist in a year or two.  See A Year of Rebuilding for China’s Li Ning from The Wall Street Journal, Li Ning Torches Inventory from The Wall Street Journal, Li Ning tumbles on fundraising plan from Financial Times and Is the end nigh for Li-Ning? from The Li-Ning Tower []
  8. Chinese Shoe Deal Could Make Dwayne Wade The Richest Athlete of All Time from Celebrity Networth []
  9. Wade to sign with shoe brand Li-Ning from ESPN []
  10. I would be remiss if I did not mention a story Matt Garner originally told me.  Qiaodan is what they call Michael Jordan in China, but it was also a knock-off Air Jordan brand that Chinese consumers thought was actually American.  The reality is that the brand was registered as “Qiaodan,” not Jordan.  But most Chinese consumers cannot tell the difference.  It is like having a place in the US called “Hafo Business School” which has nothing to do with the real Harvard Business School yet most Chinese consumers do not know what they call Harvard in English.  See In China, Air cheow-DAN Cries Foul from The Wall Street Journal. []
  11. J.Crew to Open First Asian Store in Hong Kong from Bloomberg []
  12. See p. 204, Sports Around the World [4 Volumes]: History, Culture, and Practice by John Nauright and Charles Parrish and STATS Delivers the NBA to China’s Leading Web Portals from STATS []
  13. Pro basketball hits a wall in China from FORTUNE []
  14. It’s Official: NBA Star Tracy McGrady to Play in China from The Wall Street Journal []
  15. How Big is Tracy McGrady in China? from The Wall Street Journal []
  16. The two ‘followings’ are different.  Whereas KFC operates more stores on the mainland than anywhere else outside of the US, many basketball fans have enjoyed the rise of Jeremy Lin (born in Los Angeles to Taiwanese immigrants).  See Jeremy’s KFC Photo Shoot and More Photos From Volvo Shoot from Confessions of a Jeremy Lin Addict. []
  17. Another high-profile NBA import is Gilbert Arenas who currently plays for the Shanghai Sharks which is owned by Yao Ming.  See Zero Sum Game from Slam Online []
  18. NBA Washouts Have China Calling Foul from Bloomberg []
  19. Beyond Yao: The Future of Chinese Basketball from [email protected] []
  20. Yao Ming’s Cure for What Ails Chinese Basketball from The Wall Street Journal []
  21. One Billion Fans, One Terrible Team from The New Republic []
  22. IMG Sees ‘Tremendous’ Sponsor Interest in Chinese Soccer from Bloomberg []
  23. See Beckham’s CSL ambassadorial role now confirmed from The Li-Ning Tower and Chinese Super League hoping Beckham can restore its battered image from South China Morning Post []
  24. See China bans former soccer chiefs for life, slaps heavy fines on clubs from Xinhua and Soccer in China from Facts and Details []
  25. Where are China’s Soccer Stars? from The New York Times []
  26. Asian Cup final smashes viewing records from the Asian Football Confederation []
  27. Chinese soccer clubs pay high salaries to foreign players from Want China Times []
  28. How world stole the brains behind Australian sport from The Daily Telegraph []
  29. How a swim school in Redcliffe is driving China’s Olympic gold rush from News Limited []
  30. Back in the swim from Financial Times []
  31. Skateboarding out of the shadows from China Daily []
  32. SMP Skate Park []
  33. Action Sports and Sport Participation in China from China Sports Review []
  34. The world’s 33rd most marketable athlete – Lin Dan from SportsPro []
  35. See China, Still the World Champ, Is Falling Out of Love With Table Tennis from The Atlantic and Ping Pong Diplomacy from China.org.cn []
  36. The late Zhuang Zhedong was one of the best known table tennis players on the mainland.  He was instrumental in ‘Ping Pong Diplomacy’ which presaged the normalization of relations between China and the US in the early 1970s. []
  37. See Zhang Jike: An Eligible Bachelor from Table Tennista and State Grid Welcome Visitors to the Brazil Junior and Cadet Open from ITTF []
  38. She was most recently the runner-up in the 2013 Australian Open.  See Li Na wins three-year Mercedes endorsement from SportsPro and Li Na on course to be world’s highest earning female athlete from The Li-Ning Tower []
  39. He was recently disciplined and his “commercial activities” (sponsorships) were put on hold.  See Sun Yang, advertising’s next big thing from China.org.cn and Sun Yang suspended from commercial activities from China Daily []
  40. Zou Shiming, gold-medal winner in Olympic boxing, is just one of many potential world-class athletes coming out of China.  See Zou Shiming’s professional example set to lead boxing revolution in China from Global Times []
  41. Human Action Media []
  42. Amway sponsors snooker from SportBusiness []
  43. World Snooker []
  44. Bumper revenues for Premier League clubs tempered by soaring wages from CNN []
  45. The wealthiest man in China is Zong Qinghou, founder of Wahaha which is the largest beverage producer in China.  See Man Utd signs up Chinese sponsors from Financial Times, Manchester United Signs Sponsorship Deal with Wahaha in China from Business Wire and China’s Richest Man Says Capital Markets ‘Suck’ from The Wall Street Journal []
  46. Chinese parents turn to US summer camps from China Daily []
  47. Some of these summer school programs may come under scrutiny due to relatively lax transfer credit requests.  See Chinese Summer Schools Sell Quick American Credits from The Chronicle of Higher Education []
  48. China discovers its inner tree-hugger from Financial Times []
  49. Ibid []
  50. Club Med looks to profit from China’s skiing craze from Agence France-Presse []
  51. Ibid []
  52. See Ski fields in Urumqi opens for business from Xinhua, Ice and Snow Festival kicks off in Xinjiang from Global Times and Urumqi attractions from China Daily []
  53. The ski’s the limit from China Daily []
  54. Golf course boom points to China corruption from Financial Times []
  55. The Forbidden Game from Slate []
  56. Golf course boom points to China corruption from Financial Times []
  57. See Golf defies rules to gain ground from China Daily and Mission Hills puts share float idea on table from South China Morning Post []
  58. Golf construction is booming in China, though it’s banned from Los Angeles Times []
  59. See Swimming: Chinese pools often too crowded to swim from Agence France-Presse and China’s Dead Sea Is World’s Most Packed Swimming Pool from The Daily Mail []
  60. This is a phenomenon that Matt Garner calls “stress stratification.”  In fact, due to time constraints Garner and others have predicted that many families will begin consuming pre-made food packages such as TV dinners like Hungryman.  This is further discussed in Chapter 3 (e.g., “frozen foods”). []
  61. Another estimate is much lower, 13.3% of urban Chinese male college students were classified as obese compared with 19.6% Americans in the same demographic group.  See China’s young in crisis of declining fitness from Associated Press []
  62. See Obesity in China: Waistlines are Expanding Twice as Fast as GDP from USC US-China Institute, Deaths in sports means more exercises needed from China Daily and What’s Making China Fat? from The Atlantic Cities []
  63. Another report from the International Diabetes Foundation puts the Chinese percentage slightly lower at 8.8% and in the US at 9.3%  See Prevalence of Diabetes among Men and Women in China from Yang et al. and China’s diabetes epidemic exacerbated by one-child policy from News Track India []
  64. Deaths in sports means more exercises needed from China Daily []
  65. Children’s tug of war between classroom, sports ground from Global Times []
  66. Races canceled as students struggle to stay in shape from China Daily []
  67. See Second death from Guangzhou marathon reported from Xinhu and Sudden death of college student raises attention from China Daily []
  68. See Races canceled as students struggle to stay in shape from China Daily and China’s young in crisis of declining fitness from Associated Press []
  69. Compounding this problem is air pollution (as noted later in Chapter 18).  According to John Balmes, a professor of medicine at UC San Francisco, due to the poor air conditions and relatively high levels of pollution in cities like Beijing, “it’s actually unhealthy for kids to be exercising outdoors. When you’re playing sports outside – or just being a kid and being very active – you get a high exposure to pollution because you’re breathing more per minute. Also, when you’re exercising, you breathe through your mouth instead of your nose, which has a filter.”  See Eye-Stinging Beijing Air Risks Lifelong Harm to Babies from Bloomberg []
  70. Compared to the rest of the industry, Curves has actually fallen on financial difficulties.  Thus competing firms that operate in this niche may be able to take this opportunity to expand overseas.  See In Search of More Muscle from The Wall Street Journal []
  71. The first official CrossFit gym on the mainland was recently opened in Shanghai.  See Iron Dragon: Crossfit []
  72. Down at the gyms from China Daily []
  73. Ibid []
  74. Ibid []
  75. Ibid []
  76. See Gym, Health & Fitness Clubs in the US: Market Research Report from IBISWorld, The Shape of the Fitness Industry from South Source and Industry Research from IHRSA []
  77. Down at the gyms from China Daily []
  78. For perspective consider that a year ago in 2011 Bally’s had large expansion plans for the mainland however those do not seem to be panning out.  Similarly, the fitness market has been another area that seems to have suffered from hype as back in 2002 it was reported that China’s sport and leisure market had 400 million consumers who spent $1.7 billion on sporting goods in 2000.  Thus, again while the potential remains, it may take many more years for any kind of critical mass or market penetration rates that are equivalent to the West, if ever.  See China’s Next Revolution Is in Fitness from The New York Times, Little Weight to China’s Gym Fad from Los Angeles Times and The New Sweatshops from TIME []
  79. An area of personal interest is the sport supplement and dietary supplement industry (which I did my graduate research on in the US).  While specific market research numbers are hard to come by, products from GNC are readily sold in CityShop (see Chapter 3) locations and some yogurt shops sell MuscleMilk.  And because of the prevalence of TCM (traditional Chinese medicine) and herbal supplements at every local pharmacy, perhaps foreign firms specializing in supplements could find a new market to generate revenue from if properly localized, branded and marketed. []

Chapter 9 – The education market

[Note: below is Chapter 9 from Great Wall of Numbers]

Over the past four years I have had a chance to live and work throughout China.  This was done in the capacity as an instructor, teacher and professor at a variety of colleges and schools across the country.  Along the way I have met numerous fellow travelers, international teachers and businesspersons who have worked across the wide expanse of China’s educational systems.

I say systems because there is a cornucopia of private international schools, public schools, specialized Montessori schools and a seemingly infinite amount of training centers called bǔxíbān (companies and institutions that typically offer after-school programs such as EFL, GRE, GMAT, art, business and math training).  These all exist to meet the demand of an extraordinarily large population that culturally values formalized schooling for educational attainment.

For example, in 2006 there were an estimated 16.7 million students studying at 336,200 elementary schools and 21.2 million students studying at 361,300 junior high schools (the reason for the relative decline and difference in the cohort sizes has to do with the one-child policy).123 More than 9 million high school seniors take the national college examination (gaokao) each year, the top percentage of which typically then study overseas.4 And approximately 8 million college students now graduate each year in China, a rate that has quadrupled since 2002.5

In addition, as I mention below, there are a number of extra-curricular training centers called bǔxíbān that cater to the growing domestic demand for foreign educational services.  For instance, in 2011 more than 20,000 Chinese high school students took the SAT as part of their quest to study overseas.67 With 58,196 test-takers from the mainland, one in five people who took the GMAT in 2011 was from China – a 45% increase from the previous year (and up from 11,000 in 2008).89 Both tests are conducted entirely in English.  New Oriental Education – among many other training centers – alone trains and tests up to 200,000 students a year in standardized tests like TOEFL and SAT.1011

EFL market

In January 2009, then-Premier Wen Jiabao stated that there were roughly 300 million English learners in China.  For perspective, there are 600 times more Chinese studying English than Americans who study Mandarin.12 From primary school through the first two years of college, nearly every student in China is required to take English.  One of the subjects tested during the gaokao, the annual national college entrance exam, is English.  And with great commitment comes great costs.  In 2002 the estimated price tag on EFL education was $1.4 billion and according to a 2009 McKinsey & Company report, “China’s foreign-language business is worth $2.1 billion annually.”13 As I mention below, this is substantially lower (5x) than their peers such as Japan and South Korea.

Who teaches these EFL courses?  According to People’s Daily, approximately 100,000 foreign teachers and experts are recruited each year to work on the mainland.1415 But before jumping on a plane and starting a new EFL division of your company overseas consider that not only would you need various licenses to start up a new firm, but that the EFL market is already sorting the wheat from the chaff.16 For example, a large number of nation-wide EFL providers including: Disney English, Wall Street English and English First (EF) are owned and operated by foreign companies.  EF is actually the world’s largest EFL company, with 34,000 employees and more than 500,000 paying students globally.  New Oriental Education and Ambow Education were both founded by Chinese nationals.17 They rank among the top EFL providers in China and are even traded on the NYSE.

So like all business startups, be sure to do a SWOT (strengths, weaknesses, opportunities, threats) analysis and identify what your company can provide that is not already being serviced.  Even with these well-funded incumbents, a case could be made that entrepreneurs (both foreign and domestic) can still create a profitable business model, catering to specific niches (e.g., first-contact health care providers, hospitality managers, financial and securities traders, lawyers and paralegals).18

While some have argued that EFL might be bubble activity, there is arguably a lot of organic, bottom-up support for this drive into English.  For instance, according to Jun Liu, English professor at the University of Arizona, as of 2007 about “40,000 foreign companies have been set up within China and employ 25 million people.”19 As a consequence a lot of the day-to-day operations are conducted in English, such as emailing, accounting, finance and sales.  And this outward push from within organizations can be illustrated by firms such as Air China – the third largest carrier in China – which has introduced an incentive program for its employees to learn English from a large TEFL provider.  Similar incentive programs exist at foreign-owned multinationals such as Eli Lilly, Metro (a large German supermarket chain) and Intel.  On a governmental level, in a bid to help tourists and foreigners, one such firm – English First – was even hired to teach taxi drivers and volunteers during the Shanghai 2010 Expo; they were also the official trainers for the 2008 Beijing Olympics.

And with a goal of becoming distinguishable and eventually an international brand, most businesses and large SOEs have adopted English names such as China Unicom, Lenovo, Agricultural Bank of China, China National Petroleum, State Grid and China Railway.2021 As I mention later in Chapter 12, this push outward presents an opportunity for US companies and institutions to help market and educate Chinese firms looking to do business overseas.  On this note, in June 2012, Shaun Rein, the author of “The End of Cheap China,” made the case that China will continue to need American education and American educators.22 He makes a persuasive call for US-based educational entrepreneurs as well as educational companies and institutions to set up shop on the mainland.  And if you do not, someone, perhaps even your competition will.

What you and your firm can do

For perspective, South Korea, which invests more on EFL education than any other country, collectively spends between $10-$15 billion a year on EFL education; one 2005 estimate put the figure even higher, 1.9% of GDP (approximately $16 billion).23 And with a number of domestic programs similar to its neighbors, Japan spends about $8 billion a year on EFL.24 Thus with a population ten times the size of Japan and a GDP six times the size of South Korea, there is a lot of potential room for EFL growth in China, which as noted above, spent $2.1 billion on EFL in 2009.

How much do these programs at a language center typically cost?  I spoke with a high level Chinese manager in charge of operations at a large EFL training center in Pudong, Shanghai who has had 20 years of experience working at Disney English, Wall Street English, EF, Web English and Huapu (the latter two are Chinese-owned and managed).  According to her, “ten years ago it was a seller’s market as there were relatively few language centers and as a consequence they could charge enormous tuition fees, upwards of 400,000 RMB [$64,000] a year primarily because there was and still is a large demand for authentic face-to-face experiences.  In return the centers provided one-on-one intensive training with laowai – native English speakers – for hours each day.  Today, because the market has matured over the past decade, the average high-end language package now costs about 30-40,000 RMB [$4,800-$6,400] annually in larger cities like Shanghai and Beijing – which is still a somewhat high amount considering the annual wages for most urban residents is less than $9000 a year.  Yet, there still a number of firms such as RISE and baite (百特英语) that specialize in providing English-only, total immersion environments for their customers – at a substantial cost.”

One of the ongoing issues that any service provider in any country must continuously deal with is figuring out the right price point for attracting potential customers.  Online education is one way to create flexible rates; as a consequence several EFL programs are now available at substantially lower costs compared with ten years ago (e.g., 500 RMB per month).  Another example is while the value of an EFL package is subjective based on each individual’s preferences, there are ways to make repayment easier.25 Take for instance, payment plans.  At some language centers they are now allowing customers to pay by installment.  And according to this same source, even though 10-20,000 RMB [$1,600-$3,200] a year is now considered a “reasonable sweet spot” in the mind of the typical middle class worker in a Tier 1 city; some of these consumers still would like flexibility and assistance and thus providing month-to-month billing allows them to achieve a win-win compromise.

Catering to specific clientele

In November 2012 I spoke with Cathy Su, a six-year marketing veteran at English First (EF) and Fujian native, about education-related business opportunities in China.  According to Su, “parents will go to great lengths to sacrifice themselves for their child’s educational future.  For example, in order to send their children overseas, many are essentially price inelastic.  Some are willing to invest and spend substantial amounts in order to help their children get an overseas education.  They do this for multiple reasons, yet in every case, the students all need both coaching and training to prepare for standardized tests like the SAT, GMAT and TOEFL in order to matriculate overseas.”

While there are cultural components (such as li or 禮) to this seeming inelasticity one of the key issues that Chinese families currently face is as Charles Zhang (the founder of internet giant Sohu) recently explained in an interview,

“I believe the US system is definitely better than the Chinese system. First of all, China just has way too many people. The entire system becomes very competitive and thus opportunities are limited. Education in China is not education; it is selection. Of course, the biggest selection process is the national college entrance exam, the Gaokao. The Chinese system naturally must prepare children to study for this inevitable exam, but the preparation is the complete destruction of creativity.”26

Zhang’s comments were similarly echoed by Paul French, the Chief China Market Strategist at Mintel who recently noted that, “[t]here simply aren’t enough places at enough good universities for all the Little Emperors capable of attending and passing the required exams.”27 Little Emperors (八零後) are single children born and raised under the one-child policy.  And due to this confluence of scarcity and demographic pressures, this ultra-competitive labor market has motivated parents to push their only child to accumulate other degrees and certificates (see below).  For example, according to a report from Mintel, “three-quarters of middle-class Chinese parents expect their child to earn a postgraduate degree, while only 32% said they would be happy if their child stopped at the undergraduate level.”28

This sentiment was similarly noted by Wendy Bao, with whom I also spoke in November 2012.  She is originally from Zhejiang and has worked throughout EF over the past 10 years in positions such as a product manager, market analyst and in business intelligence.  According to Bao, “Chinese parents care more about education for kids than themselves.  Or rather, if there was an investment decision between the two, Chinese parents will invest more in their children’s education and extracurricular activities because they see their progeny as more important than their own personal achievements.”

Such sacrifice is illustrated by the family of Wu Caoying, who now attends a three-year polytechnical school.  Growing up in Shaanxi province, she is the only child of her parents.  Her father works in a coal mine, earning $500 a month and her mother earns $12 a day “tying little plastic bags one at a time around 3,000 young apples on trees, to protect them from insects.”29 Together they have scrimped and saved for their daughters education and spend more than 50% of their monthly earnings so that their daughter could attend a boarding school during high school and can now matriculate to the polytech.  In return, Caoying is expected to help take care of her parents after they retire.

While part of the education-centric ethic stems from various Confucian teachings (e.g., xiushen or修身) that most Chinese are taught from a young age another reason why foreign degrees are sought is that this highly competitive labor market has led to credentialism (e.g., obtaining a certificate or degree merely to collect it for your resumé and CV).30 As a consequence Cathy Su also thinks that because of this education ethic, that in addition to traditional EFL training there is essentially an insatiable demand for niche services such as SAT coaching.  This may be especially true since the middle class is expected to grow from 300 million today to an estimated 600 million by 2020.31 And as I noted in Chapter 6, with a growing middle class comes growing disposable incomes.  Furthermore, wealthier Chinese families are increasingly looking to send their children abroad in part because of the hyper competitive domestic climate and due to the perceived creativity-friendly environment at Western institutions.  For example, a 2012 report from Hurun regarding high net worth individuals (there are approximately 2.7 million HNWI in China), “85% plan to send their children abroad for education.”3233

And what do these Chinese students do after completing their degrees?  While many of them obtain permanent residency, others return to the mainland (see ‘brain drain’ in Chapter 19) as future innovators and policy makers.  For instance, several of the largest internet companies in China were founded by Chinese nationals who attended US institutions for college and graduate school.  Charles Zhang (Sohu) graduated from MIT; Robin Li (Baidu) graduated from SUNY Buffalo; Joseph Chen (Renren) graduated from University of Delaware, Stanford and MIT; Gary Wang (Tudou) graduated from Johns Hopkins and the College of Staten Island; James Liang (Ctrip) graduated from Georgia Institute of Technology; Victor Koo (Youku) graduated from Stanford and UC Berkeley; and numerous executives in the management teams at Sina and Tencent attended a US college.  In addition many others at Alibaba attended other Western institutions or joint ventures like the China Europe International Business School, the first business school to offer an MBA on the mainland.3435 Harvard has several programs designed specifically to educate and facilitate information exchange with future Chinese policy makers.  One of its programs called China’s Leaders in Development brings in “50 to 60 official each year.”36 Its Kennedy School has trained 150 Chinese officials since its program began in 1998.  All told about half of the 668 Chinese students in the 2012-2013 school year at Harvard are enrolled in the Graduate School of Arts and Sciences.37

In fact, while the legal issues are still being sorted out, there may be opportunities for both non-profit and for-profit traditional brick-and-mortar schools in larger mainland cities.  For example, many Chinese families are faced with a dilemma in terms of educational options on the mainland.  On the one hand they can send their children – or usually the only child – to public schools.  While some of the public schools are opening special classes for students wanting to study abroad (SAT, AP, A-level prep), public schools are usually considered substandard due to lack of funding and rote memorization learning methods.  Another viable choice is for families to try and help send their kin overseas yet this is financially cumbersome to most middle-class families.38 A third option is private schools, yet there are currently very few private schools on the mainland, thus the other two options above place many families in an uncomfortable bind (e.g., they would like their children to receive the best education possible but have limited choices).

This may be changing however.  Two years ago Wellington School, a 150-year old British school, was replicated in Beijing.39 For £15,000 a year ($23,800), Beijing parents can now send their children to this new school based on the British public school system.  Oxford International College (unrelated to Oxford University) charges up to $41,700 a year in its private schools located on the mainland and also emulate the British education system.40 And while it take  some time before such imports are more widely accepted, the only other alternative currently is international schools, though while relatively popular, they are also both very exclusive (you typically need to have a foreign passport to be eligible) and prohibitively expensive ($10,000-$35,000 a year).41 Yet the trend towards international schools is growing.  According to Reuters, there are now 338 such schools (up from just 22 twelve years ago) whom collectively enroll 184,073 students.42

Or conversely perhaps your firm can help place Chinese students in American schools.  For example, according to the Association of Boarding Schools, “about 5,600 students from China [are] enrolled in its 285 member schools in the US this academic year [2012-2013].”43  According to the US Department of Homeland Security, in 2010-2011 the amount of Chinese students studying at private schools in the US was 6,725, up from 65 in 2005.44 In terms of costs, some international programs like Leman Manhattan Preparatory School in Manhattan cost $68,000 a year (30 out of the 40 international students at Leman are currently from China).45 Other boarding schools in the New York metro area cost an average of $46,875 a year.  As a consequence, the opportunities for foreign experts and entrepreneurs looking to wade into both sides of the market may be viable, even for administrative tasks.

For instance, US institutions and organizations collectively spend $980 billion annually on education, twice as much as China.4647 Due to a variety of factors including large spending per capita, US institutions continue to attract foreign talent.  For example, there were 765,000 foreign nationals studying in the US in 2011 – including 158,000 Chinese (there are now 194,000 Chinese studying in the US).4849 And according to the US Department of Commerce, these foreign students contributed $22.7 billion to the economy and many stay after graduation (Chinese students alone added $5 billion to the US economy in 2012).50  Thus in an effort to  improve both the quantity and quality of its graduates as well as raise its standing on league tables and rankings, every level of the Chinese government is implementing plans to invest ever larger sums of funds into education; including recruiting foreigners (for comparison, 24,000 Americans studied in China in 2011).51

Yet, with the administrative, marketing and teaching prowess gained from over six decades of being at the top of the international educational marketplace, managers and entrepreneurs at US institutions could conceivably capitalize on their skill bases and leverage them in China’s expanding market.5253 A year ago, in March 2012, Stanford University opened the doors to a new joint venture, Stanford Center at Peking University making it one of the first permanent higher education facilities to open on a Chinese campus.54 NYU has set up the first Sino-US joint venture university that will award a double bachelor’s degree (from both the local Shanghai branch and NYU in Manhattan).  Classes began in the fall of 2012 and students from the mainland will pay 100,000 RMB ($15,948) a year to attend.55 And Julliard, the performing arts conservatory, is building a campus in Tianjin (southeast of Beijing) catering to students aged 8 to 18.56

At the same time however, enthusiasm should be tempered as a joint Yale University – Peking University undergraduate program “collapsed” this past July due to “high expenses, low enrolment and weaknesses in its [Yale] Chinese-language programme.”57 Similarly, Duke University’s venture with Wuhan University has run into several major problems.  The construction of the new Duke Kunshan joint campus has been delayed five times over the past three years due to “slow” and “shoddy” workmanship.58 Thus success in this segment is not necessarily a foregone conclusion.

Another role that foreign administrators may be able to utilize is that of an agent, or admissions consultant.  According to one estimate, “8 out of every 10 Chinese undergraduate students use an agent to file their applications.”59 These agents in turn will help candidates fix their admissions essays, find the best references to write recommendation letters and otherwise guide clients through a streamlined process to foreign-based colleges.60 Maybe you and your company can utilize your expertise to work with new clientele.

However, as touched on above, the mainland education industry can also be tricky.  For example, in order to be granted a license, certifications have to be recognized by the Ministry of Education.61 Online-awarded degrees and certifications are typically not accredited by the Ministry.  As a consequence you may have to set up a physical brick-and-mortar office in order to do business within the Chinese marketplace.  In addition, alternative certification programs such as Microsoft’s MCSE, Cisco’s CCNA, Huawei’s HANA and others like Certified Nutritionist are increasingly prevalent – so as long as they are recognized by what the Ministry deems as a legitimate institutional authority.

For instance, what if your company trains and educates workers in an ISO management process in the US?  If you wanted to expand into China you may need to reinvent your firm on the mainland by creating a brick-and-mortar office location before you can legally market within China.  A consequence for failing to do so would be the trials faced – according to a source at the company – by the University of Phoenix, which despite its 35 years of history, was originally not seen as a legitimate degree awarding institution in China.

National Quality Assurance (NQA) is one of the largest ISO registrars in the world and an Accredited Certification Body (ACB) that coordinates with regional sub organizations to train, audit and certify organizations and companies in ISO 9000 family of quality management certifications.  SNQA is the organization in charge of verifying, confirming and auditing ISO 9001, ISO 13485, TL9000, BRC-CP and several other standards on the mainland.62 In January 2013 I spoke with Jason Jia, who is managing the new Wuhan, Hubei office for SNQA.  Jia is originally from Anhui but has spent the last 3 years working in sales for SNQA.  He noted that, “there are long-term opportunities for foreign ISO experts that can provide to mainland firms such as training and auditing services.  However one of the challenges facing these same companies is that communication issues are usually a big problem.  In addition, the maintenance and foreign labor overhead expenditures relative to local labor are usually cost prohibitive and as a consequence the daily maintenance fees are typically so high that most Chinese firms cannot afford it.  For example, we as a certification organization pay the auditor company a daily training and on-site verification fee and this quickly adds up when taking into account the relatively higher per hour costs charged by foreign companies.”

Recruitment

One lively human resource area within the education labor market provides large compensation packages yet has relatively few candidates: if you have internationally recognized awards, Chinese institutions will hire Western superstar teachers to improve their table rankings.63  For example, three years ago Jiao Tong University in Shanghai scored a coup, recruiting French virologist Luc Montagnier, who discovered HIV and subsequently received the Nobel Prize in 2008.  Another case is, Rao Yi, who grew up in China but spent 22 years at Northwestern University before being lured back to become the dean of Life Sciences at Peking University.64 All told, the Chinese national government in a project dubbed the “1,000 talents program” (see more below in Chapter 15) is offering perks and bonuses up to $150,000 in an attempt to lure “foreign-educated Chinese scientists, academics, financial experts, and M.B.A.s.”65 And according to Wang Huiyao, head of the Center for China and Globalization, approximately 15,000 individuals have come to the mainland through this program.66

At the same time, if your goal is acting as an intermediary and talent recruiter, expectations should be tempered with a dose of reality.  For example, Pat Sullivan, an accountant and chairman of international recruiting at Young Harris College told me in March 2013 that there are a number of obstacles created by current US immigration policies, which put numerous roadblocks in the way of foreign students seeking to study in the United States.  According to her, “The paperwork required for US Visas, health certificates, assurances of financial solvency, and other forms are always more time consuming than one would expect.  Planning for the arrival of foreign students must begin months in advance and requires the active participation and assistance of the host educational institution.”

Consequently, for those entrepreneurs looking to open up a new seminar or class room system, several questions need to be answered: where will you find customers who are willing and able to pay?  How will you build, manage and incentivize a sales force team to convert leads into customers?  Who will teach and design the curriculum for the courses?  Where will these seminars and courses be held?

In terms of taxes, there is one other challenge for foreign-owned companies that is not entirely unique to the EFL industry, yet should be recognized and addressed.  As mentioned above, each province has its own legal requirements for business licenses and certifications.67 For example, in Shanghai, in addition to a college degree a foreign teacher is required to have at least 2 years of previous teaching experience as well as a TEFL certificate from an authorized institution.  On the business end, due to relatively strict capital controls (e.g., individuals are limited to $50,000 in transfers annually) it can be relatively complex to repatriate your profits and assets from schools as there are also numerous taxes, tariffs and levies that do and do not apply specifically to educational companies.  While not explicitly discouraged, creative accounting, subcontracting and the “Hong Kong shuffle” (see Chapter 10) have become increasingly popular tactics by EFL firms to reduce tax liabilities.6869 Thus it is recommended that you speak with an attorney or tax expert before you invest in a new EFL program.

Cloud education

In terms of educational activities irrespective of being indoors or outdoors, according to its September 2012 report, Distimo noted that the popularity of English-based apps in China for the iPhone still remains very high.70 It is the 2nd largest installed language for apps overall and thus foreign entrepreneurs – including those in the education industry – may be able to turn this embedded built-in language base to their advantage.  Because the userbase is already largely familiar with Romanization, that is one less problem to be concerned with.  You might consider creating online virtual EFL classrooms based on apps for smartphones and tablets or rolling out cloud-based video courses that can be viewed by anyone with an internet connection.

In fact, one point Wendy Bao explained to me was that online classes and programs like Khan Academy will be the future of education.  Khan Academy is a popular non-profit educational organization that focuses on making micro lessons on a variety of topics and has delivered more than 200 million lessons online.71 In Bao’s words, “while online courses may have a slower uptake in China due to a limited – yet growing – telecommunication infrastructure, because of their inherent flexibility for being offered and accessed throughout a wide variety of time slots, this will enfranchise rural and urban students who can now utilize global knowledge databases.  These same students – who due to their inland locations and schools lacking the funds would otherwise not have access to experts including foreign instructors whose language skills are highly sought after and could be substantially cheaper via telepresence.”

Yet again, one challenge, as Bao mentioned, is that the telecom infrastructure is still relatively limited in bandwidth.  For example, as I note later in Chapter 15, according to their Q3 2012 speed survey, ChinaCache, the largest domestic content delivery network (CDN), notes that while the overall speeds are a little slower than previous speed rankings, Shanghai currently leads the country in average speeds at roughly 3.44 Mb/s and Beijing is 10th at around 2.5 Mb/s.7273 Akamai Technologies (a global  content delivery network provider) ranked China’s average internet-connection speed at 94th globally, at 1.6 Mb/s.74 In addition, depending on the regulatory and monitoring issues discussed in Chapter 20 with the Great Firewall, quality of service and bandwidth may decline as you leave the larger Tier 1 cities.  Thus entrepreneurs should take these factors into account while making a business plan.

In December 2012 I spoke with Eric Azumi, vice-president of information systems at EF.  According to him “the online market is just now beginning to be tapped.75 There have been limitations that continue to be overcome including computational and bandwidth issues that arise in every country but especially in China.  Voice recognition services similar to Siri will probably be the next technology incorporated into this segment and eventually, as the online industry matures, it will be commoditized.  What I mean by that is that at some point all competitors will have very similar software stacks in terms of features and functionality, yet there is always room for value-added services – especially as more direct-teacher training is replaced with mobile learning.”

Azumi gives as an example, the technical changes over the past 15 years as online classrooms evolved from text-only, to incorporate audio, then video via telepresence (e.g., webcams) and as he predicts in the near-term, real-time voice recognition.  Yet again even with all of these competitive forces with large, well-funded, experienced incumbents he thinks that “because of the relatively low barriers to entry just about anyone can still set up an educational center in China and elsewhere, especially if they cater to niche groups or provide a unique environment such as how coffee shops in Japan have been turned into English conversation centers that provide both relaxed and informal way of improving language skills.  And because people by-and-large still insist on face-to-face time, the general acceptance of online education will take time to diffuse here and around the globe.  Furthermore even with the advent of on-demand instructional services there are still many opportunities for traditional schools in 2nd & 3rd Tier cities which are still nascent markets that have not been exploited yet.”  These technological challenges and opportunities related to cloud computing are further expanded on in Chapter 13.

Yet for those willing to face these technical challenges, the financial rewards could be lucrative.  According to one recent estimate, up to 380 million people in China will “need high-quality education and training resources across the country” from 2012 to 2017.76 And a large percentage (~30%) of these people are expected to utilize online services and tools, creating a potential market worth an estimated $11 billion in revenue.  However, to temper any get-rich-quick enthusiasm, the amount of investment into Chinese education companies fell to $46 million in 2012, less than a quarter of the previous year.77 Why?  David Chen of AngleVest – a venture capital group focusing on angel rounds – noted that “the timeframe for growing an education business can be drawn-out, and a challenge for fund managers who have to achieve returns by a specific date.”78 Thus once again, while there is potential revenue there is also required patience for returns on investment.

Takeaway: The education market in China has the potential to be both large and profitable.  However, gone are the days when you could merely jump on an airplane, get off and instantly set-up a market-leading company.  The industry has become increasingly competitive with both professionalized workforces and various rules and regulations such as licensing and certification guidelines.  But as long as the Chinese economy and population continue to grow, there should be continued opportunities for entrepreneurs and companies who have done their due diligence.  This chapter does not discuss guanxi, a cultural phenomenon involving personal connections within the hiring and deal making process in all Chinese business transactions.  But that is a very complex topic worthy of several copious volumes and touched on in Chapter 10.


Endnotes:

 

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  1. Number of Elementary Schools Shrink in China as Population Ages from Xinhua []
  2. Age will weary the Chinese miracle from BusinessSpectator []
  3. More specifically, “Despite a 40% increase in population since 1976 the number of primary school students has gone down by 33%, from 150 million to 100 million, and there were half as many primary schools in 2010 as there were in 2000.”  See 停止计划生育政策的紧急呼吁 from Eduzx.net []
  4. The peak was 9.5 million in 2006.  It has declined in part because of the one-child policy and also because many students are matriculating overseas for education.  See More students choose to study abroad from People’s Daily and The gaokao: still life’s most important test? from China Daily []
  5. The number of higher education institutions doubled in ten years, from 1,022 to 2,263 in 2011.  This includes a combination of both universities and junior colleges.  For comparison roughly 3 million students graduate from US universities and junior colleges each year.  There are now 11 times as college students in China as it had in 1989.  See China’s Ambitious Goal for boom in College Graduates from The New York Times, China’s Graduates Face Glut from The Wall Street Journal, Chinese Graduates Say No Thanks to Factory Jobs from The New York Times and A work in progress from The Economist []
  6. Testing time for study abroad from China Daily []
  7. Currently there are no SAT test centers on the mainland due to restrictions by the government.  Thus students wanting to take the SAT must go elsewhere, typically Hong Kong.  See ”洋高考”来势凶猛国内高校面临挑战 from Sohu []
  8. See Chinese Flock to the GMAT from The Wall Street Journal and China Outperforms U.S. on GMAT from The Wall Street Journal []
  9. This growth in GMAT testing and overseas matriculation is one of the reasons why US institutions that provide MBAs have grown from 26,000 to more than 168,000 annual graduates from 1970 to 2009.  There are a number of mainland based MBA schools as well including the top ranked Cheung Kong Graduate School of Business in Beijing.  See Is the MBA Obsolete from Forbes, China Best Business School Leadership MBA from Forbes and Game Changers: Guanghua Cai from Fortune []
  10. China’s Test Prep Juggernaut from BusinessWeek []
  11. New Oriental is currently involved with a class action lawsuit that alleges the company did not clearly state that students in franchises (which the company does not own) were counted among the overall headcount (e.g., headcount inflation).  See New Oriental faces class law suit in the US from China Daily and New Oriental Sinks as Block Renews Allegations: China Overnight from Bloomberg []
  12. An education exchange would strengthen ties with China from Politico []
  13. Chinese Learn English the Disney Way from The Wall Street Journal []
  14. China to recruit foreign experts through Internet from People’s Daily []
  15. In addition to traditional formats and courses, the EFL market in China also includes: IELTS, TOEFL, SAT, GRE, GMAT and LSAT. []
  16. For a step-by-step procedure, see Starting a Business in China from the World Bank.  See also New Path for Trade: Selling in China from The New York Times []
  17. Ambow is currently facing a lawsuit by investors who accuse it of fabricating acquisitions to bolster its revenue numbers.  See Ambow Education Investors Pursue Lawsuit as Shares Plunge from Bloomberg []
  18. Teaching English in China: What You Need to Know from Yahoo! Voices []
  19. The Impact of English in China by Jun Liu []
  20. As I note in Chapter 14, through the mass consumption of Western entertainment, the Romanization and Latinization of both mainland businesses and cultures continues.  And yet this is not the only area in which Western culture is absorbed on the mainland.  According to Yasmin Haskell, “The Chinese already appreciate the importance of these sources [European sinologists]. Several years ago they were sending local students on scholarships to learn Latin at European universities. Today, as I am reliably informed by a senior American colleague, they are training up thousands of Chinese teachers of classics – not the Chinese classics of Confucius and Lao Tzu, that is, but those of ancient Greece and Rome.”  See We must look to an ancient tongue to understand Asia from The Australian []
  21. Another on-going long-term opportunity for brand marketers is working with these large SOEs as they internationalize and go abroad.  While they typically dominate their specific market segments domestically (in part because of their monopolistic privilege) they have had uphill challenges in expanding abroad.  See BCG: Chinese State-Owned Firms Not So Muscular Abroad from The Wall Street Journal []
  22. China Needs American Education. Here’s How to Bring It There from Forbes []
  23. See English language education in Korea, fad or the future? from Yonhap and The Economics of English by Hyo-Chan Jeon []
  24. See Japan Launches primary push to teach English from The Guardian, The Economics of English by Hyo-Chan Jeon and Elementary Schools to get English from The Japan Times []
  25. The economic term for this is the “subjective theory of value” in contrast to the classical “labor theory of value.”  See Chapter 4 entitled The Subjective Theory of Value by Thomas Taylor []
  26. An Interview With Charles Zhang, CEO of Sohu from Agenda []
  27. China’s Middle-Class Parents Underwhelmed by Undergrad Degree from The Wall Street Journal []
  28. Ibid []
  29. In China, Betting It All on a Child in College from The New York Times []
  30. As one of my Chinese mentors in Singapore explained, the cultural component should not be overlooked or downplayed.  There is a Confucian virtue called xiushen (修身 or self-cultivation, improvement, rectification) which has been enshrined at a deep cultural level across the Chinese populace that Western education, especially at tertiary levels, and particularly in the fields of science, technology, management, marketing and finance will probably see strong demand for years to come.  This is not simply a calculation concern (to improve one’s income potential), but even more so a cultural phenomenon. []
  31. 600 million middle-class Chinese by 2020: think tank from Xinhua []
  32. See p. 10 The Chinese Luxury Consumer White Paper from Hurun []
  33. The target schools abroad, especially in the US are elite institutions like the Ivy League.  See Chinese flock to elite U.S. schools from CNN []
  34. To be even handed there are also several successful domestic tech firms founded by homegrown talent that did not matriculate overseas such as Jack Ma (Alibaba) and William Ding (NetEase). []
  35. USC’s Marshall School of Business has a joint international venture with Jiao Tong University in Shanghai, offering an executive MBA since 2004. []
  36. Harvard Trained Communists Vie for Power as Party Gathers from Bloomberg []
  37. Ibid []
  38. Some of these new “special” programs (preparatory courses often taught by foreigners) are called “American-Chinese cooperation programs” and are being implemented at public schools, yet they also have their own admissions hurdles.  For example, they all require their own entrance examination and some of these programs charge up to 100,000 RMB ($15,000).  See “洋高考”来势凶猛国内高校面临挑战 from Sohu []
  39. See British public schools exported to China from BBC and China creates a replica of famous British public school Wellington College near Beijing from Daily Mail []
  40. An Oxford in Changzhou? International schools spread across China from Reuters []
  41. SMIC Private School in Shanghai is estimated to cost around $11,000 a year whereas the British International School in Shanghai purportedly costs $30,000 per annum. []
  42. An Oxford in Changzhou? International schools spread across China from Reuters []
  43. Spreading their wings early from China Daily []
  44. Ibid []
  45. Ibid []
  46. Can U.S. Universities Stay on Top? from The Wall Street Journal []
  47. Various levels within the Chinese government are attempting to recreate the education boom laid forth by the G.I. Bill through their own $250 billion a year initiative.  See China’s Ambitious Goal for Boom in College Graduates from The New York Times []
  48. Chinese boost for US colleges from Shanghai Daily []
  49. It is not just US colleges that have benefited from this international student pool.  According to an Al Jazeera report, “British universities receive more students from China than any other country outside of the European Union.”  There were 67,235 Chinese international students in the 2010-2011 cohort in the UK.  See Chinese students choosing to study abroad from Al Jazeera []
  50. Students from China add $5b to US economy from China Daily []
  51. Ten Years of Rapid Development of China-US Relations from Xinhua []
  52. Prior to World War II, the leading institutions of both the sciences and social studies were in German-speaking countries.  German, not English, was the lingua franca of the academic world for nearly a century. []
  53. One tool that all administrators and application departments in any country can now utilize to screen potential candidates is IntialView which is an interview platform that is becoming increasingly popular among both by applicants and administrators (38 out of the top 50 US colleges now accept interviews from this platform).  See China’s InitialView gains traction as most top US universities now accept its candidate interviews from The Next Web []
  54. Stanford research center opens at Peking University from Stanford []
  55. Shanghai NYU will open for fall of 2013 from Shanghai Daily []
  56. Juilliard to Bring New York-Style Teaching to China from The New York Times []
  57. Foreign universities: Campus collaboration from The Economist []
  58. Duke Kunshan University delayed again, following communication and funding problems from The Chronicle []
  59. Forged Transcripts and Fake Essays: How Unscrupulous Agents Get Chinese Students into U.S. Schools from TIME []
  60. While there are many genuine applicants, foreign admissions consultants should be aware that considerable amounts of fraud have taken place in this subindustry.  In fact, one report in 2011 based on a survey of 250 Beijing high school students matriculating to the US “concluded that 90 percent of Chinese applicants submit false recommendations, 70 percent have other people write their personal essays, 50 percent have forged high school transcripts and 10 percent list academic awards and other achievements they did not receive.”  See A Chinese Education, for a Price from The New York Times, The China Conundrum from The New York Times and Busted: Fraud in China by Tom Melcher []
  61. For a step-by-step procedure, see Starting a Business in China from the World Bank.  See also New Path for Trade: Selling in China from The New York Times []
  62. SNQA []
  63. Chinese Universities Send Big Signals to Foreigners from The New York Times []
  64. ‘Sea turtles’ reverse China’s brain drain from CNN []
  65. Steal this Scientist from The Daily Beast []
  66. Reverse brain drain: China engineers incentives for “brain gain” from Christian Science Monitor []
  67. For a step-by-step procedure, see Starting a Business in China from the World Bank []
  68. For a concise explanation see PRC Taxes on Hong Kong & Foreign Companies: Clarifications, Changes, Challenges & Opportunities from Orrick, Herrington & Sutcliffe.  And while not exactly the same, there is a similar method of reducing tax liabilities used by numerous multinationals; see ‘Double Irish With a Dutch Sandwich’ from The New York Times and Google Revenues Sheltered in No-Tax Bermuda Soar to $10 Billion from Bloomberg []
  69. See In Reversal, Cash Leaks Out of China from The Wall Street Journal and The Mechanics of Moving Cash Out of China from The Wall Street Journal []
  70. According to Distimo, “Applications with Chinese as a language in the top 200 were responsible for the largest share of the free downloads in China at 73 percent. English was responsible for only 69 percent of the free downloads among the top 200 in China.” See App Distribution Becomes A Global Game: The Shift Of Power & Impact For Developers from Distimo []
  71. One Man, One Computer, 10 Million Students: How Khan Academy Is Reinventing Education from Forbes []
  72. ChinaCache Releases Third Quarter 2012 China Internet Connection Speed Rankings from China Web Report []
  73. For comparison, the average download bandwidth in the US is 11.6 Mb/s.  See International Broadband Data Report (Third) from the Federal Communications Commission []
  74. China’s ‘Wall’ Hits Business from The Wall Street Journal []
  75. To be balanced I should point out that there are several other competitors that offer online language learning services including TellMeMore and GlobalEnglish. []
  76. Tencent Eyes Growing Online Education Market in China from Caijing []
  77. China Investors: We Don’t Need No Edukation from The Wall Street Journal []
  78. Ibid []

Chapter 10 – Legal services

[Note: below is Chapter 10 from Great Wall of Numbers]

I have been more or less fortunate not to have any problems with government authorities at any level (yet).  However whenever you put a group of laowai (foreigners) into social setting you will eventually hear a story or two – sometimes embellished – about legal problems.  The one personal story that I have involves visa delays.  About two months into my most recent teaching position I received a notice from my HR director that my visa was being delayed by the PSB – Public Security Bureau (equivalent to the Immigration Services).  They wanted me to come in person for a face-to-face interview at a local police station with an officer.  My director said while this was unusual we could prepare for it and analyze what they may inquire about.  At around 2pm on a June weekday I went in and met a number of plain-clothes inspectors.  One handed me a worn book of immigration laws covering the sections I possibly had violated.  After a few questions and three hours of sitting next to their terminals, one of them – Zhang (not his real name) – approached me and after a brief exchange allowed me to leave without any recourse.

Fortunately the paperwork had been merely misplaced and nothing came of it.  But what should foreign firms and expats expect when starting a business?  Always be prepared.

There are several ways in which you can proactively protect both your physical assets and employees.  The first almost goes without saying: hire a legal advisor to analyze and asses any liabilities, risks and loop-holes in your contracts and business model.

For example, Dan Harris is an American attorney at Harris & Moure who frequently travels to China and publishes the popular ChinaLawBlog.  In an email exchange in October 2012, he noted “that the most common challenge for US service-oriented SMEs is getting paid. Chinese companies are reluctant and slow to pay for services. Most service companies do not have much IP [intellectual property] so that is not always a big issue for them. And thus I would have to say contracts is their biggest issue, which gets us back to getting paid.”

Dan and his co-blogger Steve Dickinson, who lives and works in China, have written a number of excellent overviews of contract law in China and about protecting your assets, your employees and even your IP.1

Why is professional advice such as theirs important?

Ten years ago when China’s Railway Ministry elicited bids for building a nation-wide high-speed network (called the CRH, HSR or 高速铁路), several foreign companies from France and Japan submitted bids.  As part of the deal to do business on the mainland, the Ministry required that foreign firms set up joint ventures (JV) with domestic suppliers and provide technology transfers to these firms.23 Japanese firms, unfamiliar with the nebulous legal framework in China, ultimately handed over their ‘best practices’ and engineering techniques to the JV.  Their Chinese partner (CSR, 中国南车集团) then quickly replicated and reverse-engineered the technology using domestically sourced parts and labor.  As a consequence the Japanese companies were edged out of the Chinese market by the very machinery they had originally designed.4

Another example is General Motors which, wanting to gain access to China’s car market (now the world’s largest), transferred and exchanged technology to their JV partner, SAIC.  While GM still operates in China (hitting a record 2.54 million in vehicle sales in 2011), they have found themselves between a rock and hard place with China’s new policy regarding electric cars.5 This policy mandates that foreign firms provide technology transfers to their JV partners in order to have access to the Chinese electric car market.6 Since foreign firms are holding out – not wanting to part with their trade secrets and proprietary information – Chinese firms now have a distinct advantage because the national government is offering nearly a 50% subsidy to consumers for each sale of an electric car in China.78

Let’s discuss this over dinner

As noted in Chapter 1, guanxi, or personal connections, can be a very tricky and hard to fully describe to those who have never lived or worked in China.  For example, compared with thirty years ago, contracts are relatively more ironclad in legal disputes – yet the “rule of law” today is not quite the same as it is in Western countries.  This presents a challenge to any firm wanting to do business in China and thus building guanxi, personal connections with suppliers and even buyers is sometimes just as important as the resources spent in drafting contracts, subpoenas and lawsuits.

While guanxi can work for you – you might land a deal with a mere handshake at a KTV (Chinese businessmen typically dine and sing in contrast to discussing business deals on golf courses in the West) – not having enough guanxi, or not having guanxi with the right people could prevent your company from exporting your goods to consumers outside of China.9

Can you just “grease some palms” and make things happen?  Over cocktails with other laowai it may be common to hear insinuations various businesses that used bribes to improve their guanxi.  I should point out that the Foreign Corrupt Practices Act (FCPA) and UK Bribery Act deals specifically with bribery.  To better understand this law and its enforcement, it is highly advised that you consult a lawyer because the FCPA is actively enforced and the penalties for violating it are quite stiff.  Furthermore, as I mentioned in the first story in Chapter 1, even if you know the right people and make the right connections this does not immediately translate into success.

Legal structures

If you do decide to operate a business in China, what legal structure will you use?  Should you try to start up a Wholly Foreign-Owned Enterprise (WFOE), Variable Interest Entity (VIE) or some other joint-venture structure?10 Stephen Dickinson, the Beijing-based American attorney above, has written a number of primers on what legal structures foreign businesses should and should not create.  Because of Chinese regulations that prevent foreign ownership of companies from being directly involved in “sensitive” areas of the economy (e.g., for national security reasons), one way to skirt such limitations was to set up a VIE.11 Yet due to new regulations issued last year, VIEs are no longer an option and the SEC itself is rumored to be investigating how they operate as well.12 While this was not particularly surprising to lawyers and serial entrepreneurs, it may have come as a surprise to the uninformed and those who failed to carry out thorough due diligence.

Similarly, during the summer of 2011 several shareholders of Yahoo were ‘surprised’ when the Alibaba Group (owner of Alibaba, Tmall and Taobao) transferred the ownership of Alipay.13 Alipay is an online payment method (similar to Paypal) that is currently the domestic marketshare leader, at 47%.14 According to Chinese law, online payment processing companies cannot be owned by foreigners, something that a VIE structure was considered as a means to get around.  What resulted was a high-profile, very vocal series of discussions that headlined the business press for several months between May to July of 2011.  The lesson here is that, as Dan Harris noted, this was not unprecedented.  His law firm “has been involved in probably a dozen similar matters.”15 So once again, talk to a legal advisor before you set up any kind of presence in China, even if it is as “simple” as a minority shareholder position.

What kind of opportunities are there for legal professionals?

I asked a couple of Chinese lawyers this question.  They both quickly noted that experienced practitioners can find a number of opportunities in areas such as FDI and M&A.  For example, in addition to Harris & Moure discussed above, King & Wood Mallesons is an international legal firm with offices in China that specializes in more than a dozen areas of law including, Import/Export Credit Facilities, M&A, FDI and PE deals.16 Their foreign expertise allows them to provide services like FDI that local firms – lacking in international experience – sometimes cannot fully provide.

Yet before getting on an airplane with your fresh JD and Bar certifications consider the following challenges.  In order to practice on the mainland you need to be licensed in China as well. That means you need to take the National Judicial Exam (国家司法考试) which means you not only need to be fluent in Chinese but because of sovereignty issues, at this time the only people legally eligible for sitting for the exam are citizens from the mainland plus Hong Kong, Macau and Taiwan.  For comparison, in the US, each state has its own residency and citizenship requirements.  Some such as California and New York currently allow foreign nationals to take their bar exams and set-up practices.17

A frequently asked question from friends overseas is if there are many licensed lawyers in China?  Yes.  In fact, according to their new 2012 White Paper on judicial reform, the State Council Information Office states that there are nearly 220,000 lawyers and 18,200 law firms in China (this is substantially higher than the 200 lawyers in 1980).1819 These same lawyers acted as counselors for 392,000 clients and handled 2.315 million litigation cases in 2011.

A legal professional I know in New York recently asked me if there is a work-around for this to provide paralegal services instead.  Perhaps, but you probably would not be able to access large portions of information that have restricted access.  For example, currently in China only licensed lawyers can look up internal business records (e.g., shareholder meeting minutes, the shareholders list, the composition of the board, the balance sheet and other related financial reports).  And there are conditions for even licensed lawyers to access this information.  Currently, the authority granted to lawyers must be justified by some “reasonable concerns.” Access is allowed only for the appropriate purposes – for example, if a shareholder wants to exercise his inspection right, his lawyer then could claim the right to see the company records on the shareholder’s behalf.20 Similarly, doing investment research on the mainland as a WFOE (Wholly Foreign Owned Entity) is not currently legal.21

In contrast, in the US just about anyone can look up the full company records of any public company.  In addition, the domestic legal profession on the mainland has run into a number of barriers that some have called a “clawback” relative to reforms implemented in the 1980s and 1990s.22 Thus the nebulous uncertainty and dynamism for legal professionals is something to consider before establishing a permanent physical presence on the mainland.

Explicit and implicit rules

While many expat companies will set up a Hong Kong office to reduce the tax burden and liability on incomes earned on the mainland (e.g., your workers are paid through the Hong Kong subsidiary and are thus taxed at the lower Hong Kong rates), many Chinese companies also have set up Hong Kong subsidiaries to reduce their tax burden.  For example, in the Chinese energy industry, several companies that manufacture hydrocarbon drilling equipment on the mainland will ship and sell (e.g., “export”) their physical products to a Hong Kong controlled subsidiary, and then re-import them.  In some cases they can reduce their taxes by up to 20%.23

According to Chinese law, the maximum amount of funds that any individual can move out is $50,000.  Thus how to repatriate your assets is another key issue.  The Wall Street Journal has published several reports this past year about the labyrinthine difficulties that both Chinese and foreigners face when attempting to move funds outside of China.24 While not explicitly encouraged, the Hong Kong legal system protects certain activities including money transfer agents who essentially move capital across the border.  It is highly recommend that you consult with an attorney or tax expert before attempting to do the “Hong Kong shuffle.”25 Failure to do so could result in being (temporarily) arrested, like Yan Suiling – who was accused of money laundering in China (because the process she used is illegal on the mainland) but was later acquitted (because the process she did it by was legal in Hong Kong).26

Another example of legal issues and lawful avoidance involves real-estate purchases.27 In an effort to “cool down” the property market, over the past several years larger cities like Beijing and Shanghai have implemented a number of regulations that place restrictions and “curbs” on individuals purchasing multiple homes.28 This move into multi-home ownership was done in part because strict capital controls prevent domestic savers from investing overseas.  As a consequence many savers have few places to park their assets.  Depending on the region, one of the areas where they can typically invest more freely is real-estate.  So in addition to suppressed (low) interest rates set by the central bank which have incentivized construction projects and capital consumption, many savers in the past decade have had few investment choices and thus have purchased, invested and speculated in real-estate markets.29 And due to a perceived “bubble” in the real-estate market, several cities subsequently enacted laws that make it increasing prohibitive to buy multiple homes (e.g., by increasing down payments from 20% to 50%).  In an attempt to legally circumvent this, some prospective home buyers will pool their resources together and purchase housing units in a “group buy” method (e.g., like GroupOn).

Takeaway:  While there are numerous opportunities to do business in China there are also a number of challenges, including legal uncertainties.  This includes the legality of contracts, movement of assets, protecting IP and lowering tax liabilities.  In addition there is a cultural practice called guanxi, or personal connections, which can directly impact many (if not all) business transactions on the mainland.  While there may be opportunities for experienced legal professionals to work in niches, before moving to the mainland it is highly recommended that you do your due diligence to find out what specific niches areas are in demand.  In addition, all proprietors are encouraged to speak with and perhaps hire a legal counsel that is proficiently versed in both the mainland legal system as well as the culture.  Failure to do so may result in being unable to protect your assets and possibly even forfeiting them as well as the market access that your firm had hoped to achieve.


Endnotes

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  1. For their series on protecting your IP in China, see How To Protect Your IP from China from ChinaLawBlog []
  2. For their discussion on technology transfers and legal statutes in China see How To Handle Chinese Negotiating Tactics. Part Three. from ChinaLawBlog []
  3. For more regarding legal issues surrounding joint ventures on the mainland see, China Joint Ventures. Watching The Sausage Get Made. from ChinaLawBlog []
  4. See Japan Inc shoots itself in foot on bullet train from Financial Times and IPR fears won’t derail bullet train exports from China Daily []
  5. General Motors closest competitor is Volkswagen, who sold 2.81 million cars in 2012 but initiated one of the largest recalls beginning April 2, 2013.  See Volkswagen recalls over 384,000 cars in China: watchdog from Reuters []
  6. General Motors in China: Coping with the Changes in the Automobile Industry from ICMR []
  7. GM and SAIC join forces on electric cars from Financial Times []
  8. See Road Gets Bumpy for GM in China from The Wall Street Journal and GM and SAIC’s Open Marriage from China Bystander []
  9. There are endless amounts of anecdotes retold by colleagues and coworkers over the years.  One notable story involves a friend who wanted to buy natural and artificial hair in China and ship it to the US targeted specifically for African hair salons for use as braiding.  She spent several hundred hours traveling across Shandong, filing the necessary paperwork, building guanxi, buying hair samples and contacting US hair salons.  Yet due to the thin margins, legal fees related to permits, import & export duties on both sides of the Pacific and transportation costs, her business plan would prove to be unprofitable.  Thus collecting all of the necessary requirements and doing due diligence is highly recommended before investing any significant capital into an overseas endeavor. []
  10. For a step-by-step guide on forming an WFOE see China’s Approval Process for Inboud Foreign Direct Investement 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 []
  11. VIEs In China. The End Of A Flawed Strategy. From ChinaLawBlog []
  12. Variable interest entities in China from China Accounting Blog []
  13. Yahoo gets short end of stick in Alibaba deal from Reuters []
  14. According to Analysys research and consulting, as of Q2 2012, Alipay leads with 47.3%.  This is up from 46.9% in Q4 2011.  See Alipay Lead China 3rd Party Internet Payment Market 2011Q4 from Analysys []
  15. Yahoo/Alibaba/Alipay/Jack Ma/Carol Bratz: What Really Happened And What It All Means. from ChinaLawBlog []
  16. See Harris & Moure and King & Wood Mallesons []
  17. See Chart 4 on p. 14 in Comprehensive Guide to Bar Admission Requirements 2012 from National Conference of Bar Examiners []
  18. See p.5 in Judicial Reform in China from the State Council Information Office []
  19. China has 220,000 lawyers from China Daily []
  20. There are other requirements as to the eligibility of the shareholder for claiming the inspection right as well.  In addition, the restrictions on this and on accessing full company records will vary city by city. []
  21. On Doing Investment Research In China As A WFOE. Not Legal. from ChinaLawBlog []
  22. China’s Turn Against Law by Carl F. Minzner []
  23. In some ways this is similar to retailers in Western countries that practice “rolling inventory” at the end of the year.  Speak with a legal professional before conducting this type of transaction. []
  24. In Reversal, Cash Leaks Out of China from The Wall Street Journal []
  25. This issue was directly discussed in Getting Money Out Of China. That’s Illegal. from ChinaLawBlog []
  26. The Mechanics of Moving Cash Out of China from The Wall Street Journal []
  27. Another area that may change in the near future is capital gains tax on returns for private equity firms investing in China.  See Tax Experts: China May Crack Down on Capital Gains from The Wall Street Journal []
  28. Property curbs to stay from Global Times []
  29. One of the reasons this rate incentivizes real-estate speculation is that the interested earned at a bank is usually lower than CPI or inflation.  Thus merely placing funds into a savings account will actually net a loss once adjusted for inflation.  Readers may also be interested in the analysis from Michael Pettis, a finance professor at Peking University and Patrick Chovanec, a finance professor at Tsinghua University as well as Animal Spirits with Chinese Characteristics by Mark DeWeaver. []

Chapter 11 – Luxury goods, amenities and art

[Note: below is Chapter 11 from Great Wall of Numbers]

As I mentioned in Chapter 3, an estimated 82 million Chinese tourists traveled overseas in 2012.  At $69 billion in purchases in 2011 (and $98 billion in 2012), these same tourists collectively now spend the third largest amount while abroad (behind Germany and the US).1 Nine of the top 10 travel destinations for Chinese are in Asia (e.g., Hong Kong, South Korea), the exception: the US which was visited by 1.36 million Chinese tourists in 2011.23 And in the first half of 2012, “Chinese tourists visiting the US eclipsed that of travelers from other countries.”4 In fact, Chinese tourists spent an average of $7,107 in the US in 2011.5 According to Shao Qiwei, of the National Tourism Industry, “China and the US are each other’s fourth-largest tourism destinations.”678 A 2012 survey conducted by Global Blue, a tax refund tourism company, found that “82 percent of Chinese tourists see shopping as a vital part of their trips overseas.”9 For comparison, France in 2011 – with 900,000 visitors – was Europe’s top destination for Chinese tourists and the UK received about 150,000 tourists from the mainland (who collectively spent $390 million in the UK).101112

So what does this mean for your business?  How can you and your company capitalize on the popularity of Chinese traveling to the US and other western countries?  And what are they buying?

In a phrase: foreign luxury goods.13 Domestic luxury brands purportedly sold well in the 1980s and 1990s but with the entrance of foreign labels they have faced stiff competition.  According to the Shanghai Academy of Social Science, “just 10 percent of Shanghai’s traditional brands are making a healthy profit. Roughly 70 percent are struggling, with the rest on the verge of bankruptcy.”14 In contrast, according to recent reports from McKinsey and from Bain (two of the largest management consulting firms) Chinese consumers are now the biggest luxury buyers globally, consuming primarily foreign brands.1516 This is not to say that Chinese designers are not creating their own fashion trends worldwide.  Last year Haizhen Wang, from Dalian, won the Fashion Fringe Award for young designers and was mentored by Christopher Bailey, creative officer at Burberry.17 Similarly Huishan Zhang is another young mainlander who spent a year at Dior and whose first collection sold out within its first month in London.  For now however, luxury brands consumed by Chinese consumers are decidedly Western.

Overall McKinsey & Company estimates that “purchases by Chinese both at home and abroad account for over one-quarter of the global total” and that by 2015 will account for one third of the luxury market globally.18 And who are buying these goods?  According to research from CLSA, an equity broker based in Hong Kong, men account for 55% of China’s luxury goods market (compared with the global average of 40%) because as Bain noted in another recent report, businessmen gift the items to significant others and to build guanxi with officials, associates and partners.19

On that note, not all is smooth sailing for luxury goods.  For example, according to Ren Guoqiang, a partner at Roland Berger Strategy Consultants, “more than 25 percent of the luxury items sold on the Chinese mainland were used as gifts.”20 Thus during the recent crackdown on government corruption currently being carried out nationwide, gift-giving has dropped markedly.21 As a consequence, according to a report from the Federation of the Swiss Watch Industry “show[s] that Swiss watch exports to the Chinese mainland dropped 27.5 percent year-on-year in September [2012].”22 This is on the back of 40% growth from 2011 noted below.  Furthermore, in February 2013, three of the largest global luxury houses including the parent companies of Gucci, Louis Vuitton and Burberry announced that they would be slowing down their expansion in China this year due to softer sales last year.23

Yet this may be a temporary bump domestically and a substantial amount of this luxury shopping activity is actually done overseas.  Bain estimates “that 60 percent of Chinese purchases are made outside China.”24 And according to a recent KPMG study, “71% of China’s middle class made a trip outside of the country” last year of whom 61% of the study respondents purchased cosmetics overseas and 51% had bought luxury watches.25 Altogether Chinese tourists on average spend $14,686 overseas during these shopping trips, according to Global Blue a shopping tourism service company.26

Why?  One reason has to do with import taxes and duties mentioned in Chapter 1; up to a 60% luxury tax on high-end imported goods.  For example, according to the Ministry of Commerce, a Chanel bag in Shanghai costs 72% more than in Paris and the same Tiffany & Co necklace costs 6,900 RMB in the US but 11,000 RMB on the mainland.27 In addition, even when a 25% customs duty and 15% VAT are accounted for, luxury goods makers such as Burberry also mark-up their mainland products as part of an ‘elite’ perception pricing strategy (e.g., towards the nouveau rich, 暴发户). 28

As a consequence, large amounts of luxury goods are substantially less expensive when purchased abroad relative to the prices on mainland China.  And because many consumers travel abroad to purchase these products to circumvent the importation costs, according to Nick Debnam of KPMG, “One brand told us that for every dollar they sell in China, they’ll sell more than $2 outside of [the country] to Chinese consumers.  Brands are realizing it’s a global market. You can’t get fixated on just within the China market.”2930 Furthermore, KPMG estimates that luxury purchases account for 71% of all spending done by Chinese tourists overseas.31 Thus if you own or operate a luxury goods store in the US or Europe, you may be able to cater to new potential customers.

In 2011, prior to overtaking the US, the luxury consumer goods market in China was an estimated $51.7 billion (€40 billion), slightly less than the size as the luxury consumer goods market in the US ($62.4 billion).32 To get this number, overseas sales are included.  For example, according to the Financial Times, on the mainland the market for these goods in 2011 itself was actually only $16.77 billion.33 This domestic number itself will grow to $27.39 billion by 2015 (up from $9.9 billion in 2009).34 Yet if you include the shopping done by Chinese consumers in Hong Kong, Macau and Taiwan this rises to $30.5 billion.35 And then add in an estimated $15.5 to $19.5 billion spent in 2011 by tourists outside of Asia, this number rises to the $51.7 billion.  So no matter how you shake it, there is a huge demand for foreign luxury products by Chinese consumers.  Or as P.T. Barnum might say, at least in the short-run no one ever went broke underestimating public taste and in this case, Chinese tastes.3637

In fact, Harrods department store in London, to better cater to mainland customers that frequently travel to the UK and shop during the past Christmas holiday brought on board “70 Mandarin-speaking shop assistants” and “has more than 100 UnionPay terminals directly connected to Chinese bank accounts.”3839 Selfridges, another department store in London, employs “dozens of Mandarin-speaking staff.”40 Likewise, the Hippodrome Casino on the West End “has an entire floor dedicated to Chinese gamblers” and the staff speaks Chinese.41  Burberry has taken it a step further and doubled the amount of Putonghua (Mandarin) speaking staff in Europe this past year.42 Why?  Because according to Patricia Yates, director at VisitBritain noted, “the average Chinese visitors spends about three times as much – 1,600 pound ($2,600) – as the average visitor to the United Kingdom.”43 Or more to the point above, Chinese tourists spend five times as much at Herrods than Americans do.44

Similarly in New York City, to prepare for the tourist rush during the 2013 Spring Festival celebration (春节), Bergdorf Goodman (an upscale woman’s department store) added Mandarin speaking staff and Saks Fifth Avenue installed UnionPay terminals for Chinese nationals.  On the other coast, Haiyi Hotels in San Francisco launched a special discount for Chinese groups traveling in large part because Chinese visitors to California (who collectively spent $1.5 billion in 2011), “is expected to increase 57 percent between 2011 and 2015.”45 And not to be left out, luxury makers such as Gucci promoted Spring Festival with red accessories personalized with Chinese zodiac symbols and Burberry sold bags with snake-skin prints to kick off the “year of the snake” (each year is represented by a different animal, 2013 is the snake).46

Are there any other niches that SMEs can find success catering to?  In December 2012 I spoke with Adam Remington, founder of Remington Pipes, a Tennessee-based pipemaking company.47 Over the past several years his business has grown to include a customer-base in China which is interested as collectors and consumers of his hand-made tobacco pipes.  According to him, “one of our strengths is that we customize each pipe to an individual client.  The value-added is that we provide a rare commodity as specialists, as artisans, to a consumer that has an appreciation for our craft.  For example, the wood we use for the pipe is briarwood that is imported from Italy because it only grows in the Mediterranean climate.  And we use ebonite, a vulcanized type of rubber that is imported from Germany.  Then over the course of several days we hand-cut, shape, stain and paint a unique pipe produced to the customer’s specifications.”  Finished products start at $600 and can reach several thousand with a comfortable profit margin.

Remington’s firm is an example of a successful American craft business that can generate revenue from China without a physical presence on the mainland.  While they have an expansion plan to open a workshop within the next year in the Yangtze Delta Region, perhaps your craft and specialized trade company (e.g., hatter, haberdasher, cobbler) can find a niche customer base as well; maybe even by producing a product in a 3D printer as described in Chapter 7.

Luxurious conundrums and opportunities

Why are they buying these goods while traveling?  As I briefly mentioned in Chapter 8, several of my students wanted to purchase Nike shoes primarily because of the perceived authentic, “higher” quality of the imported shoes.  However, unbeknownst to many consumers around the world, numerous “high quality” goods are actually manufactured in China and then exported to other countries, including Nike shoes.48 These other countries typically levy import taxes and duties on the manufactured goods.  One challenge for foreigners who want to sell sport apparel and luxury goods into markets in China – after receiving the necessary licenses and permits – is how to bring the goods into China (see ExportNow in Chapter 7)?

If a retailer on the mainland stocks goods from Chinese manufactures – despite the actual quality – mainland consumers may think that the goods are less authentic and of lower quality.  For example, in 2011 a Shanghai-based retailer called Da Vinci furniture was accused and found guilty of lying to customers about importing its products from Italy.  Upon investigation it was discovered that the furniture was manufactured in Chinese factories, sent (“exported”) to Shanghai’s Waigaoqiao trade zone and then sent (“imported”) to Da Vinci retail outlets.49 Thus the dilemma: if foreign traders import goods from the US and other countries they will face both import and export taxes.50

What kind of goods are Chinese consumers now buying?  Watches from Citizen and Rolex, bags from Burberry and Coach, wines from Bordeaux and the Napa Valley, art from Christie’s and automobiles from Mercedes Benz and Ferrari.  In fact, China is the largest importer of Swiss watches, “accounting for 30 percent of exports of the country’s [Switzerland’s] roughly 200 brands in 2011.”5152  Another example is wine.  While France still dominates as the largest wine exporter to Mainland China, the Chinese market is now the 5th largest export market for US wineries (Hong Kong is 3rd).535455 China is also the largest importer of cognac (by value) and is expected to surpass the US as the largest consumer of the brandy by 2020.56 In fact, Camus, a French cognac producer, sees Chinese consumption as a percentage of global consumption to increase from 35% today to over 50% in the future.57

Hand bags are also very popular.  In Q1 2012, Coach, the US bag maker, had mainland sales rise nearly 40%; and by Q2 its profits rose 24% “driven in large measure by a 60% sales gain in China.”58 Stimulated by that, Coach is now “pushing for China to become its No. 1 market in the next three years.”59 There are several reasons behind this.  And this is where your company can distinguish itself from the competition.  What exactly is a luxury good?  In addition to institutionalized qualitative management techniques like Six Sigma (which are still not prevalent on the mainland) and because of the food safety issues I mentioned in Chapter 3, more than 60% of Chinese consumers wanted to purchase and import products from foreign countries because they are deemed safer and simply better.60 A recent survey from Boston Consulting Group also found that 61% of Chinese consumers were “willing to pay more for the U.S. made goods — in some cases quite a bit more.”61

Thus while the goods your company manufactures may not necessarily be typically classified as a “luxury” product, with a little rebranding and market positioning, you can turn your well-made widget into a must-have product.  Take a page from perception marketing like Coach handbags did above.  In the US, Coach bags are considered mid-level products, yet their management team has tweaked the marketing in China and elevated them to high-end luxury products.  And because Chinese consumers already consider and perceive foreign products to usually be of higher quality, why not use this advantage to satiate demand?  It can even be as simple as using the 3D printing opportunities in Chapter 7.  Perhaps by partnering with a boutique fashion designer in your hometown and some tweaking of CAD files you can be the first to market a widget that is easy enough to replicate in a MakerBot yet novel enough that it has not been produced by others (e.g., the first mover of a trendy purse).62

An American source at the company explained to me that one of the reasons Coach has succeeded despite domestic copycats and knock offs is that it continuously changes its product line, updating it throughout the year (e.g., spring, summer and fall lineups).  Because it changes so often, it is hard for copycats to catch-up.  In contrast, many of Louis Vuitton’s most popular merchandise items are classical designs that do not change as much and are frequently uniform (e.g., same iconic colors).  As a consequence, local copycats have relatively more time to clone the fashion house.  This is not to say that Coach is immune to counterfeiting as a recent investigation in China during November 2012 found thousands of counterfeit handbags including Louis Vuitton, Hermès and even Coach.63 Yet another difference is that because Coach’s price points are targeted as “affordable luxury,” it can reach a broader range of demographics.  Thus, while their handbags are still relatively expensive (e.g. $600) they are substantially less compared to a Louis Vuitton equivalent which starts at $3,000 and increases markedly.

Another challenge for luxury brands is that in the event of a downturn, which can take place even in China, sales can inevitably also take a hit.  For example, several European luxury makers including Mulberry issued a profit warning in mid-October 2012.  Mulberry noted that its “overseas shipments slumped 4 percent” in the second and third quarter.6465 Another competitor, Burberry, which operates more than 60 stores on the mainland with plans to open 100, issued a profit warning in 2nd half of 2012 due to a macro economic slowdown on the mainland and Europe.66 Another issue that is hard to quantify is gift-giving for guanxi as noted above.  According to one 2009 estimate, gifts to government officials comprised nearly 50% of all China’s luxury sales.67 During recent public appearances, a number of political policy makers have come under fire for wearing expensive belts, watches and handbags that their official salaries could not cover.68 As a consequence there has been some public backlash on social media (like Weibo discussed later in Chapter 13) that has led to investigations and crack-downs on traditional gift-giving.  Luxury consumer goods makers and other high-end goods like Moutai’s baijiu (strong domestic liquor) are purportedly vulnerable to this negative public sentiment.6970 In fact, on March 18th 2013, the Shanghai stock index dropped 1.7% to its lowest point in three months.  Leading the downturn were baijiu firms because Li Kaqiang, the new Chinese premier, announced that government spending on receptions, hospitality and banquets would be significantly reduced this year.71

Another area that US companies can provide services for is summer and winter camps like authentic dude ranch experiences.  A number of students I have had over the years have visited camps in the US and come back ecstatic.  In fact, each semester at least one student and their family have visited places like Yellowstone Park, the Grand Canyon or the Grand Tetons.72 According to the China Daily, in 2011 more than 60,000 Chinese children traveled to the US and participated in various summer programs.73 These participation rates, like tourism rates in general, are expected to increase substantially this year (one estimate is 40-50%) due in part to looser visa restrictions placed on Chinese tourists to the US.74 What services can you or your company provide to these ‘genre’ tourists?75

Amenities and services

In Chapter 3 I mention an interview with Glenn Wilkinson, a consultant with 25 years of experience in China.  In addition to opportunities in the restaurant industry another area that Wilkinson as well as Wendy Bao mentioned is that China’s growing middle class is turning to amenities.  This includes services like high-quality sports massages, spas and even quality-controlled leisure activities.  For example, there is now a large massage chain called Dragonfly Retreat (悠庭), which has grown tremendously over the past decade in large part because its entrepreneurs saw an unmet need: a professional, non-compromising service that was sanitary, reliable and with a consistent quality.  As a result, even with its sometimes long wait times, it has received high praise by CNN and About.com and now operates 17 locations (and counting) on the mainland.76

While relatively unpopular in the West, karaoke or KTV is also a multibillion dollar business.  For example, Wanda Group is the 5th largest private company in China and operates one of the largest KTV chains (with 30 KTV boxes or “bars”) on the mainland.77 Wanda is expanding overseas and bought AMC Entertainment (a large US theater chain) for $2.6 billion in 2012 and plans to invest another $10 billion in the US theater chain and $30 billion globally over the next decade.78 KTV venues operated by Muse, Cashbox and Haoledi chains are also popular in part because they gives their customers a sense of privacy in an otherwise physically crowded environment.

In fact, each weekend millions of consumers including many of my students, colleagues and friends visit and patronize KTV venues.  KTV is popular with all demographics and strata within China, from teenagers to the elderly and from couples to business associates.  How popular?  During August 2012 the most popular app on iOS and Android in China was Changba, a portable KTV booth.79 In my own anecdotal experience in both KTV and Noraebang’s (the Korean equivalent), local customers enjoy it because they have a private outlet to share their emotions and feelings with their friends – something that sometimes is difficult in relatively dense metros.  Just like happy hour in Western countries provides rest and relaxation to bar patrons, so to do KTV establishments.

What does this mean for you and your company?  What amenities can you provide that may satiate an unmet demand?

Main Event and Dave & Buster’s (D&B) are two entertainment and restaurant operators in the US that cater to families and adults.  For example, the ten Main Event locations in Texas offer food, bowling, billiards, video arcade, laser tag, miniature golf and rock climbing under one managed roof.  Similarly, D&B manages 60 locations in North America each of which combines a restaurant, video games, shuffle board plus a sports bar.  While there are a number of independent sports bars and numerous video game arcades throughout cities in China, there is no managed chain similar to Main Event or D&B.  One reason this might be the case is that in China, students in high school and college are expected to focus on studies and scholastic-based extracurricular activities – hanging out with your friends after school – especially in smaller provincial cities is not as prevalent as it is in the West.

In Chapter 6 I mentioned that internet bars or net cafes (wangba) are substantially much more popular than their Western equivalents.  Xinhua estimates that as of 2009 there are more than 138,000 “cybercafés” in China.80 And 70% of the customers are between the ages of 18 and 30.  While these demographics might suggest that rest and relaxation at establishments like Main Event may be profitable enterprises, based on my own anecdotal observations and knowledge of cultural norms, Main Event-like proprietors may face consumption behavior that is unlike that of Western teenagers and young adults.  Thus like any other investment, potential investors should do their due diligence before cutting the ribbon and breaking ground.  And trying to compete for the same demographic group that Wanda, Haoledi, Cashbox, Muse and others currently attract is yet another hurdle that must be confronted.

Art is in the eye of the beholder

While both Sotheby’s and Christie’s have been continuously denied licenses to operate on the mainland, their art house auctions in Hong Kong each generated nearly $1 billion a year in sales in 2011.  According to The Wall Street Journal, in 2011, Sotheby’s sold $960 million of collectibles in Hong Kong and Christie’s sold $855 million in collectibles also in Hong Kong.81 All told, the 2011 art season from the Big Four auction houses in Asia (Sotheby’s Hong Kong, Christie’s Hong Kong, China Guardian and Beijing Poly) pushed the Chinese auction market from the 2nd highest at $8.2 billion in 2010 to the worlds largest.  In fact, with $4.8 billion in total sales, the Chinese art market “made up 41% of the global total turnover” in 2011.82 Yet this is not necessarily an area for get-rich-quick schemes either.  To be even handed, the overall art market slumped on the mainland in 2012 (due to a sluggish macro economy).  For example, Sotheby’s noted a marked decrease in sales, generating $258 million in autumn sales (a 37% decline from the previous year).83 Overall sales at Sotheby’s dropped from nearly $1 billion in 2011 to $592.9 million in 2012.84 Likewise, Christie’s reported a 15% drop year-on-year.  And both China Guardian and Beijing Poly faced significantly larger drops as well.  Altogether auction sales in China dropped 30% in 2012, allowing the US to regain the top position as market leader.85

However there are several reasons why the art market in China has grown over the past decade.  The first is that China, despite the internal and external conflicts that have resulted in the destruction of its cultural heritage (e.g., Old Summer Palace, 圓明園) still has one of the largest indigenously produced collections of art and calligraphy, a cultural endowment in which collectors around the world are increasingly interested.  Another reason is, as I briefly discussed in the previous chapter, art sales are one way to move capital out of China, bypassing the strict capital controls on the mainland.  And one creative corollary to this legal loophole is “elegant bribery,” a phenomenon that Jia Guo of Columbia University methodically detailed last year.86

While I certainly would not encourage the risky cat-and-mouse business of bypassing capital controls, Western artists and collectors may find new consumers and clients to whom to sell their paintings, statues and art wares.  In fact, skilled artisans in classical realism, impressionism and academic painting may be able to set up art schools and salons on the mainland.  This is a region, which despite a cultural appreciation for art and institutionalized support, currently has room for foreign skilled experts.  As I noted in Chapter 9, there are a growing number of public and private education venues and projects to satiate consumer demand in scholastic activities, this includes art and sculpting.  According to Nigel Carrington, rector for the University of the Arts London, UAL is looking to set up art foundation courses in part because “the Chinese are “furiously building” art and design schools in a bid to stem the flow of young talent to the west.”87

Do you have to move to China to sell art or services?

Not always.  Ken Yeh, chairman of Christie’s in Hong Kong, after observing a surge in impressionistic buying thinks that “the potential for Western art in China is huge, just massive.”88 Last year the New York Times noted that this renewed interest in Western art appeals to the affluent, like hedge fund manager Lawrence Chu, as well as new Chinese buyers who were raised during the Cultural Revolution and are now “successful business people with huge amounts of money at their disposal.”89 Perhaps you and your company can sell paintings and statues on Taobao through ExportNow (discussed in Chapter 7).  Perhaps you can use Wildfire or Mila (discussed next in Chapter 12) to locate patrons and clients.  Either way, your company can capitalize off the consumer demand for Western art in China without needing to open a physical shop on the mainland.

Another opportunity for independent artists and hobbyists is to sell art through a Beijing start-up called Yizzu.  For several hundred RMB, consumers can purchase reprints instead of paying thousands for an original.90 Community sites like this will enable a new segment of clientele to decorate their homes and offices.  And for perspective, at the other end, in 2011 more than 700 paintings sold for $1 million in China, compared with 426 in the US and 377 in the UK.91 Thus there are now opportunities at all price points.

Takeaway: Chinese tourists now comprise one of the largest tour blocks in the world, at 82 million overseas tourists in 2012.  China is also home to one of the largest markets for luxury consumer goods and its middle class places high value on foreign-made products.  In addition, Hong Kong – and by proxy, China – is now the world’s the largest art market.  How can you and your company capitalize off of these changes?  Can you reposition your brand and product like Coach handbags has?  Do you currently provide artisan services such as training and tutelage?  Perhaps you can begin to market your brand overseas using social media (discussed in Chapter 12) to promote your company to a new customer base that automatically considers and perceives foreign products and services as high quality.  And remember, if you do not take this opportunity, your competitor’s likely will.


Endnotes:

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  1. See China Tourism Academy showed 70 million Chinese tourists outbound in 2011 from China Business Network, Chinese rush overseas for holiday from China Daily and China Voice: Keep China’s big spenders at home from Xinhua []
  2. Bless the Crass Chinese Tourist from The New York Times []
  3. Thailand now receives more tourists from China than anywhere else.  In fact, tourists from the mainland “accounted for 13 percent of the 19.8 million visitors to Thailand in the first 11 months of last year.”  For example during the 2013 Spring Festival, an estimated 270,000 Chinese tourists visited Thailand.  See Chinese Tourists Lost in Thailand Boosts Hotels: Southeast Asia from Bloomberg and 270,000 Chinese in Thailand during festival from China Daily []
  4. China now top source of leisure travelers to US from Want China Times []
  5. Chinese tourists spend more in US in 2011 from China Daily []
  6. Ibid []
  7. Some of these mainland tourists are now traveling abroad during Chinese holidays.  In fact there are numerous travel groups that are targeting the US during the winter due to its relatively slower season (compared with the intensely busy travel season on the mainland).  According to one report “four Chinese tourism companies have launched a project to attract Spring Festival vacationers from China” to the US.  See Start the new year with a trip to the US from China Daily []
  8. Hainan Airlines recently set up a non-stop direct route between Beijing and Chicago.  See Hainan Airlines to begin direct Chicago flights from China Daily []
  9. Global Blue also found that the top three favorite destinations for Chinese tourists are France, Germany and Singapore.  See Chinese overseas shopping hits record high from Xinhua []
  10. One of the reasons why there is such a large disparity between tourists to France versus the UK has to do with the Schengen Area harmonized visas (e.g., if you get an tourist visa to one member of the EU you can visit any of the other members).  The UK is implementing a new visa policy to streamline and make it easier for mainland tourists to visit; ; in 2012 the UK Border Agency issued 286,000 visas to people in China.  And according to Patricia Yates of VisitBritain, “[t]he average Chinese visitor spends about three times as much — £1,600 ($2,600, 2,000 euros) — as the average visitor to Britain.”  Collectively their spending amounted to £240 million ($390 million) last year.  See Britain looks to Chinese tourists for Christmas cheer from Agence France-Presse and UK aims to streamline visa application process from Global Times []
  11. France tops European table for Chinese tourists from The Guardian []
  12. See Chinese check-ins from The Economist and Chinese flock to Europe, US for holiday from China Daily []
  13. Another possibility that I did not mention is that you could cater to Chinese tourists coming to your hometown.  For example in 2011, “Starwood Hotels & Resorts Worldwide and Hilton Worldwide rolled out global hospitality standards such as in-room tea kettles, slippers and translation services, centered on wooing Chinese guests.”  See Meet Hualuxe, China’s Newest Upscale Hotel Brand from The Wall Street Journal []
  14. Chinese brands struggle in luxury market from People’s Daily []
  15. Chinese luxury: top of the shoppers from Financial Times []
  16. 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 []
  17. Why China is sitting on fashion’s front row from CNN []
  18. Luxury Without Borders: China’s New Class of Shoppers Take on the World from McKinsey & Co. []
  19. See China’s metrosexual men revive luxury shopping from Reuters, Let’s hear it for the boys: China’s men lift luxury market from Reuters and Gucci owner targets luxury brands to cash in on Chinese consumers from South China Morning Post []
  20. Corruption curbs crimp luxury market from China Daily []
  21. According to one 2009 estimate, gifts to government officials comprised nearly 50% of all China’s luxury sales.  See China Targets Corruption, Luxury Brands Mourn by Evan Osnos, For Bribing Officials, Chinese Give the Best from The New York Times and SARFT orders ‘gifting’ ads off the air from Global Times []
  22. Corruption curbs crimp luxury market from China Daily []
  23. 奢侈品告别“中国盛宴” Gucci今年在华暂停开店from Yicai []
  24. Chinese Shoppers Overtake U.S. as Top Luxury Buyers from Bloomberg []
  25. The actual study period was from August 2011 to August 2012.  See Coming to a City Near You: More Chinese Shoppers from The Wall Street Journal []
  26. China Gets Angry at Overseas Luxury Shopping Trips from The Wall Street Journal []
  27. See Le Chinese tour de luxe from South China Morning Post, Luxury brands still reaping big rewards in China from South China Morning Post and视频:业内人士曝洋奢侈品在中国利润吓死人 from CCTV []
  28. In economics parlance this is called “conspicuous consumption” []
  29. Coming to a City Near You: More Chinese Shoppers from The Wall Street Journal []
  30. Chinese consumer spending overseas increased 31% between 2011 and 2012 yet sales growth on the mainland for luxury goods fell from 30% to 7% during the same time.  See China Voice: Keep China’s big spenders at home from Xinhua []
  31. China’s Frills and Posh Market Springs a Leak from Caixin []
  32. Another estimate cited by Colin Speakman is that in 2012 Chinese consumption of luxury goods amounted to $46 billion in total of which $27.1 billion was spent overseas.  See The bane of domestic consumption from China Daily []
  33. Luxury goods: style rises in the east from Financial Times []
  34. Burberry lays on ‘mother of all parties’ to launch flagship Beijing store from The Telegraph []
  35. To give you an idea of how many people visit Hong Kong, in November 2012 more than 3 million mainlanders visited the SAR; this resulted in a 13.7% increase in sales of jewelry and watches.  See Hong Kong Luxury Sales Rebound on Confidence in Mainland from Bloomberg []
  36. Why China’s 1% Is Now Discreetly Hiding Its Wealth from The Atlantic []
  37. One challenge for foreign retailers that receive tourists from the mainland is dealing with the “kickback” bonus (5-10% of sales) to tour operators who bring the Chinese tourists to the actual stores.  See Copenhagen Luxury Retailers Face Chinese Tour Guide “Kickback Culture” from Jing Daily []
  38. Santa is coming and China takes a lot more notice from China Daily []
  39. UnionPay is the largest credit card company on the mainland (equivalent to MasterCard and Visa).  Despite the assumption that few people or families have credit cards in China, the reality is that by the end of 2013 there will be an estimated 360 million credit cards on the mainland.  This is up from a mere 3 million in 2003.  See More Chinese to swipe credit cards in 2013 from CCTV News, Spring Festival holiday fuels bank card transactions from Xinhua, China Credit Card Market Forecast to 2015 from RNCOS and Competing for China’s credit card market from McKinsey Quarterly []
  40. Chinese tourists snub ‘Big Stupid Clock’ from BBC []
  41. Ibid []
  42. Le Chinese tour de luxe from South China Morning Post []
  43. Santa is coming and China takes a lot more notice from China Daily []
  44. Chinese tourists snub ‘Big Stupid Clock’ from BBC []
  45. Retailers prepare for holiday shoppers from China from China Daily []
  46. There are 12 animals altogether in the Chinese astrological zodiac.  See What Do People Want Most for Chinese New Year? Cash Money from The Wall Street Journal []
  47. Remington Pipes []
  48. Approximately one in three pairs of Nike shoes are made in China.  Nike contracts out to 180 manufacturers, employing 210,000 workers on the mainland.  See Nike still sees China labor challenges from USA Today and Rising Chinese salaries pushes Adidas to look elsewhere: report from Agence France-Presse []
  49. See Imported’ furniture never left country, say officials from Shanghai Daily, What did DaVinci furniture scandal expose? from People’s Daily and Furniture retailer fined after ‘fake imports’ scandal from China Daily []
  50. While many other countries have similar policies, dozens of Chinese industries and product-lines receive VAT export rebates and subsidies which incentivize production irrespective of their profitability.  See Nation ‘unlikely’ to reduce export rebates from China Daily and Vuvuzela sounds clarion call for China’s manufacturers from Xinhua, Glut of Solar Panels Poses a New Threat to China from The New York Times and China adjusted VAT & consumption tax policies for exported goods and services from KPMG []
  51. Swiss Watch Boutiques Swap Christmas Trees for Hongbao from Bloomberg []
  52. Not all is smooth sailing for luxury goods.  For example, during the recent crackdown on government corruption, gift giving has dropped markedly.  And since luxury watches were one of the popular gifts provided to businessmen and officials, there has been a measurable decline.  According to the Federation of the Swiss Watch Industry “show that Swiss watch exports to the Chinese mainland dropped 27.5 percent year-on-year in September.”  This is on the back of 40% growth from the previous year.  See Corruption curbs crimp luxury market from China Daily []
  53. One of the reasons why Hong Kong has become a large importer of wines is that duties were removed on wine imports in 2008.  See Mainland China Now #5 Export Market For US Wines, HK #3 from Jing Daily []
  54. Yacht designers – both foreign and domestic – have also begun finding new opportunities with wealthier Chinese clients.  Two other areas are hand-made tobacco pipes and hand-made bicycles which are both seen as unique, luxurious items by high-net worth individuals.  See Made-in-China superyachts reflect changing tide of economy from CNN, Bikes for bonuses as China’s wealthy reminisce from Reuters and The new face of bling in China – bikes from Reuters []
  55. There may have been another bubble in the wine industry as wine sales dropped from $397 million in 2011 to $322 million in 2012 at the biggest auction houses.  See Wine Auctions Drop 19%, Chinese Demand Cools for Bordeaux from Bloomberg []
  56. China On Track To Be World’s Biggest Cognac Consumer from Jing Daily []
  57. China Has Become A Very Important, Huge Market For Every Cognac Company from Jing Daily []
  58. See J.Crew Brings Its Brand to China from The Wall Street Journal and Strong overseas, US sales lift Coach 1Q profit from BusinessWeek []
  59. Coach Looks to Bag Chinese Market from The Wall Street Journal []
  60. The consuming challenge of food safety from China Daily []
  61. See U.S. and Chinese Consumers Willing to Pay More for Made in USA Products from Boston Consulting Group and Chinese Willing to Pay More for Made-in-USA Goods from The Wall Street Journal []
  62. Chinese consumers are becoming increasingly savvy and in-tune with fashionable trends from elsewhere as magazines such as Elle, Vogue and Cosmopolitan publish large monthly issues customized for their Chinese audience.  See The Stylish Side of China from The New York Times []
  63. China uncovers luxury bag fakery, arrests 73 from Xinhua []
  64. Fashion industry struck by China lowdown from The Independent []
  65. It’s Up, It’s Down: Reading the Tea Leaves on China’s Luxury Market from brandchannel []
  66. See Burberry profit warning chills luxury rivals from Reuters and Burberry lays on ‘mother of all parties’ to launch flagship Beijing store from The Telegraph []
  67. See China Targets Corruption, Luxury Brands Mourn by Evan Osnos, For Bribing Officials, Chinese Give the Best from The New York Times []
  68. China bloggers expose more corruption: reports from Agence France-Presse []
  69. See China’s downturn-proof booze makers hit government wall from Reuters and SARFT orders ‘gifting’ ads off the air from Global Times []
  70. After six months since the “clamp down” on “pricey booze” began, domestic liquor makers have reported that business was not initially been hampered and in fact they have posted strong profits in Q3 2012.  Yet at the turn of the New Year, baijiu manufacturers were especially hit relatively hard due to a new national government crackdown on extravagant spending at banquets and parties funded by local governments.  And according to a recent survey of high-network individuals in China, most affluent residents prefer to receive foreign luxury items as opposed to domestically made brands.  Subsequently Moutai itself has had a number of administrative problems that have only added to the issues of crackdowns on banquet and gift-giving.  Conversely imported liquor is reportedly seeing robust growth, with UK-based Diageo seeing a 50% increase in sales of its luxury Scotch.  See Mao’s $300 Red Army Liquor Suffers Before China Congress from Bloomberg, Withdrawal symptoms: China’s rice wine market from Buy Buy China, Glass half full for imported liquor from China Daily, Premium liquor shares iffy amid frugality campaign from Xinhua, Bottoms up: China booze makers defy economic gloom from Reuters and China gift crackdown hits watches, booze but foreign brands hold on from Reuters, 茅台整改:反腐潮加快白酒业全面市场化 from NBD, 媒体称多地严查公款吃喝后部分名酒价格暴跌from 163 and白酒年关难过from Caixin []
  71. Baijiu Stocks Sink After Premier Vows to Curb Spending on Banquets from The Economic Observer []
  72. On October 22, 2012 Bill Bishop highlighted a Chinese photographer’s tour of the American West during Chinese National Day (October 1-7).   Bishop predicts that there “will be lots more travelers like this as US visas get easier for Chinese tourists.”  See美国西部特写–大提顿国家公园_梁芳洁的芳草地_梁芳洁_博联社 from 梁芳洁. []
  73. Chinese parents turn to US summer camps from China Daily []
  74. Number of Chinese tourists to USA doubles after loosen visa policy from South China Morning Post []
  75. Glenn Wilkinson, the Australian consultant that I mentioned a couple of times, told me he knows of numerous Chinese who have gone and who are currently interested in going to the Australian Outback or even Africa.  This kind of “genre tourism” caters to those wanting to experience the authentic conditions (e.g., ruggedness, safari).  See For Affluent Asians, Africa’s Appeal from The Wall Street Journal []
  76. See Best massages in Shanghai from CNN and Dragonfly Spa Review from About.com []
  77. Top 10 private companies in China 2011 from China.org.cn []
  78. Wanda of China set to buy more U.S. entertainment assets from Los Angeles Times []
  79. Changba: The Viral KTV App from The World of Chinese []
  80. China saw 138,000 Internet cafes as of 2009 from Xinhua []
  81. Art Sales’ Old Guard Gets Rival From Asia from The Wall Street Journal []
  82. Four Tips On How To Approach China’s Art Boom from Forbes []
  83. See Sotheby’s autumn HK sales drop as China economy slows from Reuters and Auction Houses Go Head-to-Head in Hong Kong from The Wall Street Journal []
  84. China art market: auction houses see slump in 2012 sales from Financial Times []
  85. Chinese slump dents global art market in 2012 from China Daily []
  86. In Guo’s words, “The briber first presents a forged artwork as a gift to the official being bribed, which does not violate the Chinese anti-corruption laws since such artworks have very low monetary value. Then, the official auctions the painting via an auction house. Finally, the briber attends the auction and purchases the artwork back for a very high price, as if he mistook the work for an original. Since bribery, rather than investment or personal appreciation, is the purpose of such purchases, “elegant bribery” is a significant source of inelastic demand for works of art in the Chinese auction market, driving prices beyond what can be explained by observable characteristics.”  See What Drives the Chinese Art Market? The Case of Elegant Bribery by Jia Guo []
  87. Art schools face uncertain financial future from The Guardian []
  88. Chinese take the art market by storm from China Daily []
  89. China’s New Cultural Revolution: A Surge in Art Collecting from The New York Times []
  90. Yizzu.com Brings Chinese Art to the Masses and Builds a Community from TechNode []
  91. Four Tips On How To Approach China’s Art Boom from Forbes []

Chapter 12 – Social Media and marketing your brand

[Note: below is Chapter 12 from Great Wall of Numbers]

Unlike Chatroulette, parachute pants and cabbage patch dolls, social media is not a passing fad.  Despite its IPO growing pains, with more than one billion users Facebook is here to stay.  And organizations like Pew Internet continue to note the strong embrace of social media by digital denizens.  For example, in September 2012, Pew reported that 46% of internet users (in the US) post original photos and videos online.1 Similarly, there are 564 million internet users in China (growing at a rate of 4 million more each month, a number expected to reach 800 million in 2015), a large portion of who – as I detail below – have also adopted and incorporated social media into their daily lives.234

Keep in mind, as Matt Garner notes in Red Flags, that you will not be able to establish a long-term presence in China as a foreign company without establishing yourself as a brand – using social media services.  This is because domestic Chinese companies will continually benchmark your bottom-line and undercut you on price.  The situation can be likened to the consumer goods company that sells excess product to a private in-house label.  Before long, the company has diluted its own brand image and the private label has cannibalized its market share.  The original benefit to an American company sourcing its goods from China is a low cost overhead. But when the American firm decides to turn around and sell its goods directly in China it often discovers it cannot because the source company has already started selling its own domestic brand of the same product.  One way to establish your brand is by using social media.

Yet social media services in China are typically no different than those in the West.  For example, I remember exactly where I was when Youtube, Facebook and Twitter no longer worked in China – at my apartment in Bengbu in the summer of 2009.  Yet, irrespective of what you might think about the Great Firewall and internet censorship, the humbling reality of China is in the words of Bill Bishop: one worlds, two internets.5 In fact, in a short email exchange in January 2013, Bishop explained to me that “If they [foreign social media experts and firms] are not tracking and engaging on Chinese social media they will not be talking to most of their Chinese customers who are online. Facebook and Twitter are basically irrelevant on the Chinese Internet.”

Or in other words: an intractable situation that will not change anytime soon.  But while international web 2.0 technology titans such as YouTube, Facebook and Twitter are effectively blocked, this is not to say that domestic internet users are not proficient with similar services.  And with its 564 million internet users (and 420 million mobile net users), it would arguably be a significant segment too important to ignore even if you think it is not worth the trouble.6

Do Chinese users spend much time on these services or buy anything?  Incitez, a market research firm, found that “consumers in China spend 46 minutes a day visiting social-media sites.”7 In comparison, in Japan the time is 7 minutes a day and in the US it is 37 minutes.  And according to a report from the Boston Consulting Group published last fall, China’s online shopping population was the largest, 193 million compared with 170 million in the US (though it trails both the US and Japan in total online spending).8 China’s shopping population has since grown to 242 million people through December 2012.9

How big is this in revenue numbers?  Altogether in 2012, e-commerce revenue totaled $196 billion.10 During the 2012 Single’s Day (November 11th or 11-11) on the mainland, Alibaba Group e-commerce properties (Tmall and Taobao) purportedly broke the single day sales record with over 100 million visitors and $3.03 billion.11 And as noted earlier in Chapter 7, the BCG report also estimates that China’s e-commerce market will become the world’s largest in 2015.  In fact, Analysis International projects that China’s e-commerce market will hit 2.57 trillion RMB ($410 billion) by 2015 and $457.6 billion in 2016.12 For comparison, e-commerce sales in the US reached $186.2 billion in 2012; the previous revenue records were $1.3 billion from Cyber Monday 2011 and $1.04 billion of merchandise was sold on Black Friday 2012.13

What are the domestic alternatives to the international social media site?  In place of these Silicon Valley firms are a slew of Chinese-based solutions, most notably:14

–          Tencent is China’s largest tech company, generating $4.5 billion in 2011 and $3.24 billion for the first half of 2012.1516 It develops the popular instant messaging clients, QQ (784 million users) and Weixin or as it is known in English, WeChat (300 million users, doubling its userbase in 6 months) and operates two microblogging sites called Qzone and Tencent Weibo.1718192021 Its success has prompted Western marketers such as Nike, Intel and Starbucks to build marketing campaigns around it.22 WeChat’s Western-equivalent is WhatsApp and the Chinese companies influence may have rubbed off on Facebook which itself has been purportedly stealthily adopting some of WeChat features for mobile users (e.g., communications tool).23 And messaging applications like WeChat have become so popular in China that SMS usage grew at a mere 2.1% in 2012 even though wireless service penetration grew at 9%.24 Furthermore WeChat now has 10 million overseas users and has recently opened a US office with a team focused solely on developing the app for developed countries.25 According to the same Incitez report above, Qzone and Tencent Weibo are the 1st and 3rd most popular networks for social sharing in China.  All told Tencent is the 9th largest web platform in the world.  For perspective, the collective instant messenger userbase in China reached 1.21 billion in Q3 2012 and the mobile instant messenger active userbase reached 480 million in the same timeframe.26

–          Youku/Tudou recently merged in the summer of 2012 to become the largest video sharing site in China’s fragmented market.  Altogether they receive a combined 400 million visitors a month.  By one estimate, their combined marketshare was originally 32.3% but decreased to 25.2% in May 2012 while their main competitor, iQiyi (which itself was recently acquired by Baidu) has jumped up to 18.4% marketshare in July 2012.  In Q1 2011 all three of them had a combined 70% marketshare.27 Tencent-related properties have reportedly gained at their expense.  Despite this challenge, Youku’s revenue increased 84% in Q3 2012 and posted its first ever profit during the same time frame.28 And in December 2012 Victor Koo (founder and CEO of Youku) now estimates that “Youku gets 74% of the Chinese Web audience in a given month [for streaming videos].”29

–          Renren is one of the largest domestic social networking sites, with about 200 million registered users and more than 45 million monthly active users.30 According to Incitez it is the 4th most popular network for social sharing.  Its feature-set serves as a very close proxy to what Facebook offers, including many of the popular games and apps.  For perspective, eMarketer estimates that China is already the largest social networking market with an expected ad revenue of $612.8 million in 2013 (based on a conservative estimate of 307.5 million users).31

–          Sina Weibo, is now the world’s second largest microblogging service after Twitter.  As of February 2013 they had 503 million accounts, 300,000 enterprise customers and at least 46.3 million daily active users, second only to Twitter (which also more than 500 million registered users and 200 million monthly active users).32333435 It has a number of additional features that differentiate it from Twitter, such as a built-in instant messenger.

–          Baidu is the largest search engine in China (with 78.6% marketshare through 2012) largely because of preferential regulatory policies that have stymied Google (which only has about 15.6% marketshare on the mainland.36 Baidu also now owns iQiyi, the Chinese equivalent to Hulu that streams licensed HD video content.37 Incitez estimates that Baidu properties account for roughly 12% of social media sharing.  It now has 80 million daily active users on its mobile search product and serves up five billion search queries daily across all of its partner sites; it is the 3rd largest tech company by revenue, $3.558 billion in 2012 (up from $2.34 billion in 2011).38 And in an effort to internationalize, in February 2013 it launched an English website for developers.39

While the start-up culture is still young and maturing, some domestic start-ups are funded by the likes of Kai-Fu Lee (former head of operations for both Google and Microsoft in China) and Digital Sky Technologies (DST) or through incubators in Shenzhen financed by Tencent.40 Others are even financed directly by Silicon Valley venture capitalists (VCs) like 500 Startups which opened a Beijing office in Q1 2013 headed by Rui Ma, an experienced venture capitalist.4142 There is even a venue similar to TED-talks called Geek Park which has held 40 forums since 2010, bringing together thousands of developers, product managers and investors.43  In fact, after initial success this past year, Microsoft now plans to incubate 100 companies annually on the mainland and will provide “the space, the technology, mentorship, access to funds” to the start-ups.44

Yet Duncan Clark, a technology analyst in Beijing, has noted that the insular protectionist policy making by officials renders it increasingly difficult for international companies to enter the domestic market.4546 What this means is that you should not wait for the Great Firewall to open back up.  Instead, take the initiative to create company accounts at Chinese social media sites.

Starting from scratch

Arguably the first service a foreign firm should start working with is QQ international.  It is free and easy-to-use because it is in English (Sina Weibo is also internationalizing and creating an English-based version).47.  It also puts you into direct contact with more than 700 million active QQ users.  But it does not stop at the desktop as many TV commercials and retailers prominently display company QQ numbers (like the AOL keyword).  In addition to the traditional contact information, many Chinese business cards also have QQ numbers displayed as well.  So if you plan to do business in China and want to interface with potential customers, having a QQ number is a must.

While micro-blog Twitter-like sites such as Sina Weibo and Tencent Weibo follow the same 140 character constraints as their Western counterparts, one distinct advantage written Chinese has over English is that the language is more compressed.  Chinese users typically only need 1-3 characters to make a word whereas English words typically need more, even when abbreviated.  While this may seem trivial minutiae, every little bit helps to better understand your potential customer base more.48

Pin-boards and group-buying

Pinterest is an increasingly popular “pin-board” style content sharing web service, breaking the record for fastest time to reach 10 million unique visitors (accomplished in less than 1 year).49 It was founded in March 2010 and raised $100 million this spring at a $1.5 billion valuation.  It competes head-to-head with Facebook’s newly acquired Instagram photo sharing site.  And it has a significant advantage in this region: it is not blocked in China.

As a consequence its usage rate is not only soaring, but its popularity has inspired the sincerest form of flattery, copying.  One recent estimate from Zhang Dan at ZDNet is that there are now about 30 Chinese clones of the site.50

One of the key differences between Pinterest and clones like Faxian and Mogujie is that users not only “pin” things that interest them, but can also buy items as well.  Typically users can make purchases directly from Chinese e-tailers like Taobao who have formed revenue sharing partnerships with the Pinterest-clones.51 As a consequence many of these start-up Pinterest/ e-commerce hybrids in China have found relatively “quicker return on capital.”

What about other services that have moved West-to-East?  The seemingly instant success of group-buying sites such as Group-On has inspired a plethora of copy-cats in China as well.  According to an August 2012 China e-Business Research Center report, there were 3,210 group-buying sites operating in China, whose transaction values reached $2.3 billion in the first half of 2012, “an increase of 124 percent from the same period a year ago.”52 It is a highly crowded space with about half of all group-buying websites closing down in 2012 including 24quan, which was shut down in September (it had been the 5th largest).  In fact, Lashou was at one point the market leader yet has dropped to 6th by revenue.5354 While it may be very difficult to start a similar service, placing your product on one of the sites could enable your company to expand its brand awareness to an entirely new customer base.

The immediate takeaway for you and your company is this: how can you position your idea, your brand, and your products in China?

If you sell consumer goods, components or even services you can utilize Pinterests organic grassroots community sharing to help promote your goods and services.  And you can also try to get your products placed on Meituan, the current group-buying leader in China.

There are of course legal concerns to regarding copyrights in Pinterest-like sites.  Because of the relative ease and viral nature of copy/pinning, Pinterest has attempted to help alleviate some of the legal headaches by implementing a “nopin” tag that companies can use to prevent copyrighted images from being pinned on the site.  Another issue that Brian Heidelberger recently noted, that touches on this viral marketing and positioning of your product: if you open an official company Pinterest page and allow your customers and fans to pin images for your promotion, these users may not own, thus creating copyright complications (e.g., because when a copyrighted image is attached to a commercial product, your company must receive legal permission to use it).55

Brand Positioning

Just like there was a virtual land rush for unique domain names in the 1990s and with Facebook Pages, so too is there a land rush for social media positioning in China.  And with that rush comes branding and market research.

In October 2012 I spoke with Pieter Nooren, Research Manager at Wildfire Asia, a social marketing firm with offices in Shanghai and Singapore.  Wildfire Asia provides technology for understanding and changing online conversations; a service with high demand in a country where word-of-mouth is shown to drive 55% of consumer purchase decisions.56

In particular, the company combs Chinese social networks to discover conversations and trends, helps brands to understand and engage in conversations, and recruits unpaid influencers to a brands’ cause.  In Nooren’s words, “We monitor the internet. We index any conversations and comments on forums, BBS and social networks according to our client’s strategic objectives. We then analyze this data to provide consumer and market insights, as well as to identify advocates and influencers in the brand’s category.”

To help their clients manage all of the data, Wildfire provides them with an online dashboard providing key conversation metrics, Weibo performance, and influencer management tools. Based on the data, Wildfire can provide “insights and strategic recommendations to the client.”  This is important, especially to foreign companies unfamiliar with both the Chinese marketplace and social networking services.  And Wildfire’s business model has been effective thus far, as the firm has grown to 25 full-time staff since its founding in 2009.

What does this mean in a nutshell?

It means that Wildfire not only tracks what consumers are saying about your brand, but gives you the ability to impact those conversations through social customer relationship management (CRM) and influencer marketing.  You can also find out what is going on with your competition using the same tools.57

You might already be thinking to yourself, “I already have a Facebook strategy, why should I bother with Weibo or Renren?”  As both Duncan Clark and Bill Bishop have noted above, it would be foolish to assume that Facebook will be allowed back in anytime soon.  And unfortunately the harsh reality is that Facebook’s reach is very limited within China.5859

Back in September 2012 there was a rumor regarding a speculative Facebook user-base number being floated around parts of Western media: that there were up to 63.5 million Facebook users in China.  This however was quickly verified to be untrue.60 Nor are there millions of Twitter users on the mainland.61 While we may never know the real number, Facebook’s own indirect estimate is closer to 600,000 (and perhaps only 18,164 active Twitter users).62 While relatively low, this falls in line with another number: there are approximately 600,000 permanent foreign residents in China.63 It should be noted that not all foreigners use Facebook in China nor do all foreigners have a VPN to access it in the first place.  Furthermore, the average Chinese user does not currently have access to a VPN or other “Wall Climbing” software such as UltraSerf, WebFreer or Hotspot.  In their mind, why should they have to pay to access foreign services when there is a similar Chinese version available for free?

Brand awareness

Social media provides important benefits in improving company brand awareness.  According to a 2012 McKinsey & Company report, Estée Lauder created a drama series exclusively for China called “Sufei’s Diary” to promote the brand Clinique.64 The 40 episode series was broadcast on a variety of digital venues in China (websites, buses, trains, airplanes).  Its online viewership alone was viewed “more than 21 million times” and as a consequence, Clinique’s online brand awareness “is now 27 percent higher than its competitors.”   Estée Lauder’s use of social marketing has paid off financially, as the company generated $500 million in China in 2011, which is an integral part of its 9.2% increase in overall corporate revenue.65

Another consideration for foreign cosmetic firms is that what Chinese consumers view as beauty may not be the same as Western tastes and preferences.  For example, fair porcelain skin is traditionally considered more preferable over tan skin due to historical social status (e.g., the affluent could afford to sit inside whereas manual laborers had to withstand the elements including sun light).  Thus Unilever, the 2nd largest consumer goods company globally plans to expand its business on the mainland “five fold” by marketing products like Pond’s Flawless White.66

While this is not to say your company will also reap immediate success, creating a social media plan today will enable your company to reach new customers and generate additional revenue streams.  Or as Incitez recommends, do not become too obsessed with return-on-investment in social media – “digging out insights is more important.”67

Using social media to find customers

As I discuss later in Chapter 13, another way that SMEs can leverage domestic social media sites is through a start-up called Mila.  Mila is a new cloud service that combs social media websites and helps companies find potential customers.  For example, if you are a real estate agent, you can post pictures of vacant apartments and then Mila can help to find people who are looking for apartments for you.  Or if you are a plumber, you can create a company profile on Mila which will then search across social networks for potential customers looking for plumbers.

Mila has been localized for the Chinese marketplace through a partnership with China Unicom and is even rebranded as Womaiwomai (沃买沃卖) for the Android ecosystem (its Mila name remains the same on the iTunes App Store).  Together with Unicom they integrate Sina Weibo (the largest microblog platform in China) and Alipay (the largest e-pay platform in China) into their product.

Thus before even moving to China your company can create accounts on a wide-variety of social media services in China like Youku.  You can then promote your brand through Pinterest-style websites and communicate with customers, clients, fans and even critics through Sina Weibo and Renren.  And perhaps most importantly, you can even find potential leads through Mila, which searches social networks to discover who is looking for services that your company offers.

Culture and branding

While there are numerous historical case studies regarding mistranslations of company names and slogans that are typically cited in business schools, creating a Chinese name for your company or product is just as important as it is in the West.6869 For example, whereas Apple and Microsoft literally translated their names into Mandarin, Pepsi was a little more creative and chose the name baishi which means “wishing 100 happy things.”70 Similarly, Coca-Cola is pronounced ke kou ke le “which includes characters for delicious and happy” and as a consequence is considered a prime example – or gold standard – of how to brand your company and product on the mainland.71 In contrast one tone of Bing (病) – the name of Microsoft’s search engine – sounds like “sickness” in Chinese and thus was mocked by netizens when it was first introduced.72

Why is this language component important?  According to a 2012 Economist Intelligence Unit report, “43 percent of nearly 600 global executives admitted to incurring financial setbacks as a result of communication misunderstandings standing in the way of a major cross-border transaction.”73 Furthermore, “90 percent of the executives [surveyed] felt that company profits, revenue and market share would climb if cross-border communication is improved.”  What this means is that you and your company should be cognizant of communication barriers and limitations at both the negotiation table and marketplace for brand recognition.

Takeaway: with nearly 600 million internet users (and as of January 2013 more than 420 million of whom are mobile users), China has a digital populace almost twice the size of the US total population.74 So what is your company’s social media plan and strategy in China?  If you do not have one, you still have time to develop and roll one out.  And while you may be unable to understand Mandarin, there are a number of free, easy-to-use online tools that can help you register a namespace at popular Chinese social media sites.  Ignoring these potential customers is the last thing your company should do.  Be safe rather than sorry – register your brand name at social media sites today.


Endnotes:

 

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  1. Photos and Videos as Social Currency Online from PewInternet []
  2. See MIIT: China’s Internet User Base to Hit 800 Mln by 2015 from People’s Daily, SMS growth in China slows as mobile users turn to alternatives like Tencent’s WeChat from The Next Web and Social, Digital, Mobile China (Jan 2013) from We Are Social []
  3. See Chinese Web Users Hit 538 Million from PCMag and China’s Internet population surges to 564 million, 75 percent on mobile from ZDNet []
  4. As of 2011, the amount of rural internet users was 136 million.  According to China Internet Watch, “In other words, there is still 82% of rural population that could not access the Internet. Paralleling that, Chinese penetration of broadband connection is low. Only 39% of families have fixed broadband connection in China. In some middle and western provinces, less than 70% of population has phones.”  See 74% Chinese Netizens Acquire News Online from China Internet Watch []
  5. One World, Two Internets by Bill Bishop []
  6. China Had 564 Million Netizens By End Of 2012; Fewer Using Desktop Computers To Surf from China Tech News []
  7. China Social Media Whitepaper (October 2012) from China Internet Watch []
  8. See Singles Day: China’s online shopping holiday from USA Today and Singles’ Day promotions draw in shoppers from China Daily []
  9. China Had 564 Million Netizens By End Of 2012; Fewer Using Desktop Computers To Surf from China Tech News []
  10. Bezos’ Kindle-Less Amazon Mashed in China by Ma’s Alibaba from Bloomberg []
  11. See Black Friday in Red China by Evan Osnos and Singles Day: China’s online shopping holiday from the Associated Press []
  12. See China Now Has 242 Million E-Commerce Shoppers, Spending $40,000 per Second from Tech In Asia and E-commerce in China – Statistics and Trends from Go-Globe []
  13. Black Friday surpasses $1B in online sales from Computer World []
  14. I would be remiss if I mentioned Group-buying and Pinterest clones but not about Kickstarter-like crowd-funding sites in China.  See Tapping into Crowd Power with Website Finance from Caixin []
  15. Tencent announces $4.5 Billion in 2011 revenue from NASDAQ []
  16. Unaudited 1H 2012 revenue was 20 billion RMB ($3.24 billion).  See Interim Report 2012 from Tencent Holdings []
  17. See Tencent’s WeChat messaging app passes 300m users, adding its latest 100m in just 4 months from The Next Web, Tencent: WeChat App Set to Surpass 300 Million Users Next Month from Tech In Asia, 200 million users strong, Tenecent’s WeChat messaging sees huge adoption outside of China from The Next Web []
  18. According to their Q3 2012 results, Tencent generated $1.82 billion in Q3 and their WeChat service passed the 200 million user mark.  See Tencent continues modest growth in Q3 with $1.8b in revenue, $511m in profit from The Next Web []
  19. WeChat is quickly gaining on Sina Weibo.  See Tencent’s WeChat Takes Bite Out of Weibo from The Wall Street Journal []
  20. See WeChat Bests Weibo in Monetizing Social Media from Caijing and Wechat’s Monetization and Overseas Quest from TechNode []
  21. For more about WeChat and how to effectively use it to reach consumer see: Conquering WeChat: Effective B-2-C Communication by Digital Jungle and The best blog posts about marketing and branding on WeChat from China Internet Guru []
  22. China’s Fast-Growing WeChat Shakes Up Weibo. Could It Jump to the U.S.? from AdAge []
  23. Facebook looks more like WeChat every day from Pando Daily []
  24. SMS growth in China slows as mobile users turn to alternatives like Tencent’s WeChat from The Next Web []
  25. See China’s Tencent Aims Mobile App at U.S. Market from The Wall Street Journal and WeChat to set up US office from Global Times []
  26. See China’s Instant Messaging Users reached 1.21 Billion in Q3 2012 from China Internet Watch and China Mobile IM Active Users Reached 480 Million from China Internet Watch []
  27. See Youku Tudou May See Postmerger Static from Barron’s and China Online Video Market Update Q1 2011 from China Internet Watch []
  28. Youku Revenue up 84% in Q3; Reports Net Profit for 1st Time from Caijing []
  29. Youku’s Now The King Of China Web Video: Can It Make Money? from Forbes []
  30. As of September 30, 2012 Renren had approximately 172 million users and is expected to hit 200 million within the next year.  See Renren Has 45 Million Monthly Active Users, Eyes on Mobile from Tech In Asia []
  31. To be even handed, some of these social media numbers require more objective analysis and may be artificially inflated.  See The myth of Chinese social media user numbers from South China Morning Post and Asia-Pacific to Top Western Europe Social Network Ad Spend in 2013 from eMarketer []
  32. See Sina Weibo poised to launch new version from China Daily, Twitter reaches 500 million user mark from The Washington Post and Twitter monthly active users: 200 million and growing fast. from Slate []
  33. See Sina Weibo Passes 500 Million Users, But Needs to Monetize More on Mobile from Tech In Asia and Of Sina Weibo’s 500 Million Registered Users, Are 90% Actually Zombies? from Tech In Asia []
  34. Monetizing your company’s fan base from social media sites like Sina Weibo is a challenge that was recently discussed by Ken Hong, the general manager of the Sina Weibo platform at Sina.  See Turning Brand Fans into BFFs from Thoughtful China []
  35. How many people actually use Weibo is another issue as a recent study conducted by researchers Hong Kong University found that a large percentage of users may be “zombies” – fake accounts used by marketers to boost follower numbers (an attract higher advertising premiums).  See Reality Check for the Chinese Microblog Space: A Random Sampling Approach by King-wa Fu and Michael Chaus []
  36. The 15.6% is an estimate from EnfoDesk regarding Google.cn; CNZZ estimates that Google’s marketshare is lower at 4.72% in October 2012.  See China Search Engine Market Share in 2012 from China Internet Watch and Google decline in China continues as its search share falls to 4th place, maps to 6th from The Next Web []
  37. Baidu acquires dominant stake in online video firm iQiyi, buys out ex-Hulu investor Providence from The Next Web []
  38. See Baidu Handles 5 BILLION Search Queries Per Day from Tech In Asia, Baidu Reaches 80 Million Mobile Apps Users, Reveals Full 2012 Financials from Tech In Asia, Qihoo Looks to Cut Into Baidu’s Market Share of China’s Internet Search Engine Market from Marketwire and Baidu Announces Fourth Quarter and Fiscal Year 2011 Results from PRNewsWire []
  39. China’s Largest Search Engine Baidu Launches English Site For Developers from TechCrunch []
  40. DST is a Russian-based venture capital firm headed by Yuri Milner that focuses in part in emerging market tech firms including those in China such as 360buy.  See China Deals Represent Half of DST Global’s Recent Investments from The Wall Street Journal []
  41. VCs coach Silicon Valley startups on investing in China from China Daily []
  42. In a bit of a role reversal, InnoSpring is a new US-China incubator based in Santa Clara, California.  See 500 Startups Is Setting Up Shop In China, Adding Beijing-Based Venture Partner Rui Ma from TechCrunch []
  43. Geek Park Lures Google’s Schmidt in China App Hunt from Bloomberg []
  44. Ibid []
  45. Could China Rival Silicon Valley from Australia Network News []
  46. This also provides a challenge for domestic Chinese internet companies wanting to expand and internationalize into the global marketplace.  See Now China’s WeChat App is Censoring Its Users Globally from Tech In Asia, If Tencent wants WeChat to go global, it has to stop international censorship from Pando Daily, China’s Tencent Apologizes for Message Problems from The Wall Street Journal and All Eyes Are on WeChat, Including the Chinese Government’s from Motherboard []
  47. Sina Weibo introduces beginnings of an English interface from Shanghaiist []
  48. In terms of understanding internet market opportunities and consumer behavior, it is highly recommended that readers peruse the 2012 China Internet White Paper from IDG-Accel which goes into detail about several areas that are sometimes overlooked.  For example, Chinese internet demographics can be broken down into the “Baigujing” (educated urban net users) and “Grassroots” (everyone else).  Understanding this type of consumer segmentation could help focus your marketing strategy. []
  49. Pinterest Hits 10 Million U.S. Monthly Uniques Faster Than Any Standalone Site Ever from TechCrunch []
  50. China’s “Pinterest” in a faster profit-making mode from ZDNet []
  51. Pinterest clones flooding Chinese web space from BBC []
  52. Nearly Half of China’s Group Buying Sites Now Closed Amid Heated Competition from PCWorld []
  53. See Popular group-buying site in China shutters from ZDNet and 24Quan, Once China’s 5th-Biggest Daily Deals Site, Suspends Operations from Tech In Asia []
  54. China’s Lashou Has Lost its Mojo, its IPO, and 50% of Market Share from Tech In Asia []
  55. How Brands Can Use Pinterest Without Breaking the Law from Ad Age []
  56. Experience Brands and the New Engagement Model from Jack Morton in 2010 []
  57. Readers are encouraged to peruse the analytics provided in several case studies.  See Case Studies from Wildfire Asia []
  58. This image was released in December 2010 showing the active regions of the world based on Facebook usage.  China is notably dark. []
  59. There are also a number of social networks designed for professional business people akin to LinkedIn; collectively their userbase has now reached 100 million.  To illustrate the dynamism in this space, one of the former leaders, ChinaHR is currently in decline and its parent company (Monster.com) has sold off all but 10% of its stake by February 2013.  See China’s Professional Social Networking Users to Reach 100 Million from China Internet Watch, Rumor: ChinaHR.com May Be Dumped By Parent Company For Measly CNY55 Million from China Tech News and Ireland’s Saongroup Acquires 90% Stake In ChinaHR.com; Half Staff Will Lose Jobs from China Tech News []
  60. No, Facebook does not have 63.5 million active users in China from The Next Web []
  61. There are NOT millions of Twitter users in China: Supporting @ooof’s result and refuting GWI’s survey from Blocked on Weibo []
  62. New Study Proves that Twitter Users in China are Rare Birds from Tech In Asia []
  63. 593,832 foreigners live on Chinese mainland: census data from Xinhua []
  64. Understanding social media in China from McKinsey Quarterly []
  65. Estee Lauder’s New Skin Care Brand in China: The Potential for High-risk, High-reward from [email protected] []
  66. Redefining the Chinese Beauty Standard from China in Focus []
  67. China Social Media Whitepaper (October 2012) from China Internet Watch []
  68. Perhaps the most popular urban legend, which is false, is the Chevy Nova.  It is sometimes mentioned in business school textbooks as having sold poorly in Spanish-speaking countries due to a retranslation of “nova” as “no go.”  This is incorrect.  See Don’t Go Here from Snopes []
  69. In China, Air cheow-DAN Cries Foul from The Wall Street Journal. []
  70. What’s In a Name? by Meredith Rodriquez []
  71. Naming in Chinese, the Coca-Cola Story from About.com []
  72. Microsoft Launches Search Engine for China — But Don’t Call It Bing from The Wall Street Journal []
  73. See Competing across borders from Economist Intelligence Unit and Bridges and Barriers by Linda Yu []
  74. See China’s Internet population swells 10% to 564m in 2012, with 75% logging on from a mobile device from The Next Web and Sohu’s mobile traffic nears PC volumes from China Daily []

Chapter 13 – IT and software services

[Note: below is Chapter 13 from Great Wall of Numbers]

At the various schools, colleges and organizations I have worked at on the mainland, each facility was staffed by employees with a diverse range of technical abilities.  In addition, the equipment ranged from slightly dated to cutting edge.  While I have had the chance to work on a SugarCRM and Drupal wire frame development project domestically, I think some general statistics will give you a better idea of the size, scope and marketshare of the software and IT service industries in China.

According to their 2012 annual report, the Ministry of Industry and Information Technology estimated that China’s software and information services in 2011 had an output of $60 billion, “up nearly 40 percent year-on-year.”1 IBISWorld estimates that the entire software and IT industry in China “generated revenue of $284.02 billion in 2011, up 35.1 percent from 2010.”2

For perspective, India’s business process outsourcing and IT industries generated $100 billion in revenue in 2011.3

In terms of BPO growth – which is commonly called offshoring in the West – NASSCOM estimates that Indian firms generated $11 billion in BPO revenue in 2008 and $32 billion in 2012.4 In comparison, by one estimate the Chinese BPO sector “generated revenues of US$3.52 billion in 2009.”5 Another estimate, by XMG Global, shows that Chinese outsourcing firms generated $43.1 billion in revenue in 2012 (compared with $63.2 billion in India).6

Since its humble beginnings as an importer of DEC computers in the late 1970s (e.g. the PDP-7 minicomputer) China’s software development and IT services industry have grown dramatically and by one optimistic estimate, could generate $635 billion by 2015.7

Yet for perspective, the US software industry generated $261 billion in 2007 and the ten largest US software companies alone generated over $235 billion in 2010.8 Furthermore 63 of the world’s largest software companies are headquartered in the US compared with 2 in China.9

Big numbers, big opportunities

What this means is that for US-based firms, there are numerous opportunities to provide both software and related-services to the Chinese market.  And while market access and intellectual property (IP) infringement issues continue to dominate bilateral forums, there is still potential for foreign firms – especially those that focus on services – to gain substantial market share.

For example, in November 2012 I spoke with Larry Chang, the CEO of Pro-Lambda Solutions which specializes in Computer Aided Engineering (CAE) solutions and provides CAE software packages.10 Chang is originally from Taipei and had spent 25 years working in the CAE industry including in the US.  After conducting due diligence, he created a startup in Shanghai five years ago based on some surprising market research: there is no domestic CAE software company that actually develops and sells its products abroad (yet).  Or in Chang’s words, “zero engineering software products that are made in China are sold outside of China.  As a consequence everything is by-and-large still imported from other countries.  Obviously, something is missing here; if and when we can provide this missing part to the society, the economic payback will follow.  That is the opportunity we see and value.”

This is not to say that Chinese individuals and software companies do not make innovative or exportable software.  For example, Kingsoft (金山软件) is a Chinese developer that develops antivirus software and a office productivity suite called WPS.  It has 50 million monthly active users globally.11 Internet giant Baidu recently invested in the firm as well.12 Similarly, local software engineers like Ni Chao, a developer in Beijing, can and do create innovative solutions to large-scale problems such as purchasing train tickets during peak hours.13 Innovation takes place outside of the computer world as Reuters recently aired a story about various inventions used by migrant workers on their long journey home during Spring Festival, such as a local designed “seat sleeper” that enables passengers without beds to sleep on a mobile tray that can be leaned on.14 And in another fulfillment of Plato’s dictum “necessity is the mother of invention,” The Telegraph discovered a Chinese man of modest means who hand-built a working dialysis machine that has kept him alive for the past 13 years.15

Yet Arthur Kroeber, founder of the research firm Dragonomics sees scalability issues even with this promising amount of creativity.  In March 2013 he told a literary panel in Beijing that, “What’s sad is the amount of creativity you see in China is phenomenal but it’s not always directed in ways that are ultimately productive.”16 He likened it to figuring out how to create homemade solutions to a car whose parts are no longer on the market, yet running into problems trying to create “innovative solutions which are scalable throughout the entire world.”

As a consequence, Chang’s long-term vision is to become the first mover, to build and design engineering software in China which is then exported abroad.  There is a small twist to his strategy.  One of the problems he (and others like David Veksler cited later) have noted is that if you build and try to sell a product in China, most Chinese consumers will consider the quality is of lesser value.  That a product is perceived to be “better” if it originated from a foreign country is a stigma that Chang is hoping to reverse.  Thus in August 2012, Pro Lambda began selling its software solutions to the international market with the intention of giving his team experience, credibility and real-world feedback, before they attempt to sell directly on the mainland.

While traditional software solutions may be a risky business, services also have its share of challenges.  According to Chang, “one of the problems with the service industry as a whole and the software industry in particular is that this value added service is relatively unknown – and quite a suspicious concept to most Chinese consumers and businesses.  For example, upon buying your software they often think ‘why do we have to pay for your services since we just bought your software?  You owe me, not the reverse.’  Thus, this is a long-term challenge but I think enterprises and developers have begun making inroads as a younger generation of consumers has begun to understand the importance and value of this business model.”

There are also a few reasons why this lack of engineering software exports exists.  Yet according to Chang, this absence presents an opportunity for those willing to do the training needed.  For example, he notes that “software architects continue to live and work outside of China as do nearly all software product managers and development facilitating teams.  As a consequence, what has moved to China in the past decade is the ‘digital assembly line’ – coders and programmers are pretty much all that currently exists.  These coders and programmers are overseen by a project manager who coordinates with the foreign-based research and development office.  Yet, there is no facilitating team and no product team for engineering software on the mainland.”  Chang’s comment about a dearth of software architects was recently echoed by Ji Yongqing.  Ji is a technology author on the mainland who noted that while there are many programmers in China, relatively small amounts of resources are put into long-term projects to generate high-end skills, ideas and fundamental software research.  In his words, “Even now in the internet industry, everyone talks about product managers and no one talks about software architects, but in truth the two are equally important.”17

Furthermore, there are at least two systemic issues for this phenomenon as David Veksler (see below) and Chang both note: the first is that most Chinese students typically did not participate in team-based activities throughout school.  Thus when they are required to work as a team on larger scale projects, they often have difficulties adjusting to cooperation-based tasks – because they have been culturally raised to always compete and silo off information that can be traded and exchanged like currency.  Or in other words, whereas many Western education systems encourage teamwork and cooperation, older generations in China were taught a different style which relies more on trust networks (e.g., only share information with those you know, with whom you have guanxi) instead of “being a team player.”

Another key issue which is being addressed and discussed at every level and corner of Chinese society is fostering innovative thinking and creativity – taking the initiative to “think different” (see Chapter 20 too).  Yet there is a Chinese phrase that describes and explains why this same phenomenon is being repressed (and one that many Westerners are familiar with): 树大招风、枪打出头鸟or in English, “the stake that sticks up gets hammered down.”18 There are numerous requirements to build a “creative class” – yet there are also numerous cultural and institutional hammers that prevent this from germinating and blossoming on the mainland.  And while rote memorization and a lack of institutionalized ‘free thinking’ (e.g., ‘free expression’) are typically cited as the two main reasons, there are a number of additional factors that explain the constraints on domestic creativity, those would fill volumes if fully discussed.

Yet to be even handed, this is not to say that Chinese people are not creative or innovative.  For example, there is an entire industry of shanzhai (山寨) products such as customized smartphones which are cobbled together in a MacGyver-like fashion (though some segments are being shut down).1920 Similarly, web services such as Sina Weibo actually made it very easy to find and maintain trackbacks which illustrates indigenous ingenuity.  On that point, Gary Wang, founder of Tudou (a video streaming site that merged with Youku last year) recently told The Wall Street Journal that Chinese incubators, app-makers and innovators actually have cutting-edge, top-quality ideas comparable to those in Silicon Valley.21 However in his view they fall short due to a lack of experience and skills because of “the educational system and shorter start-up culture.”  Thus there is long-term potential as Larry Chang noted, for utilizing and training local talent for research and development.

Proprietary leakage

Later on in this chapter I discuss trade secrets and IT security issues, but one real-world case study that entrepreneurs should be aware of is what Chang himself faced several years ago.  His sales team abruptly left and took corporate proprietary information with them and as a consequence his sales bottom line was “burned.”

Instead of offering higher pay and enforcing stricter rules, he simply showed the predicament of the start-up company to his employees.  What he does is explain to each employee that while they could become temporarily richer by leaving and selling proprietary information, if they stayed and continued to build the company the results and rewards would be substantially larger in the long-run.22 Thus he considers his employees as partners, not employees – continuously trusting them with vital information while painting a picture of the future in which they are compensated significantly more than they might have otherwise in the immediate short-run.  As a consequence, Chang figuratively keeps the door open for all staff and is certain that any proprietary information that does leave would find little market value due to his focus on branding (i.e., why buy a pirated copy of software for the same price as the legitimate software?).

And while it remains a challenging market, as he also noted that “while a younger generation of engineers are willing to buy some types of software and government institutions are required by law to stymie digital piracy, many of the top enterprises, institutions and organizations on the mainland still typically use pirated copies and do not feel bad about it.  This presents an opportunity though and I do not begrudge them,” Chang said, “for example, in order to export a product domestic firms will have to eventually benchmark it with a legitimate copy of the software in order for foreign customers to trust its quality.  As it stands now, piracy is a form of free marketing and advertising.  As subsequent generations of users adopt and use the software they will begin to trust the product and eventually buy both the product and support services.  Take Hollywood films for example.  If copyright enforcement and penalties had been very strict, it is highly likely that no one would have watched the films to begin with.”  This last point is germane to the rapid growth of video stream sites like Youku, who arguably would not have gained preeminence if they had not stored and streamed copies of Hollywood films (Youku has now signed agreements with every Hollywood studio, see Chapter 14 for more).23

As a consequence, after hiring his first software architect five years ago, Chang’s firm now has about 30 employees, with growth rate targets of 30% annually, the profit of which is recycled and reinvested back into the company.

Services

In December 2012 I spoke with Richard Qi, the director of SR Force Consultants, a Brisbane-based software consulting firm that focuses on providing SugarCRM solutions to the Chinese marketplace – specifically to joint-ventures and foreign-owned firms.24 CRM stands for customer relationship management; it is a type of organizational and productivity software that creates a streamlined method for tracking, converting and managing leads and is used at nearly every large enterprise in Western countries.  Qi is originally from Dongbei (中国东北) and worked in Australia for 10 years before returning to the mainland two years ago.  According to him, “while there is a lot of growth potential, one of the challenges to providing technical services and solutions is that many local firms simply have not done the necessary due diligence to implement and fully utilize a lot of the software and services they purchase.  For example, SAP implementations have a roughly 70% failure rate on the mainland (e.g., initial production goals were unmet) because local customers and decision makers typically do not know what to do after the software is installed and integrated.”

Thus one of the reasons why Qi caters to joint-ventures and foreign firms is that, “they usually have detailed operational meetings and specific milestones providing both their internal IT team and external contractor with the necessary requirements gathering to build and use the functionality of the system.  They know what they are getting into.  In contrast most domestic customers are not fully cognizant of the limitations and features of their IT department let alone something more complex like a CRM system.  They may know how to run and synch a Windows server with Outlook yet they typically do not have the necessary enterprise management skill base to utilize some of the more complex packages and projects that are initially funded and installed.”

Thus in his mind, one opportunity that service firms such as his provides is “filling in the blanks with locally sourced expertise.  We hire all of our consultants locally based on both bilingual abilities and technical proficiency.  Yet services such as ours do not have to be strictly focused on CRM; business consultancy in general is about delivering value to customers and not necessarily every functionality imaginable.”  Yet one of the challenges is that “many local businesses are family managed so they typically do not have the training necessary to make long-term strategic growth plans – they are focused on immediate short-term profits that result in millions of different business paths that are often counterproductive.  In the past when we have provided solutions to these local firms, the initial service requests typically involve functionality issues (“do you have a PDF convertor”?) rather than strategic long-term issues (“how to distinguish a lead from a contact?”).  As a consequence, a challenge that other service firms will face is that if they focus solely on domestic companies, your firm may become part of an endless feature-focused loop that prevents your firm from growing and keeping pace with your international peers.”

Another issue that Qi explained and is not necessarily endemic to China is budgeting constraints.  Often time because enterprise software implementation is new to most domestic firms, the allocated budget is usually not adequate.  For example, in projects like implementing a CRM typically for every $1 spent on software, $2 needs to be spent on services just in case new modules need to be added or modified or technical support issues crop up.  Yet due to aggressive timelines, many firms face budget overruns that can prevent the systems from working efficiently or providing value to the end-user.

Cloud services

Another challenge for software makers in general is that, irrespective of trade secret issues, a large portion of traditionally developed software (e.g., shrink wrapped packages) has already been emulated, copied and installed at Chinese enterprises.  For example, one estimate of the bootleg rate in China is 77% (down from 92% in 2003).252627

So where does that leave your firm?

Perhaps your company can build out cloud computing on the mainland.  For instance, according to IDC, $286 million was spent on cloud-computing specific infrastructure in China in 2011 and this is expected to increase to $1 billion by 2016.28 There are currently 430,000 data centers and more than 5 million servers on the mainland.29 Furthermore according to IDC, over the next five years the cloud computing data center market as a whole on the mainland “is valued at 2 trillion RMB ($320 billion).”30

In terms of specific build outs, Jingdong Century, owners of 360buy.com (a leading e-commerce site on the mainland), recently invested 4 billion RMB ($750 million) building two new datacenters and in January 2013 opened a new cloud R&D facility in Beijing.3132 In September 2012 Baidu announced that it is investing $1.6 billion in building a cloud computing center.33 In March 2013 EMC, an information management company, said that it expects to land 1,000 projects over the next five years by focusing on niche segments like healthcare and education in over 300 cities on the mainland.34 Also in March, the Weather Company International, producers of the Weather Channel, announced that it would further expand its cloud and data services on the mainland where it already has more than 35 clients.35 And in addition to the Kyocera’s newly launched cloud-based network security services other firms like the Alibaba Group (Taobao, Tmall, Alibaba) are already among the leading local cloud service providers as its sites host tens of thousands of storefronts for SMEs.3637

During my interview with Eric Azumi, vice president of information services at EF (see Chapter 9) he noted cloud computing as one area on the mainland ripe for opportunities primarily because local players are still largely fragmented, inexperienced and unfamiliar with international ‘best practices.’  For example, due to various legal issues (see below) it is difficult for foreign companies to set up and directly own a data center on the mainland.  Thus Salesforce.com built a new center in Japan and Europe because according to Azumi, “there is no big money for the cloud China for the largest international participants at this time but there probably will be in the future.”  Yet concurrently he sees abundant openings for experienced foreign firms to still come in and train and provide other ancillary services to this segment.

One word of caution however, “[f]oreign companies that wish to operate cloud service in China must have governmental license.”38 As a consequence, Microsoft actually leases room in a China Telecom’s data center and outsources data management to a local firm, 21Vianet.  And Amazon recently suspended their cloud rollout due to these regulatory requirements.  Thus foreign firms specializing in cloud services should investigate the necessary legal requirements before entering this segment as well.

While moving to the cloud is increasingly popular, another area where US expertise and experience still thrives and cannot be easily copied is support services.  For example, Gartner forecasts software-as-a-service (SaaS) reached $14.5 billion globally in 2012, with US-firms taking the lions share at $9.1 billion.39 And Parks Associates estimates that the US tech support industry will “grow from $9.6 billion in 2011 to more than $20 billion by year-end 2015.”40 Can you or your company provide such services?

There is an app for that

Another potential area for US and foreign software companies is modifying their iOS and Android apps for the Chinese market.  As I mentioned in Chapter 6, China is now the world’s largest smartphone market, overtaking the US this past summer.  In addition, there are certain demographic groups, such as the elderly (aged 55+) that have been thus far overlooked for targeted apps, specifically games.41

What is the breakdown for app ecosystems?

While iOS remains relatively popular within China at more than 17% market share as of Q2 2012, more than 80% of all smartphones sold within China were Android-based.42 And in Q3 2012 Android marketshare on the mainland reached 90.1%.43 This mirrors global adoption rates, as of November 2012 Android-based devices now account for 72.4% of the global market (iOS is 13.9%).44 Unsurprisingly this has brought the total Android ecosystem to more than 50% total market share in China.45 This has also led Eric Schmidt, chairman of Google, to actively woo Chinese developers to the Android ecosystem.46 Yet despite this huge potential market, nearly all of these Android phones have been stripped of Google ad-supported services as well as Google Play – replaced by custom 3rd party applications and app stores.4748 In fact, 80% of Android phones in China use a preinstalled version of the Baidu-powered search tool instead.49 Or in other words, modern smartphones with Chinese characteristics.

What this means is that for US app developers, there are some opportunities to port and translate their apps and games to the Chinese market.  For example, as I also mentioned in Chapter 6, in terms of smartphones and tablets, less than 10% of the Chinese user base are older adults (55+).  This same demographic group comprises 7.1% of gaming and entertainment app users compared with substantially larger percentages in the US.50

How much larger in the US?  For instance, while a Pew Internet study found that only 13% of those ages 65+ in the US had a smartphone, Nielsen reported in May 2012 that in the US, “more than 50% of those who play FreeCell, Solitaire, and Hearts are over the age of 55.”5152 And a June 2012 study from Forrester research found that 44% of US seniors play solo games online.5354

In contrast, according to their 2010 report from IDC, only 7.1% of those aged 50+ in China played games.  More specifically, in terms of online chess gamers and mobile gamers, those older than 50 comprised 5.7% and 2.4% of all players respectively.55 Or in short, your grandparents and their peers frequently play computer games yet few software firms design games specifically for them, let alone for their Chinese counterparts.

While there may be cultural reasons for such a dramatic difference (7.1% in China versus 50% in the US), in my own anecdotal experience of walking through the parks and streets throughout the cities I have lived in, elderly Chinese seem just as apt to play memory games, dominoes (mahjong) and poker-style games as their Western counterparts.  And according to China Daily, “the turnover of China’s mobile gaming market is soon going to hit 5.2 billion yuan ($835 million) as the number of players reach 270 million.”5657 Thus in the long run even if the adoption and penetration rate remains relatively low for the elderly demographic group, 7.1% of 202 million (the number of elderly currently in China, see Chapter 18) is a potential niche market for future growth.

And as I mention in Chapter 6, in general, developers looking to port their apps and games over to Chinese markets should consider modifying the games to include Chinese traditions, symbols and cultural tie-ins – or in other words ‘Western video games with Chinese characteristics.’  For example: the color red, number 8, and the Chinese knot (Zhōngguó jié) are all considered lucky.  Perhaps creatively integrating these symbols into your game would prove popular, just as Kung Fu Panda was (see Chapter 14).  And since Macau now generates more than six times as much as gambling revenue as Las Vegas (Macau overtook it in 2007) maybe there is a legal way to capture this market.58 Or rather, because gambling is popular across all demographic groups perhaps designing a social gambling game or non-monetary betting app would find success across the mainland.59

Based on the wide variety of demographic groups playing games on the subway in Shanghai and Guangzhou and standing in line at restaurants, casual games such as those from PopCap (e.g., Peggle, Bejeweled, Plants vs Zombies), Imangi Studios (Temple Run), ZeptoLab (Cut the Rope), Halfbrick Studios (Fruit Ninja) and Rovio (the Angry Birds series) are also popular.  In fact, “Cut the Rope” has more daily users in China than any other country and according to the Financial Times, “around a quarter of all Angry Birds downloads are conducted in China.”60 It is so popular in fact that Rovio recently turned Shanghai’s skyscrapers green to market their new product and simultaneously launch a native version for the Chinese market.61

Another advantage US-firms currently have in porting their apps to the Chinese marketplace: English is the 2nd largest language in the Chinese iOS app store.62 And this presents an opportunity for Western developers: in their September 2012 report, Distimo found that after introducing a native language app, their “download volumes on the iPhone [increased] by more than 128 percent during the next week that followed.”  And sales revenue increased by 26 percent in the same week.  Either way you look at it, even if your company does not create a Chinese-version of its apps, the potential competitive marketshare even in English remains in reach of your company.

Understanding the market

You might be asking yourself, how does the app store function in China?  Are they run by Apple and Google and are they censored?

Apple opened its first official app store in China on October 27, 2010.63 By June 2011, China became the second largest source of app downloads for Apple.6465 And China sales for Apple products and services now accounts for 15% of Apple’s total revenue, $23.8 billion in fiscal 2012.66 In fact, Apple is actively courting Chinese developers by translating their tools and guides into Chinese.67 In addition to the large Android userbase, there are more than 70 Android app stores in China, which is estimated to eventually consolidate down to 10 within the coming years.6869

In terms of censorship, as reported by the New York Times, Apple has been selectively censoring applications in its app store based on requests by the government.70 And because of Google’s on-again-off-again legal fights with Chinese regulators, it is oftentimes unclear of what is being censored in the Android marketplace.  For instance, in the fall of 2011 there was a week-long period in which both the Android marketplace and Gmail application worked intermittently.71 This occurred once again in the early parts of the summer and fall of 2012 yet service was restored in both cases.72

This also raises another visceral point.  Despite its off-and-on wrestling with Chinese regulatory authorities, with a mere 4.72% search marketshare, Google’s revenue in “China’s mobile-app ad market will probably more than double to about 1.8 billion yuan ($283 million) this year [2012], exceeding the 1.2 billion yuan from mobile-search queries.”7374 In fact, despite these ongoing disputes with Chinese regulators, Google is “still the 3rd largest advertising revenue generator in that country doing $640 million a year (annualized).”75  And despite being hard to access at times Google has roughly 15% of the search engine market on the mainland.76 If they can achieve this in the face of never ending challenges, then your firm has potential as well.77

An app that helps find customers

Over the past 18-months Windisch-based coresystems has been working on a cloud-based digital assistant called Mila (an app) that was a finalist in the GMIC G-Startup competition held in October 2012.78) Mila allows entrepreneurs and SMEs to create an online assistant and unified online store front which is hosted on the cloud for free.  The assistant (Mila) can then search social media sites like Twitter to look for potential customers based on what your company provides as services.  And once a match is found, it then guides you through a streamlined sales process including invoicing using a smartphone.

In October 2012 I spoke with Andrea Chang, the marketing manager for Mila’s branch in China.  According to Chang, in their effort to localize the brand on the mainland, Mila has partnered with China Unicom (the second largest telecom company in China).79 Together they have modified Mila to integrate with Sina Weibo (which I noted in Chapter 12 is the world’s 2nd largest microblog site) and Alipay (the largest online payment provider on the mainland).  According to Chang, “the process of opening an online shop is one of the easiest and cheapest ways to generate leads and do business in China.  Using an integrated chat feature that allows customers and business to speak directly to one another, Mila not only communicates directly with your customer but also conduct all transactions, including invoicing.”

Chang also noted that because of the wide proliferation of smartphones and social media in China that one of the advantages of using Mila is that its cloud based transaction model substantially lowers the sales cycle costs (e.g., locating potential customers) while simultaneously providing customer service (e.g., by storing customer contacts).  This in turn allows entrepreneurs and SMEs to compete more on service instead of spending resources on search-engine optimization (SEO) or virtual store fronts.

So how does this help foreign companies wanting to do business in China?

Again, as mentioned in Chapter 12, before your company even establishes a physical presence on the mainland, you can use Mila and other services like Wildfire to search and discover the potential customer base for your company’s products and services.  And as I mentioned in Chapter 12 as well, because Facebook and Twitter are currently blocked on the mainland, you will need a way to localize your customer search to Chinese web services.  Solutions like Mila and Wildfire makes the process easier for your team, even if you are unfamiliar with Chinese customs and culture.

Securing your network

Cybersecurity is a sub industry that is often overlooked and dismissed by many businesses in China.  It has not helped that some media outlets resort to hyperbole to describe the real – and sometimes imagined – dangers for all firms with insecure IT networks.  For example, in July 2012, General Keith Alexander director of the NSA announced that up to $1 trillion in cybercrime damage was done globally each year.  This figure was later debunked.80 Yet determined hackers – both domestic and foreign – can and will compromise trade secrets and other proprietary assets typically without being caught.  Because a lot of theft and digital espionage goes left unnoticed it is very difficult to guess how much damage cybercrimes create.81 However in September 2012, Symantec released arguably one of the most extensive studies related to cybercrime and estimated the damage to be $110 billion a year globally.8283

How does cybercrime affect China, Chinese business and foreigners doing business in China?

In March 2012, Businessweek published a widely circulated report about corporate espionage of a US wind turbine supplier (AMSC) conducted by its Chinese client, Sinovel.84 In short, while AMSC attempted to isolate its trade secrets and proprietary software code outside of China (using an ‘air gapped’ facility), Sinovel still managed to use social engineering (e.g., bribery) to lure one of AMSC’s key Austrian-based programmers to China.  An ‘air gapped’ facility in their case meant the proprietary code – “secret sauce” – was only accessible at a workstation that was not connected to the internet.85 Using the ‘defense in depth’ IT security strategy (e.g., multiple firewalls and secure zones nested within one another) AMSC purposefully built this facility with the sole intention of building a physically isolated silo that could not be easily compromised.  While the case is still being fought in court, this is not an isolated instance.86 According to Akamai, a leading content-delivery network provider, in Q3 2012 one third of all cyberattacks originated from China (the US was second with 13%).87 All told, since 2007 the FBI and the Justice Department have opened more than two dozen cases involving trade secret, economic espionage and embargo circumvention restrictions involving Chinese contractors and individuals.88

One solution – a drastic solution – was detailed by the Washington Post in 2011.89 They interviewed several American executives who frequently traveled between the US and China each year for a variety of meetings.  A few of the executives had a straight forward security solution: buy a new iPad before flying to China, download all of the needed information from the cloud and then never use it again (e.g., throw it away).  Another simple low-tech, yet increasingly popular solution is to simply no longer provide external media outlets like a USB in a terminal with access to sensitive information.  In fact, in some IT security circles, one nickname for the USB is now “Ubiquitous Security Backdoor” due to this chronic problem – the ease in which sensitive information can be removed with a flash drive or in which malware can be conveniently installed, such as Stuxnet and Flame.909192

But what if the hackers simply move and setup shop overseas in your hometown?  In May 2010, NetworkWorld ran a story about an ongoing espionage attempt by unknown Chinese operators and a large US firm in the Midwest.93 Similarly, according to a recent Bloomberg story, right before its attempted $2.4 billion acquisition of Huiyuan Juice Group fell through, Coca-Cola was hacked in 2009 by a Chinese hacker group dubbed Comment Crew.949596 While it is unclear whether either of the espionage activities was successful, the threat of domestic and foreign hacking should motivate your company into proactive risk assessment – even if it does not plan to operate overseas.

Yet it is not just US firms that are on the losing end of cybercrime.  According to the same McAfee study above, malware and phishing attacks cost Chinese consumers $46 billion in 2011, twice as much as the US.97 The Ministry of Information Technology and Industry published a report that said “in 2012 alone that foreign hackers used viruses and other malicious software to seize control of 1,400 computers in China and 38,000 websites.”98 In fact, according to the Anti-Phishing Alliance of China (APAC) between January and November 2012 there were 24,535 phishing websites and scams targeted specifically at China’s online populace.99 In addition, in just a matter of weeks into 2013, a new virus called “Bill Shocker” has already impacted 620,000 users in China targeting the popular QQ messenger (see Chapter 12).100 In another instance, there was a 47% month-to-month phishing surge during Single’s Day (11-11) in November 2012.  This is the biggest online shopping day of the year as mentioned in the previous chapter.  Furthermore, Rising Information Technology, a web security company located in Beijing, estimated in a January 2013 report that nearly 200,000 Chinese websites were hacked in 2011 and at least 60% “of the attacks targeting China’s large companies, government, and scientific research institutions come from overseas.”101 According to Rising’s report, because Internet security typically is overlooked “[a] growing number of Chinese companies are turning to overseas Web security companies for protection, a move which still leaves them vulnerable to attacks.”

However with these challenges come opportunities for foreign security experts such as David Veksler, CEO of CryptAByte based in Shanghai.102 In October 2012 I had a chance to talk with him regarding some of the key opportunities in China’s nascent security industry.  He noted that “Chinese companies and foreign firms doing business on the mainland are equally in need of information protection.  Since retooling and retraining in business is increasingly based on software, losing proprietary information and trade secrets to any competitor, irrespective of physical location, can lead to losing your competitive advantage in innovation.”  Later in Chapter 20 he explains several other challenges and opportunities, but according to him, there are numerous possibilities for security experts since SMEs on the mainland are typically unaware of IT vulnerabilities such as zero-day exploits.  Zero-day exploits (or day zero) are threats and attacks that take place on the first days of a discovered vulnerability, before a developer patches the hole(s).  Thus according to Veksler, security consultants can help train mainland-based IT departments on ‘best practices’ and preventive measures that Western firms have learned the hard way with.

How does this work in practice?  For example, the world economy is shifting from capital intensive retooling which typically involved heavy machinery, to rapid prototypers and 3D printers (see Chapter 7).  This means that capital tools are now software.  Thus if you want to steal a new factory in the 21st century, all you really need to do is pilfer software.  As a consequence, the theft of entire industries could conceivably take place, allowing perpetrators to simply take the data to the cheapest country (e.g., based on land and labor costs) and eat into the marketshare of the original innovator.

This cloak-and-dagger industrial espionage is in Veskler’s words, “actually becoming a prime motivator for innovation.  While competitors could learn trade secrets through hiring former employees or reverse engineering, because you are never quite sure if someone has hacked into your systems or used social engineering – like Kevin Mitnick did – to gain access to proprietary information, every incumbent must now continually innovate.  Otherwise their competition could use a stealth startup and out-maneuver you with your own confidential information.”  In economic theory, when a firm is successful it sends profit signals out to the marketplace (e.g., by satisfying consumer demand you become profitable and other participants take notice).  As a consequence, because the firm realizes it will eventually draw competition with these “signals of success” it has to always keep striving to improve and innovate.

Kevin Mitnick was a hacker in the 1980s who used social engineering (e.g., manipulating secretaries to give him secure access) to compromise corporate networks such as DEC and Motorola.103 Samuel Slater, known as the father of the Industrial Revolution in the US, was born in the UK.  He was an originally an apprentice at a cotton mill based on Richard Arkwright’s design near Cromford Mill in England.  When he immigrated to the US, he later used a design similar to Arkwright’s to kick-start the American Industrial Revolution.  This a common risk noted Kent Kedl of the consultancy Control Risks, who recently told The Economist that, “The easiest way to get intellectual property from a firm is by buying or renting an employee inside it.”104 Thus, a stealth startup today could conceivably appropriate proprietary information (e.g., CAD models, engineering designs) via social engineering, hiring or hacking, build a warehouse in a developing country where resources costs are relatively low, and fill the warehouse with 3D printers.  Then in turn, export the products to world markets.  Some of the practical issues involving VPNs for corporate environments, such as preventing industrial espionage, are discussed later in Chapter 20 as well.105

During my February 2013 interview with Shaun Rein, founder of China Market Research, he noted that “for any company in the world, internet security is an increasingly important issue.  And especially in China I think a lot of MNCs are continuously worried about protecting IP.  As a matter of fact, our firm recently received an RFP [Request for Proposal] from a very large internet company building a marketing expansion strategy on the mainland.  As part of the proposal we are supposed to disclose our firm’s security issues to make sure we are a reliable partner to work with.  In other words, to prevent any proprietary information from being leaked by a vendor they are modifying their risk management to hedge against the possibility of being hacked.  The flip side of this is that there are currently no large barriers to entry for doing internet security consulting because the government is very supportive of intellectual property transfers at this level.  At the same time, it may be more difficult selling antivirus software directly because then you would be competing with domestic forces and local firms like Kingsoft.  But services such as IT security are quite open.”

In January 2013, internet giant Baidu announced that it was investing in Kingsoft, makers of antivirus software (and an office productivity suite).106107 At the beginning of this year, several media outlets such as Businessweek have released additional reports covering Comment Crew (see above), also known as ATP1 (which may be the same as PLA Unit 61398) which has purportedly hacked into nearly 150 companies and organizations in more than a dozen countries over a period of 7 years bringing this IT security issue to the attention of more stakeholders such as MNCs.108

And with all of these local and international security issues laid bare, for another perspective one should also consider the comments from General Electric Vice Chairman, John Rice who recently explained that, “Despite hacking and other issues in China, foreign companies need to be there, due to the country’s potential as the world’s biggest marketplace.  The greater risk lies in staying away.”109 Without going into details, GE is purportedly “improving how it handles threats to its information.”  Thus eternal electronic vigilance may be the new normal but it is something that your competitors (both domestic and foreign) will probably have to overcome as well.

Takeaway: The software development, IT support and security services industry is both alive and growing at a fast pace in China.  US firms relying on traditional revenue models such as selling shrink wrap packaging will need to modify their business model for entry into China.  This may come in the form of cloud computing and software-as-a-service.  Yet either way their expertise and quality management – even at higher costs – are still marketable within China.  In addition, US firms specializing in developing apps have yet another revenue stream they can tap into if they are able to modify and translate their applications for Chinese consumption – the world’s 2nd largest app market.  Furthermore, IT security firms also have potential opportunities to secure and optimize the networks of Chinese enterprises and SMEs whom suffer billions in economic losses each year.


Endnotes:

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  1. Software outsourcing on upward curve from China Daily []
  2. Chinese Software Industry to Grow 25% Through 2016: Report from eWeek []
  3. Indian IT-BPO Industry from NASSCOM []
  4. Ibid []
  5. 5 Reasons Why China Will Dominate Business Process Outsourcing from Right Site []
  6. China, not PH, eroding India’s BPO leadership, says consulting firm from InterAksyon []
  7. See The Emerging Market of China’s Computer Industry by Jeff Zhang and Yan Wang and Chinese software, IT revenue to touch $635bn from Times of India []
  8. Software Industry Facts and Figures from Business Software Alliance []
  9. Global Software Top 100 Edition 2011: The Highlights from Software Top 100 []
  10. See Pro-Emfatic and Pro-Lambda Software []
  11. Kingsoft Boasts Over 50 Million Monthly Active WPS Users from China Tech News []
  12. Baidu Invests in Kingsoft, Moves Into Web Security, Qihoo’s CEO Calls it a “Big Joke” from Tech in Asia []
  13. See Train ticketing software highlights China’s innovation paradox from Xinhua and China Train Ticket Site Cost Nearly $100 Million, Seems to Be Harassing Programmers, And Might Be Broken Again from Tech in Asia []
  14. Rubber chickens, ostrich heads ease China’s rough ride home from Reuters []
  15. Chinese man kept alive by self-built dialysis machine from The Telegraph []
  16. Economist: China Plenty Creative, Just Not in Right Ways from The Wall Street Journal []
  17. Why China Can’t Make Its Own Mobile OS from Tech In Asia []
  18. It is a cultural characteristic of many regions in East Asia.  For example, the Japanese equivalent is 出る杭は打たれる. []
  19. See also hackerspaces in Chapter 7.  See Bandit phone king has the last laugh from Financial Times, Imitation Is the Sincerest Form of Rebellion in China from The Wall Street Journal and In China, Knockoff Cellphones Are a Hit from The New York Times []
  20. Number’s up for fake cell phones from Shanghai Daily []
  21. Chinese Companies Getting Good at Attracting Talent from The Wall Street Journal []
  22. The economic term for short versus long-term time horizons is “time preference.” See Chapter 18 in Human Action by Ludwig von Mises. []
  23. Similarly, Hearst president David Carey recently noted that Apple and Steve Jobs “taught people how to buy digital content.”  See Hearst president David Carey: Apple taught people ‘how to buy digital content’ from Engadget []
  24. SRForce []
  25. Microsoft’s newest weapon in China piracy fight from Reuters and Report: China’s software piracy rate falls to new low — of 77% from ZDNet []
  26. To combat piracy of Windows 8 in China, Microsoft will not sell a shrink wrapped package – users can only get it pre-installed by OEMs or by downloading it.  With the release of Office 2013 on the mainland, consumers can still purchase traditional packages via Microsoft’s online store.  See Microsoft Cancels Packaged Windows 8 For Chinese Market from China Tech News and Microsoft Commences Office 2013 Software Sales In China from China Tech News []
  27. One other partnership area could be to pursue a joint-venture such as the kind that Microsoft and Suning (a large mainland retailer) have recently announced.  See Suning, Microsoft Ink Multipart Retail Deal For China from China Tech News []
  28. Cloud computing investment ‘to hit $1b’ from China Daily []
  29. Ministry to set up cloud computing data centers from China Daily []
  30. Ibid []
  31. Tech Bytes: 4 Billion Yuan from China Daily []
  32. China’s 360buy.com Launches Cloud Computing R&D Center In Beijing from China Tech News []
  33. Baidu Shares Plunge on Worries over Mobile Monetization from Caijing []
  34. EMC China’s Growth Focuses On Big Data, Cloud Computing from China Tech News []
  35. Cloudy Days Ahead As Big Data Comes To Chinese Meteorological Administration from China Tech News []
  36. Cloud-based Network Security Suite Launched By Kyocera In China from China Tech News []
  37. Alibaba’s Cloud Computing Platform Combines Storage Services from China Tech News []
  38. Amazon’s cloud service aborted in China, launch of Kindle delayed from Morning Whistle []
  39. Gartner Says Worldwide Software-as-a-Service Revenue to Reach $14.5 Billion in 2012 from Gartner []
  40. Tech Support Industry Webcast Will Examine Opportunities in $9 Billion Market from Parks Associates []
  41. It is highly recommended that game developers and digital entrepreneurs read Digital Game Design for Elderly Users from Association for Computing Machinery.  The study noted a similar finding, including one that I also point out: “the growing 65+ demographic is currently not well served by the majority of commercial games on the market, creating a significant potential niche market for game developers.” []
  42. China’s smartphone market grows 164%, Apple’s iOS takes 17.3% from Apple Insider []
  43. Report: Android Rises to 90% of Smartphone Market in China from Tech In Asia []
  44. Gartner has published two others estimates which put Android marketshare globally at 68.4% in 2012 compared with 19.4% for iOS and later with Android at 69.7% and iOS at 20.9%.  See Strategy Analytics: Android claimed 70 percent of world smartphone share in Q4 2012 from Engadget, Gartner Says Worldwide Sales of Mobile Phones Declined 3 Percent in Third Quarter of 2012; Smartphone Sales Increased 47 Percent from Gartner and Gartner Says Worldwide Mobile Phone Sales Declined 1.7 Percent in 2012 from Gartner []
  45. See Android is winning – if you’re writing apps for China. Elsewhere, though… from The Guardian and Alternative app stores and platform branches: Is Android too open? from Android Authority []
  46. After North Korea trip, Google’s Eric Schmidt swings by China to woo Android developers from The Next Web []
  47. Google is beginning to try and take action to purportedly prevent further fractures and forking of the Android ecosystem.  See The Acer/Google/Alibaba tussle: It’s not about open Android from ZDNet and Acer Apparently Reconciles With Google from Forbes []
  48. While there has been a lot of discussion over the past year over whether or not it is profitable for developers to make Android apps for the Chinese marketplace, there is at least one success story that could be used as a case study: CocoaChina which makes a popular game called Fishing Joy.  See How CocoaChina proved it’s possible to make money on Android in China (to the tune of $2m a month) from The Next Web []
  49. See 80% of Android phones in China will have its default search set to Baidu from The Next Web and Android Takes Off in China, But Google Has Little to Show for It from Forbes []
  50. See Table 3, p. 9 China Gaming Market End-User Survey, 2010 from IDC []
  51. Nearly half of American adults are smartphone owners from PewInternet []
  52. Vintage PC Video Games Still Thrive in World of App from Nielsen []
  53. The Data Digest: Digital Seniors from Forrester []
  54. While unrelated to gaming see also, For the first time, half of adults ages 65 and older are online from PewInternet []
  55. Gamers in a sample size of 29,392.  Online chess gamers in a sample size of 3,050.  Mobile gamers in a sample size of 1,519.  See China Gaming Market End-User Survey, 2010 from IDC []
  56. Internet gaming: ‘A winning gamble’ from China Daily []
  57. Mobile payments are also expected to rise markedly over the next 3-5 years, hitting $112 billion by 2015.  According to Alipay (the largest domestic online payment service), in 2012 the number of people who used mobile payment increased by 223% and “over 4.3 million people spent more money via mobile phones than PCs.”  See China’s Mobile Payments Will Reach Over CNY700 Billion By 2015 from China Tech News and China’s Alipay Reported 546% Wireless Payment Growth In 2012; Tibetan City Tops Ranking from China Tech News []
  58. Revenue hit $38 billion in 2012 and is expected to reach $44 billion in 2013.  See Rolexes Pawned in Macau Signal Further Gains for Casinos from Bloomberg, Macau gaming revenues hit $33.5 billion in 2011, no slowing seen from Las Vegas Review-Journal, Broken Tooth and New Macau from Foreign Policy and Door is about to slam shut on high-rolling holidays to Macau from The Times []
  59. Despite initial reports that suggested a new pilot program was starting at a casino in Sanya, Hainan province (called Jesters), gambling on the mainland is currently banned.  Macau is the only nearby domicile where this is allowed.  Mainland residents must still apply for an entry visa in order to travel to Macau and are typically only allowed to visit it a few times a year.  There are exceptions, for example, if you live nearby in certain cities of Guangdong or if you have relatives living in the SAR.  See Sanya Says It Never Licensed Any Form of Gambling Activities from Caijing, Chinese authorities close cashless casino bar in island resort from Reuters, Macau Casinos Decline on Visa, Credit Limit Concerns from Bloomberg, Macau’s Casino Revenue Reaches Record After Holiday Week from Bloomberg and China Tightens Reins on Macau from Bloomberg []
  60. See For App Makers, China Is Untapped and Untamed from The Wall Street Journal and China: lots of three kingdoms, not enough Angry Birds from Financial Times []
  61. Rovio announces Angry Birds book app: Live from Frankfurt Book Fair from paidContent and Bad Piggies and Angry Birds Hit the Road in China, Turn Shanghai Skyline Green from Tech In Asia []
  62. According to Distimo, “Applications with Chinese as a language in the top 200 were responsible for the largest share of the free downloads in China at 73 percent. English was responsible for only 69 percent of the free downloads among the top 200 in China.” See App Distribution Becomes A Global Game: The Shift Of Power & Impact For Developers from Distimo []
  63. Apple Opens Chinese App Store from The Wall Street Journal []
  64. China Now Apple App Store’s Second Biggest Market from PcMag []
  65. Apple’s App Store made big gains in China in 2011 from GigaOm []
  66. In a January 2013 interview, Apple CEO Tim Cook predicted that China will become the biggest market overall for Apple.  See iPhone 5 launch results in new weekend record for Chinese market from ArsTechinca, Tim Cook: China Accounts for 15% of Apple’s Sales, Will Get iPhone 5 in December from Tech In Asia and iPhone 5 hits China as Apple market share slips from Reuters, Interview: Apple CEO expects China to become biggest market from Xinhua and Apple’s China dilemma: market share or cachet? from Reuters []
  67. Apple is also opening up an R&D center in Shanghai.  See Apple courting Chinese developers to strengthen iOS in China from ArsTechnica and Apple Shanghai R&D center confirmed for summer 2013 from Apple Insider []
  68. See China Has 70 Android App Stores, But That Could Soon Whittle Down To 10 from paidContent and For App Makers, China Is Untapped and Untamed from The Wall Street Journal []
  69. One problem with this fragmentation is that applying security patches is a much longer process and sometimes never occurs, leaving consumers open to fraud schemes such as ‘smishing’ (sending phony text messages).  See ‘Fragmentation’ leaves Android phones vulnerable to hackers, scammers from The Washington Post []
  70. Far-Ranging Support for Google’s China Move from The New York Times []
  71. China Cripples Android With Fitful Blocks of Gmail, Market Apps from paidContent []
  72. Similar blockages have occurred in November during the leadership transition.  Readers may be interested in the developments with GitHub as well.  See What is going on with GMail in China, and how to get around from GreatFire and China, GitHub and the man-in-the-middle from GreatFire []
  73. Google Finally Leads in China – in App Ad Sales from Bloomberg []
  74. Google decline in China continues as its search share falls to 4th place, maps to 6th from The Next Web []
  75. Google Still Does $640 Million In Annual Revenue In China from Forbes []
  76. China Search Engine Market Share in 2012 from China Internet Watch []
  77. According to one recent report, sometime at the beginning of December 2012 Google acquiesced and removed “a feature which had previously informed users from China of censored keywords” and “at the same time, they deleted the help article which explained how to use the feature.”  Yet according to another source “the opportunity to capitulate was lost forever when Google gave the middle finger and left.”  See Google Bows Down To Chinese Government On Censorship from GreatFire.org and Mr Kim, tear down that wall; Mr Xi, carry on from The Economist []
  78. Mila from coresystems can be downloaded from Google Play and Apple’s App Store (WoStore is China Unicom’s equivalent []
  79. China Unicom has its own marketing channel which Mila uses. []
  80. Does Cybercrime Really Cost $1 Trillion? from ProPublica []
  81. Pentagon Warns: ‘Pervasive’ Industrial Spying Targets U.S. Space Tech from Wired []
  82. In February 2013 Microsoft researchers published a report discussing reasons and variables for why certain geographic regions and areas are more or less prone to cybersecurity holes and abuse.  Unsurprisingly economic stages of development played a big role (e.g., wealthy countries have lower rates of malware infection compared with developing countries).  See Wealthy Countries Better At Protecting Citizens…From Malware from The Security Ledger []
  83. 2012 Norton Study: Consumer Cybercrime Estimated at $110 Billion Annually from Symantec []
  84. China Corporate Espionage Boom Knocks Wind Out of U.S. Companies from BusinessWeek []
  85. FAA: Boeing’s New 787 May Be Vulnerable to Hacker Attack from Wired []
  86. China Court to Weigh Corporate-Spy Case from The Wall Street Journal []
  87. China Source of Most CyberAttacks, Says Akamai from PC Magazine []
  88. Summary of Major U.S. Export Enforcement, Economic Espionage, Trade Secret and Embargo-Related Criminal Cases from Department of Justice []
  89. In China, business travelers take extreme precautions to avoid cyber-espionage from Washington Post []
  90. Ubiquitous Security Backdoor from SANS Institute []
  91. This security issue is not endemic to China.  For example, over the past two years, a school in Virginia and a hospital in Oregon accidentally lost USB drives which contained sensitive information.  See OHSU says stolen USB drive contained some patient data from KATU and Students’ personal data exposed after USB drive stolen from SOPHOS []
  92. See Flame and Stuxnet Cousin Targets Lebanese Bank Customers, Carries Mysterious Payload from Wired and Resource 207: Kaspersky Lab Research Proves that Stuxnet and Flame Developers are Connected from Kaspersky Lab []
  93. See Black duck eggs and other secrets of Chinese hackers from NetworkWorld and Michigan Couple Stole GM Secrets for Chinese, U.S. Says from Bloomberg []
  94. Coke Gets Hacked And Doesn’t Tell Anyone from Bloomberg []
  95. Comment Crew (also known as APT1) is also suspected of hacking into other firms (both foreign and domestic) including a high-profile case involving Solid Oak Software, a California-based firm that specializing in developing internet filtering software.  Two other large hacking organizations are the collective known as ‘Beijing Group’ and the PLA’s Unit 61398 whom are suspected of conducting economic espionage (APT1 and 61398 may be one in the same).  See China Mafia-Style Hack Attack Drives California Firm to Brink from Bloomberg, A Chinese Hacker’s Identity Unmasked from Businessweek, Mandiant, the Go-To Security Firm for Cyber-Espionage Attacks from Businessweek and Mandiat APT1 Report from Mandiat []
  96. The New York Times has repeatedly been hacked since October 2012 as have the servers of The Wall Street Journal and The Washinton Post as well.  The perpetrators of all three are purportedly located in China.  See Hackers in China Attacked The Times for Last 4 Months from The New York Times, Chinese Hackers Targeted Wall Street Journal Computers from The Wall Street Journal, The People’s Republic of Hacking from Foreign Policy, A Chinese Hacker’s Identity Unmasked from Businessweek and Chinese hackers suspected in attack on The Post’s computers from The Washington Post []
  97. Chinese lost US$46 billion to cybercrime last year from Shanghai Daily []
  98. U.S. Ready to Strike Back Against China Cyberattacks from Associated Press []
  99. Phishing scams target China’s growing online population from Xinhua []
  100. Malware controls 620,000 phones, sends costly messages from Help Net Security []
  101. Nation under increasing threat from hackers from China Daily []
  102. CryptAByte []
  103. See The Art of Deception: Controlling the Human Element of Security by Kevin Mitnick and Takedown: The Pursuit and Capture of Kevin Mitnick by Tsutomu Shimomura []
  104. Who needs cyber-spying? from The Economist []
  105. Domestic Chinese firms are also investing into this segment.  See Baidu Invests in Kingsoft, Moves Into Web Security, Qihoo’s CEO Calls it a “Big Joke” from Tech in Asia []
  106. Baidu Invests in Kingsoft, Moves Into Web Security, Qihoo’s CEO Calls it a “Big Joke” from Tech In Asia []
  107. In 2002, foreign firms such as Symantec, Trend Micro and Network Associates were required to give code samples (e.g., viruses, rogue wiretaps) to the security ministry in order to receive approval for access to the mainland consumer market.  In addition to Kingsoft, domestic firms now include Qihoo 360 and Rising.  As of Q3 2012, Qihoo 360 had 442 million monthly active users and the enterprise version reached 420,000 users (representing millions of computers).  See China Is Asking Software Firms To Provide Samples of Viruses from The Wall Street Journal and Qihoo 360 Acquires Chinese Web Log Analysis Platform from China Tech News []
  108. See A Chinese Hacker’s Identity Unmasked from Businessweek, Mandiant, the Go-To Security Firm for Cyber-Espionage Attacks from Businessweek and Mandiat APT1 Report from Mandiat []
  109. Being in China Is Less Risky Than Not Being There from The Wall Street Journal []

Chapter 14 – Pop Culture

[Note: below is Chapter 14 from Great Wall of Numbers]

According to the Ministry of Culture, China has now become the world’s largest TV series producer and third largest film producer.1 While domestically made Pleasant Goat and Big Big Wolf (喜羊羊与灰太狼) and homegrown talent like pianist Lang Lang, actress Fan Bing Bing and comedian Zhou Libo are increasingly popular outside of China, irrespective of where I have taught on the mainland, on any given week my students would invariably ask me what kind of foreign pop culture I enjoyed consuming.2

One student I vividly recall in the spring of 2010 had the English name ‘Scofield’ – as in Michael Scofield of Prison Break.  (Remember ‘Cena’ from Chapter 2?  This was one of his peers).  Needless to say ‘Scofield’ was quite a fan of the show, eagerly downloading the latest episode throughout each season.   While exact numbers are hard to come by, during its run, Prison Break itself was purportedly the most popular imported TV show from the US, eclipsing even Desperate Housewives.3 Because of this, Wentworth Miller, who starred as Michael Scofield later appeared in commercials for Me & City (an apparel company) and Ford Motors in China.

While it probably does not come as a surprise to frequent travelers or those with friends living in other countries, US culture is continuously exchanged globally throughout the day.  It is perhaps one of the largest, unquantifiable exports that US institutions and individuals produce.  It is a type of ‘softpower’ that is the envy of all emerging markets.45 And its popularity in China is no exception.

As I mentioned in Chapter 8, Chinese, both young and old are voracious consumers of US sports and in particular the NBA.  They are also equally interested in other parts of US culture.  In addition to paying attention to LeBron and Kobe statistics, after class these same students would frequently ask what I thought about shows I had never heard of at the time: Gossip Girl, Big Bang Theory, Vampire Diaries, ad infinitum.

How do they watch these shows?

While digital video recorders (DVRs) are essentially non-existent on the mainland, in addition to Bit Torrent, there are a number of sites and technologies that stream content on demand such as PPTV, Sohu, iQiyi and Youku (the latter two were mentioned in Chapter 12).6 Several Chinese video sharing sites have even signed agreements with US publishers to ‘legally stream’ content.  Prior to its merger, Youku licensed “Inception” from Warner Brothers and if users wanted to watch it, they had to pay about $.75.  Similarly Tudou (which later merged with Youku) licensed “Desperate Housewives” and “Lost” from Disney.  This culminated in November 2012 where the new Youku Tudou signed a 5-year deal with Sony Pictures which in turn means that Youku now has an agreement with every major Hollywood studio.7 In January 2013, Tencent announced that it had signed a similar agreement with several studios including Warner, Universal, Miramax and Lionsgate.8 For 5 RMB a movie or 20 RMB a month for an ongoing subscription, users of Tencent’s video portal can now view Hollywood movies a mere two weeks after they are first shown in US theaters.   But by-and-large, these are historically seen as exceptions, not the rule.

How much of an exception?  According to a Los Angeles Times story, China’s bootleg DVD industry “raked in $6 billion in 2010. By comparison, China’s box-office receipts totaled $1.5 billion last year [2010].”9

Yet for perspective consider this.  My students knew who Katy Perry was before I did.  They were fans of Game of Thrones (written by an American) before I even heard of it.  They had memorized the lyrics to Lady Gaga songs and their ring tones blared Rah-rah-ah-ah-ah through the halls.  They knew what happened to Charlie Sheen (not winning) and could laugh at inside jokes told between Barney Stinson and Ted Mosby.  And as mentioned below, it is little wonder that they also consume Mad Men as well.

Translating popularity into revenue

Another Los Angeles Times report recently discussed the popularity of Mad Men on the mainland.10 While intellectual property (IP) issues are a continued source of debate on both sides of the Pacific, Sohu, a large internet portal, recently signed an agreement with Lionsgate (which produces Mad Men) to distribute it online.  While the exact details are not public, other foreign companies have received ad-sharing revenue as these streaming sites place 30-60 seconds worth of pre-roll ads.  Altogether the online video ad business on the mainland is estimated to have generated $1.2 billion in 2012.11

Could your company sign similar revenue deals?  For the time being, probably not, unless you are a relatively large studio such as Disney, Warner Brothers or Lionsgate and have legal representation on the mainland.

While Mad Men may not be as popular as Gossip Girl (which is so popular that it is being remade locally121314 ) or Prison Break, according to Ken Ji, who works for the internet portal Soufun, “I think it reflects reality.  You can see from ‘Mad Men’ that [the] U.S. was already sort of open in the 1960s. China is developing and moving toward the stage reflected in the show.”15 Viewers like Ji and my students can also relate to the smoke-filled rooms in the show.  According to the same Times piece, “63% of workers are exposed to cigarette smoke on the job.”  And in my personal experiences, whether it is on a bus, a restaurant, an elevator or even a doctor’s office – smoking is near ubiquitous in many areas, especially outside of larger cities like Shanghai or Guangzhou.  All told, more than 300 million Chinese currently smoke, the repercussions of which I discuss later in Chapter 18.

I mention this because a number of my students and colleagues found it somewhat strange that a working man such as myself, did not smoke.  Apparently because Chandler Bing and Don Draper smoke, so too must other foreigners.

How does this help you and your company set up business in China?

Again, remember, understanding your customer preferences and consumer behavior is just as important as the product itself.  For example, Kung Fu Panda was a smashing success on the mainland because the American producers got the authentic look and feel of China spot-on, leading to a number of domestic thought-leaders and policy makers asking, “why didn’t a Chinese company make it?”1617 In contrast, one of the most popular Chinese-made sit-coms on TV right now is iPartment – a popular yet controversial show because many of the jokes and situations apparently directly come from Friends, Big Bang Theory and How I Met Your Mother.18

What this means for you

Even if you are in the movie production industry you might not know that the Chinese film market is now the world’s 2nd largest box office, scooting past Japan last year.  Ernest & Young estimates that the mainland box office will grow 17% annually through 2015 and overtake the US in 2020.19 There are now over 12,000 theater screens in China, a number that will also double by 2015.20 And despite market restrictions that prevent nearly all but a select few of foreign films from being screened, foreign films still managed to account for 65% of the revenues for the first half of 2012.  In fact, according to Xinhua, box office sales in China “totaled $1.28 billion in the first half of 2012, up 41.7 percent year-on-year, due to imported movies.”21

To really give you an idea of how popular foreign films are, in the first half of 2012, out of the 38 imported films screened, 14 were considered revenue blockbusters, and only two of them failed to bring in more than $16 million.  In contrast, “among the 141 China-made movies screened in the same period, only 5 percent managed to break even and the rest lost money, industry insiders said.”2223 Altogether, movie ticket sales increased 30% in 2012, reaching a new record of $2.69 billion.24 And the 76 foreign films screened on the mainland represented 52.4% of ticket sales (compared with 227 Chinese-made productions).25 In fact, 7 out of the top 10 highest-grossing movies shown in China last year were imports.

In this same Xinhua story, Zhang Huijun, president of the Beijing Film Academy believes that this polarized situation might actually spur more creativity domestically because Chinese producers now ask themselves, “[h]ow can they produce quality films that cater to the audience and generate lakes of cash?”

Yet while this transition and transformation germinates domestically, you and your content company may be able to still capitalize off the popularity of “being foreign” (see also Chapter 3 and Chapter 11) and establish new revenue streams in China.  That is not to say that foreign firms can ignore quality.  Yet for perspective, this is a country where a mere 600,000 foreigners are year-round residents.26 In fact, in my own anecdotal experience, I have been photographed several hundred times simply because I looked different (or laowai).27

But also consider one challenge that Forbes recently reported on: the difficulties and challenges both foreign and domestic companies have in repatriating their earnings.2829  This is due in part to laws and regulations as well as a large SOE called China Film Group (CFG) which, even with seemingly ironclad contracts, still purportedly extracts a lion’s share of revenue for the films it distributes (it has an exclusive monopoly on mainland distribution).

For example, as I noted in Chapter 10, before setting up and doing business in China, it is highly recommended that you do your legal due diligence.  I then quoted an exchange I had with legal expert, Dan Harris, of the law firm Harris & Moure who said one of the biggest challenges of doing business in China was contract enforcement and getting paid.  This same Forbes piece above quotes Mathew Alderson, also an attorney at Harris & Moure, who said “getting paid is a big concern” for both domestic and foreign studios alike (and on both sides of the Pacific for that matter).

So a quick recap: foreign pop culture, especially entertainment from the US, is incredibly popular in China.  It is readily consumed and easily accessible through a variety of venues and channels, including the internet and movie theaters.  China’s movie theater industry has rapidly expanded and is now the largest outside of the US (see also Chapter 11 regarding Wanda and AMC).  Yet despite this popularity, monetizing and repatriating the revenue is a challenge for all foreign companies.

Marginal liberalizations and popularity

What kind of headway are foreign firms making into this maturing market?  Prior to a deal hammered out earlier in spring 2012 by US trade representatives only 20 US films were allowed to be screened at theaters; the number is now 34.  And according to the Forbes article above, in order to prevent “receipt leakage” and to audit the box-office receipts of an upcoming joint production, the US producers are “demanding that a collection agency” be used as 3rd party monitor.

Yet again, despite these hurdles, the popularity noted above indicates that pent up demand for foreign cultural products is not likely to subside.30 So what can you or your company produce that can capitalize off its cultural ‘uniqueness?’  And again, remember “Made in the USA” is actually a perceived badge of quality (see also Chapter 11).

What other types of entertainment are popular?

The third most-searched query on Baidu (which at 80% has the largest search engine market share in China) in all of 2012 was for 4399, a new popular gaming portal that develops easy-to-use casual games that are popular with younger demographic segments.31 NetEase is the 2nd largest tech company in China; it employs more than 6,000 and generated $7.29 billion in 2011.  While it has diversified and operates both a large popular portal (163.com) and a cloud word processor called Youdao Yunbiji, one of its biggest revenue sources is World of Warcraft (WoW) developed by US-based Blizzard Entertainment.  WoW is globally the largest (by revenue) massively multiplayer online role-playing game, with around 10 million subscribers.32 NetEase is Blizzard’s official partner in arguably the most popular, foreign revenue generating game on the mainland.3334 In fact, by some estimates, half of all WoW subscribers are now from China.

While I briefly touched it in Chapter 6 and Chapter 13, online gaming in China is a large and growing industry.  Just how big?  According to Pan Chenyu of PricewaterhouseCoopers (PwC), “China is now the world’s largest online gaming market, contributing one-third to the global revenue in this sector in 2009, or 56 percent of the Asia Pacific total.”35 In fact, sales revenue for online games in China for 2012 reached $9.69 billion, an increase of 35.1% from the previous year.36 And a recent report from China Daily noted earlier in the chapter, “the turnover of China’s mobile gaming market is soon going to hit 5.2 billion yuan ($835 million) as the number of players reach 270 million.”37 With approximately 330 million players (150 million who are below the age of 19), perhaps you can port or develop games for this market.

What else is consumed besides electronic games?

Based on my own anecdotal evidence, despite their on-again-off-again love-hate political relationship, many Chinese (especially under-30) consume large quantities of Japanese entertainment.  Yugi-oh collectible cards are sold in convenience stores and entire series of anime such as One Piece, Sailor Moon, Naruto, Full Metal Alchemist and Shin-chan are downloadable from the same video sites noted above.  In addition, local video arcades are full of systems originally from Japan such as SEGA and Namco and toy stores in larger cities are stocked with Japanese imports (like Hello Kitty).

Each large city typically also has stores that import and sell “officially” banned products like consoles such as Sony’s PS2 as well as Microsoft’s Xbox 360 (ironic since they are both manufactured in China as well).3839 Since being officially banned in 2000 due to parental outcries over “wasting time,” companies like Nintendo have reworked their products to fit the legal framework and while they still face domestic knockoffs and clones (like the “Vii”); Nintendo has managed to generate revenue through their a local partnership in the iQue and iQue DS consoles which are made and distributed on the mainland.

In November 2012 I spoke with Kyron Yang, a native of Kunming who is now completing a graduate degree in computer science at the University of Utah.  Prior to his graduate studies he worked as a voice actor for a genre of games called “street mechine” (卡战三国).  It is a genre of turn-based, role-playing styles blended between a collectible card game and traditional action game and is sometimes played on consoles at video arcades.40 Essentially a player controls a character or several characters that in turn collect cards and can use those cards to perform certain actions (e.g., fight).  In East Asia, this type of game is increasingly popular with both teenagers and adults, yet is also very popular with younger demographics.  According to Yang, “the market for this type of games is very competitive because the mechanics are relatively simple, much like ‘paper, rock, scissors.’”  Yet one word of caution, there are now policies that restrict the amount of hours that games can be played by minors thus solely targeting this demographic could place growth restrictions on your firm.41 Perhaps a company looking to build an entertainment venue like those discussed in Chapter 11 (Main Event, Dave & Buster’s) could find success by using these types of game consoles in their venues targeted at a wide range of demographics.

Takeaway: despite being the largest film market outside of the US and the largest TV producer globally, China’s maturing entertainment industry is dominated by foreign imports.  Whether it is movies, TV shows, music or even games, Chinese consumers have a seemingly insatiable appetite for foreign-made entertainment.  Yet with this demand also comes challenges in the form of bootlegging, regulatory hurdles and capital controls (see also Chapter 10).  At this time the market may only support physical sales and value-added services (theaters) yet small inroads have been made in terms of liberalization and revenue sharing.  As usual, be sure to do your due diligence before diving in.  The rewards may still not justify the investments.


Endnotes:

 

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  1. China becomes largest TV series producer from China Daily []
  2. See An Animated Goat, Banker Look Abroad from The Wall Street Journal and Letter from Shanghai: Class and capitalism mix with comedy from The Washington Post []
  3. “Prison Break” catches on in China from The Seattle Times []
  4. Sun Tzu and the art of soft power from The Economist []
  5. Hollywood ‘gaining ground’ in China from BBC []
  6. On September 26, 2012, Bill Bishop noted the irony in Youku’s rise to the top.  It has now largely purged itself of “copyright infringement” material yet arguably would never have caught on and been popular in the first place if it had not stored and streamed this materials in the first place.  See also, Romney Dumped Shares In Chinese Video Giant That Was Piracy Haven from BuzzFeed Politics []
  7. The new company Youku Tudou now has agreements with every major Hollywood studio including, Warner Brothers, DreamWorks, Paramount, Disney, NBC Universal, Lionsgate and Twentieth Century Fox.  See Youku Tudou signs 5-year deal with Sony Pictures, completes its collection of Hollywood studio licenses from Engadget []
  8. Action rolls as online portals sign on with US movie giants from China Daily []
  9. DVD pirates running rampant in China from Los Angeles Times []
  10. In China, ‘Mad Men’ reflects reality of modern life from Los Angeles Times []
  11. Youku’s Now The King Of China Web Video: Can It Make Money? from Forbes []
  12. Why China Loves ‘Gossip Girl’ from Forbes []
  13. With ‘Gossip Girl’ a Hit in China, Could a Chinese Remake Be Far Behind? from Ad Age []
  14. China getting its own ‘Gossip Girl’ from Los Angeles Times []
  15. In China, ‘Mad Men’ reflects reality of modern life from Los Angeles Times []
  16. ‘Kung Fu Panda’ Hits A Sore Spot in China from Washington Post []
  17. One of the reasons why there is a disconnect despite having a large domestic film production industry yet a relative lack of popularity has to do with creative control.  See In Hollywood Movies for China, Bureaucrats Want a Say from The New York Times []
  18. Netizens post evidence of scene stealing from Global Times []
  19. Spotlight on China from Ernst & Young []
  20. MPAA says Chinese box office receipts reached new record: $2.75B in 2012 from ArsTechnica []
  21. Overseas blockbusters drive China’s box office surges in first half from Xinhua []
  22. China film industry suffers Hollywood headwind from China Daily []
  23. This is not to say domestic films are neither creative nor popular.  For example, Lost in Thailand is a low budget comedy that has gone on to break the domestic box office for Chinese-made films and is also popular with audiences.  Yet its domestic success did not translate into overseas success as it only generated $57,000 in the US and $72,000 in Hong Kong.  See Low-Budget Comedy Finds Record-Setting Success from Caixin and China’s Hollywood dream gets lost in translation from CNN []
  24. Nation’s movie ticket sales hit $2.69b last year from China Daily []
  25. Ibid []
  26. This number, while seemingly low probably does not fully take into account undocumented workers and “permanent” tourists (e.g., those that do visa runs each month across the border).  For example, at least 20,000 Africans legally live in Guangzhou alone (up to 150,000 Africans are estimated to live there including tourists and those illegally overstayed their visa).  For comparison, between 580,000 and 820,000 Chinese migrants live in Africa.  See 593,832 foreigners live on Chinese mainland: census data from Xinhua, The Promised Land by Evan Osnos and China cracks down on African immigrants and traders from The Guardian and Eastern Promise in Little Africa from The Global Mail []
  27. There are endless streams of stories about how foreigners (laowai) are paid to attend various functions, meetings and forums and not actually say or do anything.  For instance, during the time I lived in it, the city of Bengbu, Anhui had at any given time 10 Westerners living in a city of 3 million.  Yet throughout my stay I was offered any number of voice acting and ‘modeling’ jobs not because I had any particular talent, but rather because I was laowai.  See Chinese companies ‘rent’ white foreigners from CNN []
  28. Dazzled By China’s $2 Billion Movie Box Office? Try Getting Paid from Forbes []
  29. Another challenge for foreign film studios is that China Film Group can delay the theatric release and sometimes even pare releases together (e.g., head-to-head against other foreign ‘blockbuster’ films).  See ‘Skyfall’ China Release Date Pushed to 2013 from The Hollywood Reporter []
  30. Direct censorship, chilling effects and self-censorship also play a role.  For example, there are daily quotas for domestic TV primetime slots which have led to large, continuous productions of certain genres such as World War II re-enactments.  Or as Zhou Weicheng, general manager of Greentown Media recently explained, “There’s a limit on costume stories and spy dramas are not allowed to be aired during prime time slots.  What can we shoot other than the anti-Japanese war?”  See Hollywood and China: Revenue and Responsibility by Evan Osnos, Director takes Chinese censorship, business battles public from Los Angeles Times, What Lee’s `Life of Pi’ Oscar Says of Chinese Film from Bloomberg, State Meddling Stifles China’s Film Industry from The New York Times, China TV extra dies eight times a day as Japanese soldier from South China Morning Post and The east is read? from Global Times []
  31. 4399, the Third Most-searched Query on Baidu in 2012 from Tech Node []
  32. This number fluctuates throughout the year; it was at 12 million approximately a year ago after a new expansion was released (Mists of Panderia) but has dipped down to 9.6 million. See World of Warcraft cities hacked from BBC and World of Warcraft down to 9.6 million subscribers from Joystiq []
  33. The9 (第九城市) was the original partner in China, however in 2009 Blizzard switched and began working with NetEase. []
  34. There are other popular foreign games such as Counter Strike and DOTA, but the foreign publishers do not purportedly generate much revenue from them. []
  35. China’s online game revenue tops the world from China Daily []
  36. See China’s Online Game Industry Sales Reached CNY60.28 Billion In 2012 from China Tech News and China’s online game sales up 16.9% in H1 from China Economic Net []
  37. Internet gaming: ‘A winning gamble’ from China Daily []
  38. See Why Are Consoles Banned In China? from Kotaku, Ban on games consoles may be lifted, suggests Culture Ministry source from China Daily, China’s Ministry of Culture: We’re NOT Considering Lifting the Game Console Ban from Tech In Asia, China’s complicated history with video games: when a ban isn’t really a ban from Engadget and If the Xbox Came to China, Would the Chinese Notice? from BusinessWeek []
  39. According to Engadget, the PS3 may have been given official approval for sale on the mainland.  See Sony quietly gets PlayStation 3 certification in China, we hope for a few more Dynasty Warriors players from Engadget []
  40. One of the most popular of these card games is San Guo Sha (三国杀) based in part on the Romance of the Three Kingdoms novel.  The mechanics are similar to another Western game called Bang!  The company Yang worked for is 中山市众森信息科技有限公司 in Guangdong.  There is also a very popular web-based version at Sanguosha.com []
  41. Chinese Web Gamers at 51% Discount a Buy to Opennheimer from Bloomberg []

Chapter 15 – Human resource and infrastructure challenges

[Note: below is Chapter 15 from Great Wall of Numbers]

Consulting firms in China are abundant and usually just a stone’s throw away.  The primary reason has to do with China’s developmental status: China currently lacks expertise and experience in several fields.  As a consequence many domestic companies are willing and increasingly have the funds to hire foreign experts to guide, manage and even direct operations at companies.  To paint a clearer picture of the situation, according to Chen Yuyu, associate professor at Peking University, “[h]igh-end jobs that should have been produced by industrialization, including research, marketing and accounting etc., have been left in the West.”1 As a consequence, because they are faced with dilemma of working in low-skilled, low-waged professions, a recent survey found that “among people in their early 20s, those with a college degree were four times as likely to be unemployed as those with only an elementary school education.”2

At the same time, it is advised that rosy enthusiasm – get-rich-quick in China – be tempered with a dose of reality.  For example, the Wall Street journal ran a piece in March 2012 which details the gradual shift away from recruiting expats at all corporate levels.3 This is due in part to increasingly expensive compensation packages needed to lure experienced expats and because of a growing talent pool of educated Chinese returning from overseas dubbed “sea-turtles” (hǎiguī). This changing outlook is best summed up by hedge fund manager Mark DeWeaver who recently told me in an interview,

I don’t think immigrating to China would be a logical choice for most foreigners.  There just wouldn’t be that many job opportunities for them, particularly if they don’t speak the language.  They would also be competing with the many Chinese graduates of US colleges that return home after graduating.4

Between 2000-2009, more than 630,000 Chinese-born immigrants received US green cards.5 Over the past 30 years more than 1.2 million Chinese studied abroad, approximately 20% of who matriculated to US schools and institutions.678 During the 2012-2013 school year, more than 190,000 Chinese students studied at US schools (up from 160,000 the year before) – they also comprise a quarter of all international students in the US.910 In fact, 37% of all international graduate students in the US now are Chinese nationals.11  While there is some overlap between the two groups and some manage to stay and attain green cards, some of the remaining – well-trained and educated – return home to join the Chinese workforce.12

According to the Ministry of Education, due in part to the incentives mentioned above in Chapter 9 (“1,000 Talents”) approximately 186,000 overseas Chinese returned to China in 2011, an increase of nearly 40%.1314 While some do move back to the West again, others stay.  For example, Kevin Woo is a Shanghai native who received an LL.M. from the University of Wisconsin yet works as an auditor for a large Chinese real-estate firm.  He returned to Shanghai in part due to the soft labor market in the US.  Anthony Wang received his bachelor’s and master’s from the University of Waikato and now works at his family-owned factory in Anhui.  Tony Wu received his bachelor’s from the University of Stirling and now works for AMER International Group, a large Chinese resource company in Shanghai.

So before packing your bags and flying out to China to open an office, you and your company need to answer the following questions: are you really a foreign expert?  Make a list of things you can do comparatively better than your Chinese counterpart.  What is your marginal productive value and what is the typical salary an expat with your skill set makes in China?  What are the advantages and disadvantages of opening an office overseas headed by a foreigner?

If you hesitated to answer at least one of these questions, remember that you and your company can always hire Western educated local Chinese who understand not only the complex culture of China but also can usually communicate effectively in English and understand many aspects of the West as well.

With that said, there are still a large number of multinationals that have moved in and set up shop on the mainland, recruiting both locals and expats alike.  Some notable examples in Shanghai are Indianapolis-based Eli Lilly which manages about 2,000 in the Pudong and Xintiandi districts; Sunnyvalle-based Intel which operates a 2,000 person division in Minhang, Shanghai, and another smaller office in Beijing of less than 1,000 workers (less than 5% are foreigners) both divisions focus on software development of chipset drivers; English First (EF), a Lucerne-based Swedish company which is the world’s biggest EFL training company and employs more than 2,100 full-time employees in the Shanghai metro alone, approximately 15% of which are expats.  In contrast, BP’s Pudong office has 200 employees, 10 of whom are foreigners; AIA’s Shanghai office only has about 150 non-sales employees; and Geneva-based Mercuria – a $75 billion resource multinational company (MNC) – operates a small corporate office of about 25 people also in Pudong.15

Some other auxiliary issues to consider before opening an office in China: according to the 2012 Expat Explorer survey, half of the expats recruited expect not only to earn more money upon relocation to China but also perks.16 For perspective consider that according to one October 2012 estimate that the per capita income of Tier 1 cities such as Guangzhou ($9200), Beijing ($8980) and Shanghai ($8325) are significantly higher than the average urban annual salary ($3,430).1718 For comparison according to the Social Security Administration the national average wage in the US in 2011 was $42,979.19 Yet Mercer’s 2012 ranking report on the most expensive cities notes that the cost of living for expats in China is disproportionally higher in these same cities: (being closer to 1st means more expensive) Shanghai is 16th, Beijing is 17th and  Guangzhou is 31st.2021 Similarly, an ECA International cost-of-living survey published in December 2012 found that Beijing is the 22nd and Shanghai is the 26th most expensive cities globally for expats.22 Why?  Because according to Lee Quane of ECA, “[e]ssentially what’s happening in China is that prices are rising at a faster rate than they are in the West, and that’s caused Beijing to leapfrog all those other locations in the rankings.”23 Or in other words, make sure to get firm budgetary numbers for the costs of: expat compensation packages (transportation costs, hardship perks, recruiting bonus) and rental property expenditures.

How large are these mainland cities?  Shanghai is the largest, with 23 million permanent residents, Beijing is slightly smaller with 20 million residents and Guangzhou has 16 million.24 Furthermore in terms of internet penetration rates across the country, Shenzhen has the highest (76.8%) followed by Guangzhou (72.9%), Beijing (70.3%) and Shanghai (66.2%).25 In contrast, Hong Kong is 68.7% and Singapore is 77.2%.  In terms of foreigners, despite the fact that more than 57 million inbound tourists visited the mainland in 2011 (see Chapter 4) there are only 600,000 foreigners who are permanent residents and 220,000 foreigners legally working on the mainland.26 Shanghai itself is home to the most foreign residents (200,000), roughly a third of all foreign residents on the mainland (in contrast Hong Kong has about 400,000 foreign residents).27

What city should you set up your first office and hire local labor from?  In addition to doing your due diligence regarding business licenses, you and your company should perform a cost-benefit analysis of mainland cities.  While labor costs are significantly cheaper in Tier 2 & 3 cities, salaries in Tier 1 cities also varied.  For example, the average monthly salary for an internet censor in Beijing is $653 whereas a similar censor in Tianjin is paid $480 a month.28 Similarly while land rental rates may be cheaper inland, larger metros like Shanghai, Guangzhou and Beijing typically have modern infrastructure (e.g., subways, well-maintained highways) which in turn attracts multinational corporations (MNCs).  Shanghai, which was according to a recent Forbes report is the best city for business on the mainland, itself has roughly 60 MNCs – more than any other city on the mainland.2930 This is due in part to subsidies and duty-free policies.  For example, a MNC can now receive an 8 million RMB ($1.3 million) subsidy for 3 years plus duty-free imports at facilities by setting up an office in Shanghai.31

Attracting, retaining and discovering talent and connections

Another seemingly mundane recruitment issue facing foreign and domestic companies alike is the labor hiring cycle.  Simply put, some recruiting months are not the same as others.  While most firms in large cities use the Gregorian calendar year for GAAP accounting, nearly every domestic firm celebrates holidays based on the traditional lunar calendar.  The biggest holiday of the year is Spring Festival or Chinese New Year, typically at the end of January to beginning of February.  Like their Japanese counterparts, it is customary for domestic companies to award significant bonuses – 20-50% of a month’s salary and even higher – to each employee just before Spring Festival.32 As a consequence, it becomes increasingly difficult to hire qualified workers after Mid-Autumn festival (also called Moon festival which is usually held in September) because employees not only would lose their potential bonus at the first, current company but would only be eligible to receive a reduced bonus at the new company.  This is just one more cultural issue US firms should be aware of before starting up a domestic office.

How hard is it to hire expats?  I posed this question to nearly every person I interviewed and the answer was unsurprisingly the same as it would be in other countries: compensation packages are usually the top priority.  And specifically, full medical insurance with coverage and reimbursements to private hospitals (see Chapter 19).  One of the reasons why this was important is that in the eyes of these managers, directors and CEOs, expats typically feel more comfortable in a foreign country if they knew they could have access to doctors and medical providers that spoke their native language.  As a consequence, firms looking to attract overseas talent may need to factor in the costs of medical reimbursements which can run up to 20,000 RMB ($3200) a night at some of the foreign owned and operated medical facilities.

Natalia Shuman, the new COO of Kelly Services’ in China mentioned in a recent interview that the top challenge in China for 2013 is,

I think retention and hiring talent are still going to be challenging.  More multinational companies are expanding their Chinese operations.  And the war for talent continues.  From the staffing and recruitment industry prospective, the operating environment here in China is tough: the competition is strong, limited collaboration between players, not enough regulations from the staffing associations, quality issues, cost pressures and price wars.33

In terms of retaining employees, in November 2012 I spoke with one foreign executive at a technology company in Shanghai who has employed a unique strategy in an attempt to kill two birds with one stone: retaining skilled employees and maintaining information integrity.  After losing several key staff to competitors, instead liquidating his assets he decided to go a different path, a “hollowed castle” route based on a strategy from Zhuge Liang in Romance of the Three Kingdoms (三国演义).

In a nutshell, there was a volatile period two thousand years ago when what we now know as China was divided into three warring states (三国时代).  One of the states (Shu) had its capital in Chengdu, in the contemporary western province of Sichuan.  This kingdom was ruled by a calculating leader named Liu Bei who had under his command an able minister and war general, Zhuge Liang.  At one point in this time period Liang had ordered all of his troops to leave the city and engage the enemy (Wei) capital of Chang’an (now Xi’an) to the north.  Yet his enemy took a different route avoiding a clash with the Shu, moving rapidly towards Chengdu whereupon they began preparations to lay siege to the Shu castle.  Liang, with little recourse attempted an unusual tactic: he opened the castle doors, disguised the remaining soldiers as civilians and played music from the top gates.  The leader of the opposing forces, Sima Yi, knew that Liang was a shrewd and calculating opponent and thus came to the conclusion that this ploy must be a trap.  So Yi withdrew his forces.  This type of reverse psychology is termed the Empty Fort Strategy (空城计).  Similarly this executive has since brought his subsequent teams into the fold, explicitly imparting the knowledge that they alone hold the key to their own long-term success – and that they could walk away at any time.  His staff turnover was subsequently lower largely due to what he considers from this frankness towards future revenue generation and employee trust.

In terms of specific retention examples in the service industry, when I spoke with both Scott Freeman and Richard Qi (see Chapter 13) they both noted that based on their experiences in the domestic IT industry there is a usually a dividing line of 1985.  That is to say, that the turnover rate is substantially higher for those born post-1985 (50-60%) than those born before it (20%).  Or in other words, the younger the employee, the riskier they may be – yet simultaneously, the younger the employee the more familiar they may be with new ways of thinking differently.  And it is a conundrum that is not endemic to China.

Another way to utilize and attract talent is a method used at Motion Global (MG).  Nira Binderer is an HR manager at MG in Shanghai and noted in our May 2012 interview that MG unequivocally sees China as the long-term home for its future base of operations.34 While it is no secret that from a wage and salary perspective it may make financial sense to hire local talent (e.g.,Chinese graduates from lesser known schools earn less than $350 a month at their first job35 ), Binderer said that MG had a unique external hiring strategy: hire expats as interns.  According to her, MG will give each intern a small stipend each month, but requires the interns to pay their own way (flights, accommodation, food) to show just how dedicated and genuine they are regarding SEO (search-engine optimization) and internet marketing.  After a two-month probation, their salaries increase proportionally to the success of their SEO campaigns (judged by analytic tools measuring click through rates, bounce rates, etc).  When I visited their Shanghai headquarters in May, more than two dozen foreigners (typically recent college graduates) were working side by side with local Chinese.  I spoke with one former intern, Miles Vaughn – now in Florida, who noted that he learned more in the months he was at MG than in any classroom.  In his words, “I hit the ground running and had a chance to not only learn as I went but each week we had a chance to talk with SEO teams from other companies including Google.”

While it would be difficult to convince the average expat to pay his or her own way just to be an intern at your new China office, hiring interns in general could help tide your firm over during cyclical periods such as the post-Mid-Autumn holiday (when fewer workers are willing to leave their employers due to bonus incentives).  Interns can also be viewed as an ongoing-asset.  After all your firm has invested both time and money in them, perhaps they can eventually be promoted to a permanent position in the future.

As mentioned several times previously as well as in Chapter 13, one of the problems that Larry Chang specifically faced when setting up shop in Shanghai five years ago was a lack of local contacts.  He did not know any businessmen or government employees and the locals were unfamiliar with him because he did not go to school with any of their colleagues, teachers or family members.  Thus building his guanxi (social, business, personal connections) was a challenge that required significant attention – one that he still focuses on.  In Chang’s words, “SMEs cannot make their own guanxi over night.”  One way he has successfully gotten his foot into the door is by meeting with consultants who act as his ‘air force’ – while he trains a figurative army of software designers, he relies on consultant connections to help put him into contact with suppliers, vendors and other contacts.  After years of meetings, this has enabled his firm to grow 30% annually.  Thus entrepreneurs should be cognizant of this all-encompassing cultural trait that Matt Garner described in Chapter 1 as “relationship focused” – in contrast to the “results focused” in the West.

Telecom infrastructure

ClarkMorgan runs a very tight ship in Shanghai’s Changning district, next to Jing’an Temple.36 Founded more than a decade ago by Australian Andy Clark and Briton Morry Morgan, it is primarily known as a firm specializing in corporate training, yet I would argue it publishes one of the top quarterly magazines on HR-related issues in China.  When I visited their office in May 2012, I had a chance to see firsthand the typical workday in which expat and local employees worked side by side, sometimes even sharing the same scarce tables.  The Shanghai office is staffed by approximately 20 full time employees (half expats) and as Gary Isse explained to me in an interview, “one of the challenges we continually face is maintaining a reliable network connections both internally and externally.”

This is one of the struggles that all potential firms wanting to move to China will face: how to deal with a relatively static telecom industry within each city.  While China is home to state-of-the-art telecom gear manufacturers such as Huawei and ZTE who produce modern equipment, its domestic broadband build-out is lagging neighboring peers such as Japan and Korea in part because its internal telecom infrastructure is organized into two disparate tiers.

In October 2012 I spoke with Scott Freeman, CEO of ITBN, a private internet service provider (ISP) that provides broadband connectivity solutions in Beijing and Shanghai.37 ITBN was founded in 2000 and offers a range of connections from dedicated ISDN lines to full fiber connections.  While ITBN charges a premium for their services, they also provide something that these SOEs cannot: reliability and bi-lingual telephone support and thus have captured a significant percent of the urban market share.

While much speculation exists about the telecom infrastructure in China, Freeman described the seemingly complicated national network thusly, “there are hundreds of licensed and probably thousands of unlicensed ISPs in China. Some have national licenses (like we do); others have only provincial licenses. Many more operate without licenses. The official differentiation between ISPs like us and the big state-run ones is that we are called “second-tier” ISPs, whereas they are called “first-tier” ones.  Theoretically the first-tier telcos are supposed to control all of the physical connections in and out of the country.  Other than that it’s not so clear what else differentiates them on the ground, other than the fact that the big state-run telcos have a lot more money and the extra job of content monitoring.”

As Freeman noted, aside from a few licensed private firms such as ITBN, there are essentially only three tier 1 ISPs in the whole country (China Telecom, Unicom and Mobile) all of whom are state-owned enterprises.38 In fact, on a user basis China Telecom and China Unicom (both SOEs) are the largest ISPs in the world.39 And while there may be developmental reasons for relatively slower bandwidth speeds (compared with their neighbors), in terms of throughput, according to their Q3 2012 speed survey, ChinaCache noted that while the overall speeds are a little slower than previous speed rankings, Shanghai currently leads the country in average speeds at roughly 3.44 Mb/s and Beijing is 10th at around 2.5 Mb/s.40

While the quality of wireless telephony signals between the US and China is debatable, the Ministry of Industry and Information Technology announced in September 2012 that it plans to being issuing 4G licenses within the following year.41 Thus while Western countries are finishing rolling out 4G networks, aside from a pilot roll-out in a dozen cities such as Chengdu, Hangzhou and Wenzhou (from China Mobile), the majority of Chinese users unfortunately have another couple of years before 4G becomes an installed reality.42 And in the case of ClarkMorgan, there just are not many broadband packages that fit their needs at the prices expat managers are accustomed to (e.g., choice between a relatively inexpensive 5 mb/s DSL versus an expensive dedicated T1).

Takeaway: before opening up a Chinese branch for your company be sure to research the costs of living, property rental prices and telecom infrastructure availability in the area.  In addition, paying attention to hiring cycles, offering internships and recruiting hǎiguī may also give your company a significant advantage over your competition that fails to do so.



Endnotes:

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  1. See China’s Graduates Face Glut from The Wall Street Journal and University Graduates Have Hard Time Finding Job, Initial Survey Finds from Caixin []
  2. In other words, many college graduates are typically uninterested in low-wage, low-skilled factory work.  See Chinese Graduates Say No Thanks to Factory Jobs from The New York Times []
  3. Asia’s Endangered Species: The Expat from The Wall Street Journal []
  4. Animal Spirits with Chinese Characteristics: An Interview with Mark DeWeaver from The Libertarian Standard []
  5. Legal and Unauthorized Chinese Immigrant Population from Migration Policy Institute []
  6. According to a 2008 report from Reuters, “Of the 1.2 million Chinese people who have gone abroad to study in the past 30 years, only one fourth of them have returned, according to the Chinese government.”  In addition to Chapter 19, see China’s Brain Drain at the High End by Cong Cao, China’s Brain Drain Dilemma: Elite Emigration from The Jamestown Foundation and China fears brain drain as its overseas students stay put from The Guardian and China goes on the road to lure “sea turtles” home from Reuters []
  7. Unrealistic U.S. Immigration Policies Push Away China’s Best And Brightest by Forbes []
  8. An Export of Students: Where Are China’s Ultra-Rich Sending Their Children to Study? from Good Infographics []
  9. 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 []
  10. Spreading their wings early from China Daily []
  11. U.S. a Hot Spot for Chinese Grad Students from The Wall Street Journal []
  12. Tough US job market sends Chinese students home from China Daily []
  13. Reverse brain drain: China engineers incentives for “brain gain” from The Christian Science Monitor []
  14. Is overseas returnee working as driver a waste of talents? from People’s Daily []
  15. It should also be noted that due in part to an economic slow-down on the mainland and because of political tensions, numerous Japanese firms are purportedly considering relocating elsewhere.  According to Reuters a “quarter of Japanese manufacturers are rethinking their investment plans in China and some may shift future production elsewhere.”  For perspective, since 1990, Japanese firms have invested almost $1 trillion the mainland.  And despite these tensions, in 2012, “Chinese consumers bought nearly 3 million Japanese cars and trucks.”  See As China tensions simmer, Japan pulls back from “world’s factory” from Reuters and Five Predictions for China’s Auto Industry in the Year of the Snake from The Wall Street Journal []
  16. Expat preference for the growing Chinese economy is apparent from HSBC []
  17. Other estimates such as the National Bureau of Statistics put the per capita averages higher:  (~$13,000/capita), Beijing (~$12,500) and Guangzhou (~$13,000).  The reason for the disparity involves not just sample size but also what geographic districts are included or excluded (e.g., in the NBS case they divided total GDP by population in the region).  See Guangzhou has highest average salaries for cities in mainland China from South China Morning Post []
  18. Charting China’s Family Value from The Wall Street Journal []
  19. National Average Wage Index from Social Security Administration []
  20. Modern China: A tale of luxury villas and displaced villagers from McClatchy []
  21. Worldwide Cost of Living Survey 2012 from Mercer []
  22. Beijing, Shanghai Cost-of-Living Leaps from The Wall Street Journal []
  23. Ibid []
  24. See The Current Demographic Profiles of Shanghai (2011) from Shanghai Municipal Population and Family Planning Commission, Beijing’s temporary population fell in 2011 from China Daily and Guangzhou seeks opinions on population draft from China Daily []
  25. Shenzhen Has the Highest Weibo Penetration Rate in China from China Internet Watch []
  26. See 593,832 foreigners live on Chinese mainland: census data from Xinhua and Plan to reduce minimum stay for foreign workers from Shanghai Daily []
  27. Shanghai’s foreign population above 200,000 from Want China Times []
  28. Wages have also decreased for certain professions over time.  For example, in 2000 a computer science graduate could earn $725 a month in Shenzhen, a wage that has decreased to $550 a month due to more competition from graduates.  See China’s ‘Manhattan’ becomes censorship capital from Financial Times and Chinese Graduates Say No Thanks to Factory Jobs from The New York Times []
  29. See Shanghai tops China’s “best city for business” from Sina and Top 10 best cities for business in China 2012 from China.org.cn []
  30. Another estimate puts the number of Asia-Pacific headquarters in Shanghai at 393.  See Almost 400 MNCs have their Asia HQs in Shanghai from IANS and Shanghai tops China in attracting multinational headquarters from Xinhua []
  31. Shanghai policies woo multinational headquarters from Xinhua []
  32. This is different than shūshin koyō (employment for life).  For a dated yet clear explanation of the Japanese bonus system see Bonuses and Employment in Japan from Journal of the Japanese and International Economies, 1987 []
  33. Developing a Competitive Edge from Insight []
  34. Motion Global []
  35. China’s Graduates Face Glut from The Wall Street Journal []
  36. Clark Morgan []
  37. ITBN and ITR []
  38. While there are a few large, private, independent ISPs on the mainland such as 263.net (网络通信) and Great Wall Broadband (recently acquired in Q4 2012 by Chengdu-based Dr. Peng Telecom, 成都鹏博士电信传媒集团股份有限公司) nearly all traffic is still routed through the three SOE tier 1 backbone monopolies.  China Tietong Telecommunications (中国铁通集团有限公司) which used to be China Railcom, merged with China Mobile in May 2008.  China Netcom (CNC) merged with China Unicom in October 2008.  See Users angry at slow Internet speeds from Global Times []
  39. Just two Chinese ISPs serve 20% of the world broadband users from ArsTechnica []
  40. ChinaCache Releases Third Quarter 2012 China Internet Connection Speed Rankings from China Web Report []
  41. China 4G licenses to be issues in 2013 from ZDNet []
  42. See China Mobile Network Costs Mean First Net Drop Since ’99 from Bloomberg, China Mobile Builds First 4G Base Station In Chengdu from China Tech News and China Unicom Books 50% Net Profit Growth In 2012 from China Tech News []

Chapter 16 – Localizing and understanding your customer

[Note: below is Chapter 16 from Great Wall of Numbers]

My own experiences with Western fast-food establishments overseas can be summed up best by the rivalry and fortunes between KFC and McDonald’s in China.  It was November 2008, when I first arrived in Shanghai (and the mainland) I noticed immediately within walking into the KFC near the Holiday Inn in Pudong that the listed menu items were both visibly different and numerically more.  While Americans like to joke that there is a Starbucks at every street corner, the same can almost be said about KFC, especially with train stations in China.  No matter where you travel to, you are bound to see the Colonel.  And during these subsequent travels I noticed that KFC’s food selection varied from place to place: Guangzhou had different tastes than locations in Hefei, which tasted slightly different than those in Shanghai.  Furthermore, while the items offered were typically the same from city to city, relative to US menus there were a number of visibly different choices.  For example, KFC served corn as dessert in fruit cups, egg-yolk –filled-cupcakes operated as appetizers and traditional gravy was hard to find.1

In contrast, I rarely saw McDonald’s at every turn of the street.  In fact, when I first moved to Bengbu, Anhui in 2008, there were three KFC’s and only one McDonald’s.  Why was one more popular than the other?  One rumor was that McDonald’s simply imported the food items from the US and used it as the sole menu choice for Chinese customers unfamiliar with hamburger (remember, pork is the most consumed meat in China, not beef).23 But the real story is much more complex and interesting.

KFC and McDonald’s both opened up stores at around the same time in the 1980s.  Yet today, there are more than twice as many KFC restaurants as McDonald’s.  Harvard Business Review has discussed this case-study in depth,4 pointing out five key reasons for KFCs success:

1)       Corporate managers at KFC’s then-new China division led by Sam Su, “infused a Western brand with Chinese characteristics.”  As cliché as that may sound, managers at KFC China reworked the menu (expanding it more than 75%) so that it offered a mix of traditional foods as well as local tastes and flavors.  Because the parent company (PepsiCo) was relatively hands off, regional managers could continuously introduce, remove and tweak menu’s to better cater to local tastes.  The notable example HBR cites is that of spices: Shanghai customers thought food was too spicy and those in Sichuan felt foods were too bland.  So local managers were given flexibility to cater to the specific regional tastes.

2)       Instead of trying to compete head-to-head with McDonald’s in the largest cities, KFC managers first opened restaurants in smaller cities spread across the country.  As a consequence, because they were the first ones in the city, they were able to accomplish the three L’s of retailing: location, location, location.  So not only did they manage to win highly-trafficked real-estate but also a distributed supply chain to help “reduce costs” as they scaled.  The end result, KFC is now the largest restaurant chain in China, “with more than 250,000 employees and about 40% of the market for fast-food chains.”

3)       Starting in 1997, KFC built a distribution network from the ground up.  While relatively expensive, the investment paid off because they have supply-chain quality control all the back to the individual suppliers and animal feed companies.  As a consequence KFC “now has the most advanced and integrated cold-chain system in China, with 11 full service logistic centers and six satellite centers serving every province except Tibet.”

4)       Employee training is an on-going challenge to everyone operating a retailer with ambitious expansion plans.  KFC needs “at least 1,000 new managers and 30,000 new members a year” and so it has implemented a sort of rolling team of trainers that move from one new location to another, training each new restaurant team both job skills and people skills so they can provide “excellent customer service.”

5)       Unlike how they expanded in the US and other international regions, KFC locations in China are almost exclusively (90%) run by the corporate instead of the franchise model.  They did this because of a dearth of experienced entrepreneurial talent available and “to closely control every aspect of their operation, from menu to decor, and to monitor results and the success of new products.”

Since their first store opened in 1987, KFC now operates approximately 5,000 restaurant outlets in 700 cities and is on pace to open one new store everyday of the year – with a goal of opening 15,000 nationwide including 700 more in 2013.5 And despite a food scare regarding antibiotics in chicken suppliers mentioned in Chapter 3, they plan to continue this expansion.6 A large reason why they have been successful is as noted above in the HBR study: adapting to local tastes with foods such as fried dough, sweet potato buns and fishball soup.  Furthermore, its parent company, Yum Brands, now operates 5,400 stores on the mainland (including Pizza Hut restaurants); more than double what it had five years ago.7 As a consequence, China now represents for over half of Yum’s operating profit and sales globally.8 In fact, in 2010, KFC China for the first time had surpassed the US market in revenue.  In contrast, McDonald’s has a mere 1,464 outlets and 16% of the fast-food restaurant market share.9

How can these tribulations help you?

Before opening a physical store, ask yourself these questions:

  • Will my target market want my product as-is, or should it be tweaked and modified to fit their tastes?
  • Where should our company set-up shop first?  Does it need to be in a higher-profile Tier 1 city or can it take the distributed “long tail approach” that KFC utilized by placing proportionally more stores in smaller cities?10
  • Can you locally source your supply chain?  If it is inorganic matter, based on the discussion in Chapter 7 will you try to utilize a 3D printer?
  • Who will you recruit to fill your management, sales and customer service roles?
  • Should you franchise your operations out or manage them from a central location?

Other foreign restaurants and coffeehouses have moved into China as well.  By catering to both local and Western tastes, Starbucks now has more than 700 stores and 12,000 employees on the mainland and plans to have 1,500 stores and 30,000 employees by 2015 making it the 2nd largest market behind the US (for comparison Starbucks recently announced it plans to open 3,000 new locations in the Americas including 1,500 more in the US by 2017).111213 By introducing flavors specific to Chinese tastes such as Red Bean and Green Tea Frappuccinos (popular domestic flavors), they have managed to localize their brand.1415 As a consequence, same store sales increased 10% in 2012 from the year before and “Starbucks stores in China now average $886,000 in annual sales, up from $507,000 in 2008.”1617

Their success has seen the entry of Britain’s Costa Coffee, which opened its 100th Chinese store in 2011 and now has 186 as of July 2012.18 And across the straights in Taiwan, 85C, a coffee chain plans to open up 100 more coffee shops by 2017 (it currently operates 366 on the mainland and 347 on Taiwan).19 According to Euromonitor International, coffee shops on the mainland generated $558 million in sales in 2011 and expect sales to triple by 2016.20 In fact, coffee sales collectively rose 20% from 2010 to 2011.21 In other segments of the industry, Subway restaurants (赛百味) also plan to expand from the current 358 restaurants to 900 by 2015.22 Carl’s Jr. opened its first mainland restaurant in Shanghai in 2009 and has plans to add 100 by 2016.  And with arguably the most aggressive expansion plan, Burger King plans to open 1000 restaurants by 2019 (up from 63 currently).23 And like KFC before them, these firms are succeeding and hope to succeed by blending both local and Western tastes in a quality-controlled manner.

This localization-first strategy is similarly echoed by mainland experts such as Savio Kwan, former COO of Alibaba who recently told The Wall Street Journal that “Companies need to avoid bringing Western business ideas straight into China. It’s not always transferable.”24 Similarly, Hermann Hauser, cofounder of Amadeus Capital Partners opined that “Overseas businesses need to tailor their products specifically to the Chinese user, and in particular consider the average GDP per person and adapt product pricing.”25 And again, while there is a significant outlier of high-networth individuals at the top, the vast majority of the population earns less than $5,000 a year.  What can your firm localize and sell to this price point?

Takeaway: while it would be impractical to transplant your company or business model in place of KFC, you can use the lessons they learned in doing business in China.  Hiring teams comprised primarily of local residents has the added benefit of understanding consumer expectations and buying behavior.  In contrast, if you attempt to fill your teams with expats and foreigners, they may not fully understand the local tastes, customs or taboos.  And arguably one of the most important questions for companies wanting to sell physical goods: as described in Chapter 10, what are the regulations and laws concerning your industry?  What kind of guanxi do you need to have with local suppliers, distributors and decision makers?  Answering all of these will enable your company to accurately assess strengths, weaknesses, opportunities and threats.


Endnotes:

 

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  1. Western fast-food establishments such as McDonald’s, Pizza Hut and KFC (the latter two of which are both owned by Yum!) are generally perceived as ‘higher-class.’  That is to say that because their food is generally more expensive relative to local restaurants, families treat a visit to McDonald’s, Pizza Hut or KFC as a something “special.”  The marketing campaigns and quality control programs at these establishments further reinforces this image of ‘higher-class’ which surprises the typical Western tourist who probably does not view it the same way. []
  2. See China’s Volatile Pork Industry from the USDA and China rejects U.S. complaint against chicken tariffs from Los Angeles Times []
  3. 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 []
  4. KFC’s Radical Approach to China from Harvard Business Review, November 2011 []
  5. Yum Brands Says The Chinese Still Love KFC from The Wall Street Journal []
  6. See Yum Brands Rebounds From Chicken Antibiotic China Scare from Bloomberg, Yum stumbles badly in China, warns on profit from Reuters and ‘Kentucky Fried China’ no more? from Reuters []
  7. Yum’s Yuck Factor in China from The Wall Street Journal []
  8. ‘Kentucky Fried China’ no more? from Reuters []
  9. KFC’s Big Game of Chicken from BusinessWeek []
  10. The Long Tail: Why the Future of Business is Selling Less of More by Chris Anderson []
  11. See Why Starbucks succeeds in China and others haven’t from USA Today and Starbucks opens first India outlet in historic Mumbai ‘shrine’ from Vancouver Sun []
  12. Starbucks: we love China from Financial Times []
  13. See Starbucks back on expansion path in Americas, China from Reuters and Starbucks to More Than Double China Staff to 30,000 by 2015 from Bloomberg []
  14. Neat! Starbucks Asia – Red Bean & Green Tea and Hojicha Frappuccinos from Brand Eating []
  15. Another niche opportunity may be exporting tea to China.  For example, the descendants of Charley Grey (the Prime Minister whose eponymous namesake ‘Earl Grey’ tea comes from) have been successfully growing and exporting tea to Chinese consumers; selling 10 metric tons in 2012.  See Earl Grey descendants sell English tea to China from Reuters []
  16. Starbucks: China to Become No. 2 Market from The Wall Street Journal []
  17. See the informative two part series: Will China be Starbucks’ Cup of Tea? and Will China Be Starbucks’ Cup of Tea? Part 2 from contextChina []
  18. Whitbread sales boosted by Costa Coffee growth from Reuters []
  19. Taiwan cafe chain hits the spot on mainland from South China Morning Post []
  20. China the new battleground for coffee brands from The Malaysian Insider []
  21. Starbucks Plays to Local Chinese Tastes from The Wall Street Journal []
  22. See Subway Aims For 900 Sandwich Restaurants In China By 2015 from China Retail News and Subway eyes further China expansion from China Daily []
  23. Burger King Plans to Open 1,000 Stores in China from Bloomberg []
  24. The Do’s & Don’ts of Business in China from The Wall Street Journal []
  25. Ibid []

Chapter 17 – Architects, aviation and debt structuring

[Note: below is Chapter 17 from Great Wall of Numbers]

There are over 170 cities with a million people in China compared with nine in the US.1 By 2020 China’s urban population will reach 800 million, by 2025 there will be 221 cities with 1 million people and by 2030 there will be more than 1 billion people living in cities.234 While some of the build-outs may turn out to be unsustainable, McKinsey & Company estimates that 50,000 skyscrapers will be built in the next 20 years on the mainland, “the equivalent of 10 New Yorks.”56 In fact, one-third of all the 100 tallest buildings in the world are now on the mainland and one estimate suggests China will surpass the US in skyscrapers by 2017.7 And as China’s urbanization increases (crossing the 50% barrier in 2011, see Chapter 6), according to one argument – these people need to live somewhere.8 Thus numerous foreign architects, currently facing a soft labor market in the West have moved to the mainland, to design and construct a cornucopia of buildings including mian zi gong cheng (面子工程).

For example, it is a truism to note that nearly every country and political class around the world has erected shrines commemorating battles, people and events (e.g., monuments of grandeur, arches of prestige).  In China, “face projects” are called mian zi gong cheng.  While it could be argued that while the productive capacity of such projects range from practical to ‘hopeful’ (e.g., Three Gorges Dam versus the Great Wall itself), there are any number of modern day Pyramids continually being built in mainland China (and elsewhere).9 The reason it is arguably important to study these face projects is that they provide an insight to what Frédéric Bastiat called the “seen and unseen.”10 Or rather, what are the opportunity costs foregone in the construction of such edifices?

For example, the Pyramids in Giza offer a historical illustration of this principle in action.  These Pyramids, while stunning cultural monuments, consumed vast quantities of economic activity that produced little in return.  After a factory is built, it can be used to manufacture any number of products including consumer goods.  Pyramids on the other hand, despite their timeless grandeur, are little more than a decorated tomb, a very large mausoleum.  And while modern graves do provide positive sanitary spill-over effects (e.g., prevent the spread of diseases) it would be disingenuous to argue that the funeral industry is a productive long-term generator for any economy.11 Thus in an alternative timeline, what were other productive uses that the Pyramid materials and workers could have been used in?12

And as Frank Shostak pointed out several years ago, while measured by some modern economic metrics constructing the Pyramids would have looked like a GDP boom (e.g., increased economic activity), the actual reality is that this kind of face project consumed several orders of capital without providing any in return.1314 In short, it was a money pit with no tangible return-on-investment other than psychological feelings of “greatness.”  And you cannot eat “greatness.”15

What is the point of this history lesson?  How does this apply to modern China?  In Mark DeWeaver’s new book he discusses Fuyang airport located in Anhui:

Consider the city of Fuyang in Northeastern Anhui Province, for example.  Located in a relatively remote location in one of China’s poorer interior provinces, the city originally had only a small landing field for flights to Hefei, the provincial capital.  In the 1990s, the local government decided to “raise the city’s profile” by building an international airport.  The original airport’s 400 meter runway was expanded to 2,400 meters (long enough for commercial flights to most Asian destinations) and a 7,200 square meter terminal and other amenities were built at a total cost of 320 million yuan.

In 2004, after being open only a year, the new facility had to be closed because there was not enough traffic to keep it operating.  While it was finally reopened in 2008, as of the beginning of 2011 its website showed only three flights a day.16

When I taught in Anhui I asked several students from the Fuyang area if they had ever used the airport.  They said it was more practical to use the large train station because the airport only had flights to just a couple of cities (Beijing and Shanghai) during the day.  While there is potential growth due to the population size (Fuyang itself is either the 1st or 2nd largest county in Anhui depending on which areas are included), this represents an unproductive asset that would probably not have been built in this location or time frame if left to market forces.

Is this an isolated incident or just a rare exception?  Neither.  According to the Financial Times, in 2010, three fourths of all airports in China lost money.17 In 2011, of the 180 civil airports in operation, more than 70% lost money.18 In fact based on research from Li Xiaojin, a professor at Civil Aviation University of China, an airport in China needs to handle 1 million passengers a year in order to turn a profit.  Yet according to his estimates, 80% of airports do not hit this mark.19 And according to the Civil Aviation Administration of China (CAAC), these losses in 2011 amounted to more than $314 million.20

How does any of this have to do with opportunities for foreigners?

Over the next five years an additional 82 new airports will open in part because policy makers see these losses as short-term pain.21 Yet this is not entirely without merit as this may just be a modern chicken and egg problem as airports are only useful if there are other airports that connect to them (i.e., the network effect).  If recent trends hold, then the popularity of flying may make these projects more financially feasible.  For example, over 270 million passengers flew domestic routes in China in 2011, up 70% from 2003 – and the International Air Transport Association projects “379 million will be flying domestically by 2014.”22 Furthermore, according to Reuters, in the last decade passenger air traffic has grown 14% a year, which is twice as fast as the growth in train travel.23 Thus despite the added competition from CRH (high speed rail lines) that have been seen as the main reason why domestic carriers have operated at losses for the last 3 months in a row (through January 2013), ultimately many of these airports may turn a profit.24 As a consequence, foreign airport designers may also find opportunities in China.  For example, in building airports in western provinces like Tibet, foreign aviation consultants have been brought in to build transponder landing systems such as Automatic Dependent Surveillance-Broadcast (ADS-B).25

Engines and cleantech

Another opportunity is avionics and engines.  For example, the Aviation Industry Corporation of China (AVIC) is a large SOE with 400,000 employees which has set aside around $16 billion to build a new engine and may spend up to $49 billion on an even larger engine research effort in the next decade.26 And Commercial Aircraft Corporation of China (COMAC), another large aerospace SOE, recently announced that it has now had 380 orders for its domestically made C919 commercial jet.2728 Yet because the nascent domestic aerospace industry has been unable to build and design a reliable jet engine to power the domestically made planes, foreign engine makers are expected to sell $100 billion in engines alone to China over the next 20 years.  Domestic issues also present opportunities to foreign airplane manufacturers, who are expected to sell 5,000 airplanes worth more than $600 billion to Chinese airlines over the next 20 years, as well as to foreign pilots seeking flight time.29

Because of retirement changes in their home countries that have extended the tenure of senior pilots, many junior foreign pilots have begun flying routes in China to accrue flight time.  In fact, over the past several years, Chinese airlines have been actively recruiting pilots in the US, offering various perks and enticing several hundred so far.30 Thus, because of the growing pains on the mainland, there are numerous opportunities for foreign aerospace and aviation experts.  In fact there are only about 6,000 pilots altogether on the mainland, half of whom are students or teaching in aviation schools.31 Yet more than 10,000 pilots are estimated to be needed in order to fill the demand as the industry expands.  For comparison, in 2009 there were 594,285 active certified pilots in the US.32

Again, as noted in Chapter 4, with more than 57 million inbound tourists in 2011, there is certainly potential for air-related services to cater to the growing tourism market.  Yet how these domestic airports and airplanes are built, financed and maintained (public versus private) will have long-term consequences for the overall economy (as well as the local domiciles they are built in).

It is little wonder then that China produces and consumes more than half of all cement globally.  It is also the largest producer and consumer of steel.33 And while the domestic market is fragmented, subsidized and unsustainable at local levels, one of the areas where foreign firms can find new opportunities is developing and selling “cleantech” to cement manufacturers.34 For example, as part of the 12th Five Year plan 10% of these cement facilities are set to use “cleantech” with a goal of reducing waste and emissions.  As a consequence, Switzerland-based Holcim Group (one of the world’s largest cement producers) is beginning to sell its technology to mainland firms.  According to Ian Riley, the head of Holcim Group in China, “[i]f you think about all those things that the Chinese government wants companies to do that require good technology and good management, there are a lot of excellent opportunities indeed for companies such as ours.”35

Another example is Canadian-based Westport, a maker of heavy-duty truck engines that run on natural gas instead of diesel.  While there may be some IT security issues that all firms should be aware of (e.g., see trade secrets in Chapter 13), Westport’s Q2 2012 sales increased 206% year over year, leading its CEO to note that, “I don’t think you can do anything but conclude that it’s very, very encouraging, and China is going to be a fabulous opportunity for natural gas over the next few years.”36 And based on an estimate from China Merchants Securities, the “cleantech” market in China is expected to be worth $473 billion by 2015.37 Furthermore, state owned oil majors and policy makers hope to replicate the natural gas boom in the US onto the mainland by investing heavily into fracking technologies to diminish the use of coal (see Chapter 19 on ‘air pollution’).  Modern fracking is a method utilizing pressurized liquid to force and retrieve previously-hard-to-recover hydrocarbons (e.g. gas and oil) from rock and sand formations.  In fact, one estimate by geologists is “the nation’s recoverable reserves at about 25 trillion cubic meters, on par with the United States.”38 Thus both foreign and domestic firms specializing in the natural gas segment (e.g., extraction, storage, transportation) may find new revenue streams in an industry that is expected to pump “6.5 billion cubic meters of natural gas from underground shale formations by 2015.”

Ancillary services

In December 2012 I spoke William Song, a software engineer at TravelSky (中国航信).  TravelSky is a state-owned enterprise based in Beijing that manages a computer reservation system that handles all of the airline travel data and increasingly others such as hotel and railways (similar to Sabre and Amadeus in functionality); or in industry vernacular they develop a global distribution system (GDS).  According to him “we have a monopoly in the sense that we are the sole provider of information technology related to booking, reservations, pricing and ticket settlements on the mainland which we aggregate from airlines; we generate revenue every time an e-ticket is issued with partner airlines.   Consequently, consumers using domestic online travel agencies (OTAs) such as eLong and Ctrip (the equivalent of Priceline) and Qunar (similar to Kayak) indirectly utilize our system in booking their air travel.”  In 2011 TravelSky generated $589 million in revenue compared with Sabre and Amadeus who together generated more than $6 billion in revenue during the same period.39

The way GDS systems like TravelSky work is, “basically for each passenger that boards a flight, the airlines pay a ‘booking fee’ to our company (like a commission).  In return the airlines use our system to distribute flight information and ticket prices to travel agencies and airports that can use this information to provide services to passengers.  In other words, when you buy a ticket and use it, all of the flight logistics information systems behind it are managed by our company.  From a technical standpoint these databases are huge considering the size of the current industry in China and that it includes the data for all procedures of the whole journey.  Yet because we were originally a department of CAAC (Civil Aviation Administration of China) we still maintain close ties to the indigenously made software stacks.  Thus one of the challenges for both domestic and foreign companies that have experience making this kind of software is that in the short-run there will not be a second or third company like us, so there are not many opportunities for their expertise.  In fact, all of the SOEs which have monopolies over their respective industries such as rail, gas and telecom have other SOE companies like us to help them develop and restore the data.”  And this is where ancillary services and business models can be built for, such as fulfilling the needs of travel agency owners.

In March 2013 I spoke with David Tang the owner of a travel agency in Guangdong.  According to Tang, “one of the challenges created by TravelSky’s monopoly is that their interface is very dated – it uses a command-line style system reminiscent to DOS.  As a consequence, travel agencies around the country hire outside vendors to develop easier-to-use front end software packages that hook into TravelSky’s system.  My company has been around for more than five years and we have spent at least 100,000 RMB ($15,000) this past year to work with a vendor in Shenzhen to develop a customized interface.  Ctrip and other agencies have also built their own systems.  Thus one of the business opportunities is to provide the hundreds of travel agencies around the country with customized interfaces to work with TravelSky’s databases.  In addition, foreign GDS systems like Amadeus have begun to be used on the mainland as a way to book hotels and I predict that at some point the government will allow foreign competition to take place in the GDS field with airline bookings as well due to the fact that foreign technology is probably 10 years more advanced than the domestic GDS capabilities.”  Ctrip is publicly listed on NASDAQ and is the largest OTA in China, with 36 million hotel bookings and 30 million flight tickets handled through their system annually.40

While Tang’s last point is speculation, William Song suggested one future business opportunity may come from opening this up as well.  Song noted that, “I think that OTA aggregation services which are easy to use and can eventually utilize our data can make a small fortune.  For example, apps for smartphones which can aggregate destination times and prices no matter where you are.  Both incumbent and start-up travel agencies will be able to use AI robots (or ‘spiders,’ a program that can collect data) to recalculate information and provide services and metrics to the end customers.  For example Qunar is one such domestic start-up, whose founding team came from Kayak.  Even though the real time flight information is stored in our database, direct access to this is usually unneeded today because we continuously distribute the flight information directly to airlines and OTA’s who in the future can be scanned by the AI robots for use by other services such as smartphone apps.  Or in other words, eventually 3rd parties can use robots to crawl through our databases or our partners’ databases to collect information.  Thus there are opportunities for new competitors in this segment.”

Rails and a paddle

As I mentioned in Chapter 9, when I first arrived on the mainland four years ago, I spent time sight-seeing in Shanghai before moving to Bengbu.  And as I mentioned in Chapter 4, my initial encounter with proficient English speakers colored my view of the populace (e.g., selection bias, see Chapter 9 about EFL).  Similarly, the trip to Bengbu itself skewed my view on economic developments on the mainland because the trip was done on a new high-speed train traveling at 300 kilometers/hour.  It took approximately 3 hours, a journey that just 10 years ago would have taken half a day on older rolling stock.  At the time I wondered if other travelers on the mainland had similar access.  The short answer is yes, the longer answer however dovetails into mian zi gong cheng and opportunities therein.

Two years ago a broker friend at Morgan Stanley similarly asked me what my perception of the high-speed rail network was, “Have you ever been on one?  Are they packed and profitable?”

Like many public projects, the high-speed railway system (CRH) began with objectively good intentions: build a state-of-the art transportation network capable of connecting and bringing commerce to all corners of the mainland.  Yet as Ludwig von Mises showed, such centrally managed plans cannot efficiently achieve the stated goals.41 Similarly, the Railway Ministry is now massively indebted in part because in its push to build a 20,000 kilometer nationwide high-speed rail network, subpar materials were used in certain sections and billions have been siphoned from the budgets via corruption.

As I mentioned in Chapter 10, in their bid to build rolling stock for the CRH project a Japanese consortium of locomotive and rolling stock designers (the same ones that built the Shinkansen) were edged out of the mainland market by the very technology they had designed and transferred to CSR, a domestic SOE that now builds half of the rolling stock.42 While it might be assumed that with this “free technology lunch” that the CRH project now gained would have resulted in fewer long-term costs, the reality is that building a rail network – as in any country – requires significant capital expenses for land, labor, tracks, ties, signal boxes and electrical conduits.  Similarly, because the state effectively still owns all land (e.g., private individuals can lease land from the state for 50-70 years, after which time it reverts back to the state), it might be assumed that property costs would reduce the bottom line.  Yet again, the assumption is incorrect.

In February 2011, Liu Zhijun, the railway minister was fired amidst a probe that alleged a variety of bribery and kickback charges.43 Upon investigation, one case mentioned by the National Audit Office noted $28 million that “was misappropriated by individuals or companies involved in building the Beijing-Shanghai high-speed railway.”44 And as Evan Osnos, a reporter for The New Yorker, recently described this was not an isolated case.  For example, another account from the National Audit Office found on the accounting books of a SOE a “sixteen-million-dollar “commission” to an intermediary in return for contracts on the high-speed rail.”45

This was only the tip of the iceberg as Osnos’s research found that this public-works project eventually encompassed payouts and bribes that are still being uncovered; amounts that dwarf those listed above:

Like many others, Ding knew something that government auditors uncovered only later: China’s most famous public-works project [the Railway] was an ecosystem almost perfectly hospitable to corruption—opaque, unsupervised, and overflowing with cash, especially after the government announced a stimulus to mitigate the effects of the 2008 global financial crisis. It boosted funding for railway projects to more than a hundred billion dollars in 2010. In some cases, the bidding period was truncated from five days to thirteen hours. In others, the bids were mere theatre, because construction had already begun. Cash was known to vanish: in one instance, seventy-eight million dollars that had been set aside to compensate people whose homes had been demolished to make way for railroad tracks disappeared. Middlemen expected cuts of between one and six per cent. “If a project is four and a half billion, the middleman is taking home two hundred million,” Wang said. “And, of course, nobody says a word.”

While the investigations are still ongoing, by one account former Railway minister Liu had taken a “4% kickback on railway deals,” another estimate suggests he netted $152 million.46 Zhang Shuguang, former deputy general engineer of the Railway ministry reportedly embezzled $2.8 billion into US and Swiss banks.4748 All told the Railway Ministry is in debt by at least $330 billion and posted a loss of $1.4 billion in the first half of 2012.4950515253

How did it get to be this size?  The Rail Ministry in China was essentially an autonomous entity – with its own schools, hospitals and until recently even its own judicial system – that only had to answer to itself.54 And as a consequence and as part of a major revamp implemented by the new Xi administration, the Rail Ministry is now being split up, with the Ministry of Transport taking over the railway construction and network planning.55 The operational units of the Rail Ministry will be spun off and separated into a new state-owned enterprise managed by the State-owned Assets Supervision and Admission Commission (SASAC).

This is not to say that corruption, bribery and kickbacks do not occur in other countries, nor am I suggesting that this scandal will doom the Chinese growth story or that the high-speed railway network will never be completed.  Rather, I am citing this to be even handed, to show that just because planners come up with “big hairy audacious goals” this does not automatically translate into instant successes.5657

In fact, Mark DeWeaver’s book cites dozens of such stories including several others like the Loudi “White House” and a half dozen amusement parks built by local governments which gone bankrupt.58 Many Olympic venues alone from the 2008 Beijing Summer games have gone into disuse and several have been demolished.5960

Despite $141 billion in investments and another $134 billion approved for future expansions, none of the nearly two dozen subway metro systems on the mainland is profitable.61 This is not to say that these subway systems do not generate substantial revenue.  Rather they do not generate enough revenue to cover their expenses (i.e., they are operating at a loss).  And because some projects may not provide enough return on investment to maintain the capital stock some party or multiple parties are subsidizing these activities.  For example, only one of Shanghai’s lines is profitable.  Beijing’s metro will post a loss of about $150 million in 2012.  And Shenzhen’s metro charges an average of 2.8 yuan per trip yet the actual costs are 5.9 yuan per trip.62 According to The Atlantic one of the reasons it is costly is that “[a]t 500 million yuan per kilometer, or about $80 million, their pricetags are not that much cheaper than they are in Seoul, where wages are much higher.”63

Similarly last year the Los Angeles Times detailed a number of other face projects built by local governments, that while creative and innovative – such as a $44 million hotel designed to look like a ping pong paddle – ultimately produce little in terms of sustainable economic activity.64 The one silver-lining for foreigners is that the demand for Western educated architects can be high in certain provinces, especially for those willing to work on mian zi gong cheng.6566 In fact, according to industrial designer Michael Young, “China will produce as many world-class designers as Japan within 20 years.”67 Notable examples include Wang Shu, who won the 2012 Pritzker Prize, the world’s top prize in architecture.  Thus foreign architects may find new opportunities in training and working with domestic firms on a variety of projects over the coming decades.

Structuring debt

In an era of a closed capital account and relatively cheap public capital (as discussed in Chapter 5 and Chapter 10), both of which incentivize capital consumption and fixed asset investment, these types of cases will probably continue into the foreseeable future.68 All told these projects and other local government financing vehicles (LGFVs) that received stimulus funds since 2009 account for approximately $5.4 trillion in loans.697071 Despite the ban on municipal bonds (see Chapter 10), these LGFVs issue bonds called chengtou which are traded in secondary markets.  Andin 2012, 942 billion RMB ($150 billion) of chengtou bonds were issued by these LGFVs.72 Thus experts in debt restructuring may be able to do consulting for local banks when publicly traded bond markets become a reality.  And one advantage of having a publicly accessible bond market is as Shawn Mesaros mentioned to me, “domestic banks could then become facilitators.  They could offload debt and focus on value added services, creating new investment vehicles which allow for diversification.”  Another advantage is that a bond market would allow for liquidating non-performing loans and spread and distribute risk away from “too big to fail” financial institutions.

And as mentioned in Chapter 5, foreign experts in debt structuring may find new opportunities on the mainland due to this ongoing business cycle.  For instance, foreign firms specializing in managing distressed loans such as those used to finance the construction of tech parks, have already capitalized on opportunities on the mainland (with mixed results), including Shoreline Capital Management who raised $300 million for a new fund last year specifically to invest in distressed Chinese debt.73

Another opportunity, although probably out of the reach of most SMEs and entrepreneurs is what Siemens has provided to several mainland subway systems: propulsion systems.  Under several different agreements, Siemens has sold equipment packages that include gearboxes, auxiliary converter units, traction motors, traction converters and train control systems.74 In fact, as of 2010 Siemens maintained 90 operating companies and 61 regional offices in China alone across all of its divisions (including healthcare and energy).75 It has 30,000 employees on the mainland, generated $8.4 billion in revenue from China in 2012 and “nearly 90% of its raw materials and semi-manufactured goods are purchased from the Chinese local market.”76 This is part of an effort to develop and install their mobility technology which is used and deployed in nearly a dozen mainland metros and railways.  Thus irrespective of the long-term financial sustainability of metro expansion plans, there may still be opportunities in the short-term for foreign component manufacturers in this sector.

Yet a word of warning.  During California’s requests for bids in 2011 for a proposed high-speed rail project (HSR), Chinese firms offered to help build it.  However the technology that Chinese firms were planning to build the HSR infrastructure (cars, signals, gearboxes) are all based on technology transfers from Siemens, Kawasaki and Bombardier.77 Thus the foreign firms found themselves competing with their very own technology as China now tries to build HSRs in other countries.  This turn of events resulted in a series of press releases and some protests, yet subsequently both Siemens and Bombardier continue to transfer technology and sell equipment to Chinese firms.78 Be sure to speak with an attorney (see Chapter 10) before transferring any technology.79

Takeaway:  There are some opportunities for foreign firms and individuals that want to participate in the airline and aerospace industry as well as a number of opportunities for foreign architects.  However, while it is impossible to predict what the exact opportunities forgone in the construction of these face projects are, we do know that ceteris parebus, that there are other productive choices that market forces would have gravitated towards instead (e.g., allowing capital to accumulate instead of being consumed).  And as a consequence, the countless face projects dotting the mainland arguably act little more than a weight, a drag on overall growth.  What other productive uses could both the skilled and unskilled laborers that built these uneconomic airports, railways, amusement parks and stadiums been used in instead?  The answer to that is left to the imagination of the reader.


Endnotes:

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  1. While city limits and boundaries are arbitrary and different in every country, according to their 2010 estimate the 9 cities are: New York, Los Angeles, Chicago, Houston, Philadelphia, Phoenix, San Antonio, San Diego and Dallas.  See Annual Estimates of the Resident Population for Incorporated Places from the US Census Bureau []
  2. China’s urban population to hit 800 million by 2020 from People’s Daily []
  3. China’s Megacities from Bloomberg []
  4. One of the upcoming challenges that policy makers face with this urbanization is reforming the Hukou, or household registration system.  See Eight Questions: Tom Miller, ‘China’s Urban Billion’ from The Wall Street Journal []
  5. This is not to say that these properties will lay dormant, especially as the middle class grows and rural migrants continue to move to Tier 1 cities.  See Who Says China is Building Too Much? from The Wall Street Journal Building the American Dream in China from The New York Times []
  6. Some of these property developments lay vacant.  For example, the Kangbashi New Area in Ordos, Inner Mongolia, is a master planned city designed for over 300,000 people yet is home to only a fraction of that.  Thus becoming a modern example of a Potemkin village.  Another purportedly similar Potemkin-esque village is the One City, Nine Towns residential project that had a goal of attracting 500,000 affluent residents.  One such town was Thames Town (泰晤士小鎮) which is a replica city modeled after classic English buildings along the Thames river that has failed to attract residents and is relatively deserted.  Another example is Xinagluowan Business District in Tianjin.  Again, this is not to say that this will lead to any kind of macro-level collapse, but rather serves as illustrations to temper bullish expectations and intentions.   See China’s ubiquitous ghost cities from Financial Times, Ordos: The biggest ghost town in China from BBC, Chinese City Has Many Buildings, but Few People from The New York Times, Where is Everyone from Daily Mail, Ordos, China: A Modern Ghost Town from TIME, Ordos Bust Creates Mecca for Used Luxury Car Buyers from The Economic Observer, China’s Ghost Towns Won’t Have a Hard Landing from Bloomberg and One city; nine towns; no people from Global Times, Inside the McMaoMansion: How China copies the west from Shanghaiist, One City, Nine Ghost Towns from Pop-Up City, 天津滨海新区响螺湾众多房企项目烂尾、封盘 from Caijin and China’s ghost towns and phantom malls from BBC []
  7. See China builds one skyscraper every five days from Want China Times and China Skyline Getting Bigger, More Skyscrapers Than USA from Forbes []
  8. Many of the migrant workers and less affluent (such as students) are part of a demographic group called yizu or ant tribe (蚁族).  These consumers typically live in residential apartments that have been reapportioned to accommodate many multiples of what the buildings were typically designed for (e.g., 10 people inside 3 rooms).  The wear and tear and lack of maintenance may consume more capital than is generated to repay the loan used to finance its original construction (e.g., non-performing loan).  See China’s Graduates: An Ant’s Life from The Wall Street Journal, Ant tribes and mortgage slaves from The Economist and What Worker Shortage? The Real Story of China’s Migrants from The Wall Street Journal []
  9. One alternative scenario regarding the Dam is that a number of smaller ones could have been built upstream instead.  Other issues involve the displacement of villagers and the actual financial cost which by one estimate is twice the official number.  See China Admits Problems With Three Gorges Dam from The New York Times []
  10. Selected Essays on Political Economy by Frédéric Bastiat []
  11. The funeral industry may have been bustling with a glut of customers during the Black Death, but ultimately provided little in the way of long-term capital accumulation or production.  Or in other words, if dying was an engine of growth then the world wars, the mass democides and genocides of the 20th century should have created an economic boom (e.g., “bomb our way to prosperity”). []
  12. Khufu’s Great Pyramid alone consists of roughly 2.3 million limestone blocks that were quarried 500 miles up the Nile at Aswan.  Thus if this project itself had not been undertaken – ignoring the resources consumed by the construction and final assembly crews – the thousands of quarry workers alone that had to be fed and sheltered could have worked on other productive projects such as building towns and villages, constructing buildings for blacksmiths and millers, or even just farming additional crops.  While it is impossible to say what additional crops and farm labor would have added to the overall economy, we do know ceteris paribus that by removing healthy productive workers from economic-surplus generating activities, other knock-on activities that could only take place with a surplus of crops (like research and development which require some laborers to forgo toiling in the fields) will likely be delayed, stunting technological change, innovation and growth.  This is in addition to the 8,000 tons of granite and 500,000 tons of mortar plus the agriculture and lodging that was required to feed and shelter the tens of thousands of workers at both the quarry and construction sites.  The alternative opportunities foregone by diverting and redirecting scarce labor and resources towards these unproductive assets is left to the imagination of the reader.  See Explore Ancient Egypt from PBS and The Great Pyramid by John Romer []
  13. What is up with the GDP? by Frank Shostak []
  14. While dual and even triple track accounting and statistical book keeping probably does occur in other countries, it is important to distinguish and recognize that economic activity is not the same thing as long-term economic productivity or growth.  Otherwise ‘white elephant’ projects would be a boon and not a bust.  See Local Exaggeration in GDP: 5.8Trl Higher than Central Data from Caijing []
  15. This is in reference to the French phrase, “Qu’ils mangent de la brioche” (Let them eat cake) which was purportedly said by Queen Marie Antoinette upon hearing hoi polloi faced a shortage of bread.  While she probably never said that exact phrase, the historical context is germane as the 18th century French Royal family was able to continually live an opulent lifestyle at the Palace of Versailles due to wealth confiscation of the peasantry.  During the purported time frame, because of a famine there was no bread to eat, which was a major staple.  Thus telling the peasantry to eat desserts and cake showed how disconnected she was with the plight of the populace.  Similarly, despite the vast quantities of agriculture needed to support the Pyramid workforces, the lavish lifestyle of the Pharaohs – the sheer opulence of their mausoleums (originally covered in gold and marble which were later looted) – is another display of Royal despotism that is wholly disconnected with reality.  This is also a tangential twist to eating “confidence.”  During the height of the 2008 financial crisis one of the ideas for kick-starting consumer consumption was by “instilling confidence into consumers.”  Yet no matter how much ‘jawboning’ takes place, you cannot eat confidence. []
  16. Animal Spirits with Chinese Characteristics by Mark DeWeaver []
  17. China’s airport overkill from Financial Times []
  18. More than 70% of Chinese airports lost money in 2011 from Want China Times []
  19. China Airport Boom: Will There Be a Bust? from TIME []
  20. 82 new airports to be built from GlobalTimes []
  21. See China Plan Seeks to Bolster Airports, Locally-Produced Airplanes from Bloomberg and 我国5年投资4200亿建设支线机场 或大面积亏损 from Sina []
  22. Air rage: Chinese screaming mad over delays and Reuters []
  23. China Tea Leaf Index: Look to the skies from Retuers []
  24. Airlines fly into headwinds from high-speed trains from South China Morning Post []
  25. See Performance-Based Navigation Implementation Roadmap from Civil Aviation Administration of China and Surveillance accuracy analysis of ADS-B supporting the separation service in western China from IEEE []
  26. See China nears approval of $16 billion domestic jet-engine plan from Reuters and Unable to copy it, China tries building own jet engine from Reuters []
  27. China sells jets, dabbles in Eastern Air revival from Reuters []
  28. Chinese aerospace firms have made progress in other areas including military jetcraft such as the new Y-20 strategic transport aircraft that recently made its maiden flight in January 2013.  See The Y-20: China Aviation Milestone Means New Power Projection from The Wall Street Journal []
  29. Boeing Raises China 20-Year Plane Demand Forecast 5.2% from BusinessWeek []
  30. See Chinese airlines seek elite foreign pilots from China Daily and Skies too friendly for foreign pilots, key document says from China Daily Asia Pacific []
  31. Sky’s the limit for booming general aviation sector from China Daily []
  32. US Civil Airmen Statistics from the Federal Aviation Administration []
  33. China says top 10 steel mills to control 60 percent of capacity by 2015 from Reuters []
  34. The domestic steel industry – despite subsidies – has collectively been operating at loses due to slow demand and as a consequence many participants have been unable to pay back loans.  See Loans to Steel Traders in China Pose Risk from The Wall Street Journal, China’s steel industry in trouble: association from Xinhua, Steel demand to slow over next two years from Financial Times, Central Gov’t Reshuffles a Bad Deck at Steel Services Firm from Caixin, China faces steel-production paradox from MarketWatch, Baosteel’s sell down could signal start of rethink by state-owned enterprises from South China Morning Post, China’s steel makers set for two more years of poor profits from South China Morning Post, Steel producers prepare for difficult months ahead as property sector slows from China Daily and Deal Journal China stimulus won’t work this time, says Citigroup analyst from The Wall Street Journal []
  35. Cementing a strong business in China from China Daily []
  36. Behind China’s Green Wall: Special Report from The Tyee []
  37. See 2015年环保产业总值或超3万亿元 成市场新动力 from Sohu and Environmental protection industry to reach 3 trillion RMB by 2015 from China Green News []
  38. Despite the aggressive timeline for hydrocarbon extraction, another hurdle is a lack of experience.  None of the 16 firms awarded drilling rights at a recent auction has ever drilled a hole.  See China’s ragtag shale army a long way from revolution from Reuters, Environmental Frets as Frackers Move In from Caixin and China’s “Ultimate Goal Is a Huge Fracking Industry” from Mother Jones []
  39. TravelSky Announces 2011 Annual Results from Strategic Financial Releations []
  40. Ctrip []
  41. Without an organic price mechanism that arises via market participants (e.g., interaction between entrepreneurs, investors and consumers) central planners – lacking this mechanism – must arbitrarily pick coefficients for their models and equations.  In other words, they cannot rationally calculate away from net losses and towards profitable (and efficient) solutions.  Thus a priori their plans lead to inefficiencies and disarray.  See Economic Calculation In The Socialist Commonwealth by Ludwig von Mises []
  42. Japan Inc shoots itself in foot on bullet train from Financial Times []
  43. China’s Railway Minister Removed from Position from Caixin []
  44. Former rail minister expelled from Party from China Daily []
  45. Boss Rail by Evan Osnos []
  46. China’s New Wealth Spurs a Market for Mistresses from The New York Times []
  47. Chinese rail crash scandal: ‘official steals $2.8 billion’ from The Telegraph []
  48. These were not isolated incidents as Luo Jinbao, former chairman of China Railways Container Transport also received a variety of bribes.  See State firms paid half the bribes rail executive Luo Jinbao received from South China Morning Post []
  49. See China’s Ministry of Railways debt: Three ways out of the mess from Institute for New Economic Thinking and Local Gov’ts Angle for Slice of Rail Projects from Caixin []
  50. China’s Railway Ministry Posts $1.4 Billion Loss from The Wall Street Journal []
  51. According to a November 2012 report from the Global Times, the NDRC recently approved an additional $7.87 billion of new railway projects.  This is on top of the $110 billion for 25 other rail projects.  The Railway Ministry spent 506.9 billion yuan ($81 billion) in the first 11 months of 2012.   And according to another November 2012 news story, the Railway Ministry is planning to spend 612 billion yuan ($82.6 billion) on capital expenditures related to the railway system this coming year.  However in January 2013 it was announced that $104 billion would in fact be spent on railroad construction.  See China approves $7.87 billion in railway projects to jumpstart economy from Global Times, Ministry Spends More than 500 Bln Yuan on Railway Fixed-asset Investment from Caixin, 铁路基建投资又迎新高潮 明年将超5160亿 from Jin Ji Can Kao Wang, Railway Investment to Increase Next Year, Ministry Says from Caixin and Funding set for renewed railway boom on horizon 2013 from Global Times []
  52. According to an estimate from a Citigroup analyst, the Railway Ministry will buy 300 to 400 train sets within the next two months financed by $6.2 billion in ‘tenders.’  See China May Make First High-Speed Train Orders Since Crash from Bloomberg []
  53. In November 2012 another $12 billion has been approved for railway projects.  And in December 2012 it was announced that 500 billion yuan ($69.9 billion) “will go into infrastructure investment next year [2013].”  See NDRC approves 75b yuan rail projects from China Daily and Ministry Spends More than 500 Bln Yuan on Railway Fixed-asset Investment from Caixin []
  54. See Railway ministry loses powers from Global Times, China Takes a Slow Train to Railway Reform from Caixin and 全国铁路法院全部改制移交地方 from the Supreme People’s Court of the People’s Republic of China []
  55. See China to dismantle bloated rail ministry from Reuters and China’s Leaders Plan Government Revamp as Xi Set to Take Reins from Bloomberg []
  56. ‘Big Hairy Audacious Goals’ is a term that comes from a popular business management book called “Built to Last” by James Collins and Jerry Porras. []
  57. Inside China’s High-Speed Rail Triumph from The Daily Beast []
  58. China Cities Value Land at Winnetka Prices With Bonds Seen Toxic from Bloomberg []
  59. As a matter of fact, hosting the Olympics typically leads to an unsustainable boom of unnecessary construction nearly every place they are held – in fact few Olympiads have ever turned a profit.  For example, the multi-million Wukesong baseball stadium was demolished and turned into a shopping mall.  See Beijing’s Olympic building boom becomes a bust from Los Angeles Times []
  60. Another argument has been made that Olympiads act as unsustainable booms, creating unproductive assets that in the long run creates economic dead weight.  For example, the 2004 Athens Olympics is considered in retrospect as having spurred part of the debt problem that contemporary Greeks currently face.  See Did the 2004 Athens Olympics contribute to the Greece financial meltdown? from Examiner and The Stadium Gambit and Local Economic Development by Dennis Coates and Brad R. Humphreys []
  61. For Subway Projects, a Costly Ticket to Ride from Caixin []
  62. This is not a phenomenon found only on the mainland as very few subways are profitable in other countries.  The Hong Kong MTR and Japanese counterparts are a few notable exceptions.  See Why Subways Suffer Losses from The Economic Observer and Japanese Private Railway Companies and Their Business Diversification from Japan Railway & Transport Review []
  63. Why China’s Subway Boom Went Bust from The Atlantic []
  64. Amid poverty, Chinese officials splurge on lavish vanity projects from Los Angeles Times []
  65. See Building the American Dream in China from The New York Times and Copycat Architects in China Take Aim at the Stars from Spiegel []
  66. Recreating iconic landmaks and villas probably will not stop anytime soon thus there are continual opportunities for Western architects to literally bring the West to the East.  See Eight Questions: Bianca Bosker on China’s ‘Original Copies’ in Architecture from The Wall Street Journal []
  67. “China is a dream scenario for a designer” – Michael Young from de zeen []
  68. Another illustration of the irrational exuberance of “face projects” that dot the mainland is the 328-meter New Village Building in Huaxi.  At the top of the £300 million skyscraper is a one ton 24k gold bull.  What are the alternative opportunities foregone in consuming resources towards this project?  What are alternative industrial uses for $54.4 million of gold (at 2012 prices)?  See China’s richest village opens its own skyscraper from The Telegraph []
  69. According to Shang Fulin, chairman of the China Banking Regulatory Commission, as of September 2012 the local government debt collectively amounted to $1.48 trillion.  See High local debt levels coming under control from China Daily.  Other higher estimates can be found in China tells banks to roll over local govt loans: report from Reuters and Are Chinese Banks Hiding “The Mother of All Debt Bombs”? from The Diplomat []
  70. Other investment vehicles also include wealth management products (WMPs) such as trust companies which are a type of wealth management service that amounts to more than $1 trillion and is considered to be part of a “shadow” banking system (e.g. off-balance sheet transactions).  According to Xiao Gang, chairman of Bank of China, there are 20,000 WMPs in circulation currently.  See Examining China’s ‘Shadow Stimulus’ from The Wall Street Journal, In China, Hidden Risk of ‘Shadow Finance’ from The Wall Street Journal, Regulating shadow banking from China Daily, Uncertain foundations from Financial Times, China to tighten shadow banking rules  from Financial Times, China’s brokerages turn shadow banks from Financial Times and Don’t Worry About Wealth-Management Products, Regulator Says from The Wall Street Journal []
  71. Impending Bad Debt Headache Likely Bigger Than Expected from The Wall Street Journal []
  72. China’s booming fake muni bonds from Financial Times []
  73. Back in Fashion: China’s Bad Debt from The Wall Street Journal []
  74. Siemens to support the development of mass transit in China from Siemens []
  75. Siemens to supply signaling for new metro lines in Suzhou, Qingdao and Chongqing from Siemens []
  76. Siemens Reported Revenue Of EUR6.35 Billion In China In 2012 from China Tech News []
  77. See Train Makers Rail Against China’s High-Speed Designs from The Wall Street Journal and A Problem with California Plans to Tap Chinese Tech from The Wall Street Journal []
  78. See Siemens transfers low-floor tram technology to Chinese manufacturer from Xinhua and Bombardier to share railway technology with Chinese from The Globe and Mail []
  79. See China Technology Licensing. Sometimes It Makes Perfect Sense. by Dan Harris and China’s Awkward Quest for Bullet Train Technology from [email protected] []

Chapter 18 – Retirees, Insurance and NGOs

[Note: below is Chapter 18 from Great Wall of Numbers]

While there have been a number of reforms in the past three decades, another potential headwind that Chinese policy makers will increasingly face in the future are financial burdens and pressures from entitlement programs such as its social security and health care.  In fact, one common misunderstanding many Western analysts have is that during the introduction of market reforms state subsidized living has been phased out.

While it is true that the monolithic cradle-to-grave “iron rice bowls” (铁饭碗) structure has been somewhat liberalized, the shortfall in funding the public pension system will still hit $2.87 trillion this year.123 In fact, according to Cao Yuanzheng of the Bank of China, “[s]uppose the annual rate of GDP growth was 6 percent. China’s pension shortfall would reach 68.2 trillion yuan by 2033, accounting for 38.7 percent of the year’s GDP.”4

One of the reasons for the marked increase is, as I mentioned in Chapter 6, that the life expectancy in China has grown from 65 in 1976 to 73 in 2010.  And because of the one-child policy, ceteris parebus, the population is likely to peak within the next 20 years.56 Thus assuming the retirement age is not increased, by 2050, it is estimated that 31% of China’s population will near the age retirement age; and within 40 years China will have nearly 500 million elderly people.7 In contrast, today about 14.8% of China’s population is over the age of 60.  And according to Li Jun of the Chinese Academy of Social Sciences, “by 2050, China’s working age population (aged 15-59), will be reduced to 710 million, a staggering 230 million less than in 2010.”8 In fact, the Chinese working-age labor force itself shrank by 3.45 million in 2012, a decline that is expected to continue into the future.9

Under the current system men are eligible for public retirement benefits beginning at the age of 60 and women at state-owned enterprises can retire at 55 (women in private industry can start receiving benefits at 50).  Thus in an attempt to alleviate the stress on the system in June 2012 one proposed reform openly discussed in Beijing was to raise the retirement age beginning in 2016 – increasing the required age one year on alternating years – creating a uniform retirement age of 65 by 2045.10 Yet such proposals have also proven to be resolutely unpopular with younger generations.  For example, one poll from People’s Daily this past June found that 93.3% of the 450,000 respondents voted against raising the retirement age.1112

Pension costs and opportunities

Irrespective of the stated goals in universal health care programs, economic laws such as supply, demand and scarcity are immutable.  Hospitals, medicine, medical equipment and doctors are all scarce, finite resources.  Whereas a free market would ration these resources via prices which arise from interaction between market participants, national health care plans ultimately involve some price distortions (e.g., subsidies) that invariably create artificial shortages and/or oversupply.13 Or rather, there is no such thing as a free lunch, ultimately someone has to pay.  And any activity that is discounted financially (e.g., subsidized) will ceteris parebus be consumed more.  While a significant portion of the political class and electorate on each hemisphere are increasingly fond of universal health care “for free” – the underlying finances of these entitlement programs will become markedly burdensome in the long run.14 China is no different and there may be opportunities for NGOs and foreign businesses to plug into the holes and gaps that are not covered by state programs.

China’s 11th Five year plan (2006-2010) included a number of health care reform provisions.  One provision included extending subsidized healthcare to every Chinese citizen by 2020.15 On January 21, 2009, China’s State Council signed off on this plan which was further expanded in the new 12th Five year plan (2011-2015).  In the three years since these provisions were enacted, over 1.5 trillion yuan ($240 billion) has been spent in the medical sector.16 According to one estimate roughly 95% of the populace now has access to “basic health care.”

As noted in Chapter 6, there are a number of opportunities for both foreign and domestic health care professionals, pharmaceuticals and medical supply companies to find new opportunities in this growing industry.  For example, medical equipment companies such as QIAGEN, which makes medical diagnostic equipment (e.g., blood tests), have found a new revenue source from the 33,000 hospitals and clinics that have been financed as part of this new government plan.  In fact according to one estimate in 2010, the medical device market on the mainland alone is worth roughly $11 billion, “with a compound annual growth rate of 30.6 percent in revenue.”17

At the same time, while it is difficult to predict how long the health care sector will continue receiving subsidies from governmental bodies, because of the rapidly aging population and because the elderly typically spend significantly more on health care, even if the level of subsidies remain this aging process will place challenges on the system in the long-run.18 Challenges that have the potential to be turned into opportunities.  For example, the World Health Organization estimates that 28% of people older than 15 are smokers – that there are approximately 330-350 million smokers in China.1920 40% of the world’s smokers reside in China and roughly 60% of all adult men smoke (compared with 4.2% of women).21 Yet despite various health campaigns and public service announcements highlighting the dangers of smoking and second-hand smoking, there are a number of incentives that prevent this activity from being purged.  For instance, at $18.7 billion in 2010, China National Tobacco (a SOE) generated more profit than either HSBC or Walmart.22 For perspective, in terms of worldwide sales, China National Tobacco has a commanding 40.6% on cigarette sales globally (Philip Morris has 14.9%).23 Furthermore, the tax revenue generated by tobacco sales was more than $95 billion in 2011 and $137 billion in 2012.24 Cigarette sales in China are expected to grow 13.5% a year and reach 2 trillion RMB ($321 billion) by 2016.25 Yet arguably these direct incentives (tax revenues) probably do not offset the medical expenses and costs that government bodies will eventually pay for in medical care for smokers as they age.

Case in point, each year on the mainland there are around 1.2 million smoking-related deaths (such as chronic obstructive pulmonary disease (COPD)), a number that is expected to increase to 3 million by 2030.26 What are the financial costs?

While smoking-related deaths and illnesses may not have the same direct economic consequences as HIV/AIDS has had on south African countries like Botswana — the economic impacts are both pronounced.  HIV/AIDS struck significant portions of Botswana’s able-bodied working-aged populations, stunting the country’s economic performance.27 Likewise, while the effects of smoking are more pronounced and detrimental in later stages of life, the total health care costs borne by friends and relatives (and insurance) will create an economic headwind considering that the funeral bills, hospital visits, treatments and medicine for 3 million individuals must be borne by someone.

For perspective, the roughly 42,000 people that die in the US each year due to second-hand smoke represent $6.6 billion in lost productivity.28 And according to a recent study in the US, on top of Medicare subsidies, more than three quarters of households spent at least $10,000 in out-of-pocket expenses in the last five years of life.29 While both the level and costs of care in China are still significantly lower than those in the US, there are 202 million Chinese aged over 60 a number that will double by 2030.30 Thus the increased costs borne by one or more parties will be increasingly substantial in the decades to come.  In fact, by 2015 it is estimated that in China “a decade of costs tied to health care and losses of productivity from diseases such as diabetes and heart disease are expected to reach as high as $550 billion.”31 Or conversely, according to the World Bank by reducing deaths in China from heart disease and stroke (which smoking contributes to) by 1% a year this could, “generate economic value equal to 68 percent of China’s 2010 real gross domestic product, or $10.7 trillion.”32

Compounding this issue is the one-child policy along with the Confucian ideal of ‘filial piety’ (e.g., children care for their parents as they grow older).33 For example, one source I spoke to explained that because many parents are dependent on their children to support them when they retire, that the death of their only child can be devastating both emotionally and financially.  In fact, according to this source, in the event that an only child dies, those living in rural regions typically do not have access to any other social safety nets; that the only stipend they may receive from 3rd parties is a 50 RMB ($8) a month from the local government.  The Ministry of Health (now the National Health and Family Planning Commission) estimates that “at least 1 million families had lost their only children by 2010” and many of those parents are too old to have another.34 Ren Yuan, a professor at Fudan University, has a higher estimate of 10 million families who have suffered this loss, including 300,000 in Shanghai.35 This then presents an opportunity for both domestic and foreign NGOs, to provide assistance to these at-risk demographic segments (see below for examples).

And again, this presents opportunities to both foreign and domestic health care providers and medical device manufacturers to help provide care for COPD and emphysema as well as Alzheimer’s (as mentioned in Chapter 6, China has the largest population of Alzheimer’s sufferers).36 How else do these policies also impact foreigners?

Retiring on the mainland

Under a series of new laws and regulations passed in the last year, foreigners who have spent at least 15 years collectively (not necessarily sequentially) are allowed to retire on the mainland.37 At the same time, the new laws which went into effect October 15, 2011 also requires employers to levy similar social security taxes on foreign workers, even if those workers have no plans to retire on the mainland (similar to FICA taxes in the US which are levied irrespective of nationality).38 Yet there are additional reforms on the drawing table.  For example, under new regulations announced on December 11, 2012 foreigners “who obtain permanent residency will have the same pension, employment and property rights as Chinese citizens.”39 This also includes social insurance benefits (e.g., medical, unemployment) and simplifies investment and registration procedures for starting up a new business.

According to the Social Security Administration, about 350,000 American retirees who receive Social Security benefits do so “in countries other than the U.S.”40 While the majority of those retirees live in Europe, Canada and Mexico I have met several dozen retirees working at various institutions in China in various capacities (e.g., teachers, health care consultants, accountants).  While there is an official age cut-off limit of 70 years enforced at many of these institutions, there are still a number of part-time and NGO opportunities that are open irrespective of your age.

Because the costs of living are typically substantially less in provinces further inland (relative to their home countries), one possibility for retired Westerners – irrespective of whether or not they have worked in China previously – is to work as foreign experts at education and cultural institutions.  For example, Irvin Abercrombie of California (see below) previously worked as a process design and industrial distribution engineer at various sites across the US.  Since his retirement he has spent the past eight years working at colleges and schools across China.  And as I mentioned in Chapter 9, more than 100,000 foreigners are hired each year to work in the EFL industry alone on the mainland.41

Insurance

Following its admission into the WTO, foreign companies were allowed to set up joint ventures on the mainland.  As a consequence, dozens of foreign-funded insurance companies are doing business across the country.  The largest foreign insurance firm is AIA, who holds about 1% market share on the mainland.  The aggregate of all foreign firms is below 5% in the life insurance market and about 1% in property and casualty.42 Yet even with that relatively small amount, according to Mark Kellock an analyst at Barclays Capital, “that [1%] sliver still accounts for 8% of all its [AIA] new business.”43 For comparison, China Life is the largest Chinese insurance company, with about 33% marketshare and generated almost $60 billion in revenue in 2011.44

And because of a relatively low penetration rate of around 4% overall, the life insurance sector doubled between 2007 and 2010.45 Altogether premiums revenue reached around $220 billion in 2010.  For comparison, in 2009, the US insurance industry generated $934 billion in premiums.46 The world wide insurance market generated just over $4 trillion in 2010 with European firms accounting for 35.4% of the total market share.47 And Swiss Re projects that both life and non-life insurance premiums will grow in China about 9% a year until 2020.48

Yet this industry is not a get-rich-quick market.  According to Moody’s, of the then-47 foreign insurance companies in China, only 11 made a profit in 2010.49 In fact, in 2011 the annualized return on investment for the insurance industry declined by 3.6%.50 Similarly in 2012, the 26 joint Sino-foreign insurance ventures as a whole collected a mere 47.5 billion RMB ($7.61 billion) which is roughly 4.7% of marketshare, down from 8% in 2007.51 The lower joint-venture numbers are a result of exits and liquidations by partners leaving the market.  Unsurprisingly, according to PricewaterhouseCoopers, the top three industry challenges include regulatory uncertainties, market shakeout (along with entry by domestic banks) and “finding and keeping good personnel.”52 These are essentially the same issues that all open industries throughout China face.

What this means is that for foreign firms and individuals with experience in all forms of insurance, actuarial and re-insurance industries have the potential to find new growth opportunities due to the relatively low penetration rate (4% as noted above).

Non-profits and NGOs

On May 12, 2008, approximately 69,000 people were killed during the deadliest earthquake that has hit China in the past 30 years.  Subsequently, aid and donations (totaling $11.2 billion) from around China and the world poured into Sichuan, the epicenter of the disaster zone.53 Yet after the dust settled, several investigations discovered that various organizations and institutions had siphoned off tens of millions of dollars due to a lack of transparency and accountability.54 In fact, the Red Cross Society of China (RCSC) itself failed to collect the funds donated to drop boxes placed throughout several hundred locations around China – four years after the quake.55

One of the reasons has to do with institutional administration.  In June 2011, a businessman on the board of the RCSC was discovered to have diverted charity money to his girlfriend, Guo Meimei, who in turn spent the funds on a Maserati, business-class airline seats and handbags from Hermès (she posted pictures of it all on Sina Weibo).56 This created a scandal that resulted in a shakeup of the organization and created public backlash that has lowered trust in such organizations.  In fact, according to China Daily, “90 percent of the people surveyed said that they will not donate to RCSC any more.”57 And due to the perceived corruption within the sector and long-held cynicism subsequent donations fell that summer by 80% – impacting every charity on the mainland.58

According to official statistics there are technically 425,000 “social organizations,” however only about 1,000 organizations that are typically considered NGOs (e.g., environmental, women’s rights, anti-discrimination).59 And while there are the usual series of hurdles and challenges that all participants face, the relatively few NGOs presents an opportunity for both foreign and domestic firms and individuals.

Ecotourism and agritourism

In November 2012 I spoke with Irvin Abercrombie who is originally from California and retired as an industrial designer eight years ago.  He has since spent nearly all of the subsequent time working in various capacities in the education industry on the mainland.  In 2007 he co-founded Dragon Lake Keepers with Pat Sullivan (see Chapter 9), an environmental group located in Anhui.  According to him, “I initially started this group informally with students at a local college I was teaching at.  I was surprised by the relatively large quantities of litter that was piled on the side of roads and wanted to lead by example, so each week I would take a group of volunteers to a nearby lake called Longhu (Dragon Lake) and we would literally pick up the trash with our hands.  Word quickly spread that a foreigner was voluntarily picking up the rubbish that most people do not think twice about before they drop.  Subsequently we were interviewed by a number of media outlets including a Huainan television station (a neighboring city) to find out our motivations.  And as a consequence we quickly restructured our group into a formal organization that includes support from the IFED (now PCDN) and even have t-shirts and a theme song.”  PCDN is the Peace & Collaborative Development Network an NGO specializing in connecting professionals in areas such as conflict resolution and international development.60

What Abercrombie is describing is an environmental issue that has been moved to the forefront of policy making discussions.  While it is hard to fully quantify the impact of environmental pollution (due to a number of variables), a recent MIT study published earlier in 2012 estimated that the lost labor and increased health care from air pollution “cost the Chinese economy $112 billion in 2005.”616263 A World Bank study published in 2007 found that “the health costs of air and water pollution in China amount to about 4.3 percent of its GDP.”646566 The Asian Development Bank says “air pollution could be imposing annual economic costs equivalent to as much as 1.2 per cent of the size of the economy.”67 During January 2013, breathing the air in cities such as Beijing was likened to living in a smoking lounge or smoking the equivalent of 21 cigarettes (Guangzhou’s air was equivalent to 25 cigarettes and Shanghai was at 9).686970 As an unintended consequence, one of the business opportunities for domestic and foreign businesses is to sell air purifiers.  For example, Philips electronics recently posted sales growth of 300% over the past several months and “their two most popular models have been out of stock for most of January.”71 Yuan Da, a Chinese firm that makes air purifiers sold 3.5 million units online in January 2013 compared with 1 million in October 2012.72 In addition to selling face masks, air purifiers and even cans of bottled air, another opportunity is building “pollution domes” above recreational facilities to wall off airborne dust such as those above international schools in Beijing.73 Or to take a page from Chapter 13, air quality monitoring apps for smartphones have become quite popular, with one developer – Wang Jung – seeing 58,000 downloads of his app in one day (up from a mere 1,000 it typically gets).74

In the run up to the 2008 Beijing Olympic games, between $17 billion and $32 billion was spent creating a “greener” environment surrounding the city (e.g., closing down factories, creating parks).75 This is an ongoing process as between 2011 and 2015 various institutions and governmental departments plan to spend $56 billion to cut the level of harmful particles in the air (e.g., PM 2.5 particles).76 This past year these particles were estimated to cause the deaths of approximately 8,500 residents “in Shanghai, Guangzhou, Xi’an and Beijing [which] has led to a total economic loss of 6.8 billion yuan ($1.09 billion).”77 It is not just air either as an estimated “57% of China’s urban underground water is polluted” and roughly half of the cities are left with drinking water that fails to meet acceptable hygienic standards.78 According to the Ministry of Land and Resources, “heavy metal pollution results in the loss of 10 million metric tons of grain and the contamination of another 12 million metric tons annually, incurring 20 billion yuan [$3.2 billion] in direct economic losses each year.”79 And while there are a number of reasons why this pollution takes place including a tragedy of the commons and lack of clear property rights enforcement, organizations like Dragon Lake Keepers can provide a service that is currently in short supply.

In fact, Abercrombie’s long-term goal with the organization includes not just cleaning and educational workshops but also ecotourism and agritourism.  For example, “I helped put together a business plan that would allow English-speaking students to act as tour guides for foreign tourists who are interested in the surrounding historical sites and agricultural produce.  The city of Bozhou is nearby and it is the home to TCM [Traditional Chinese Medicine]; Zhu Yuanzhang (the ‘poor emperor’) was born in a neighboring county; there is a local vineyard that produces some of the most popular wines sold on the mainland; and there are even fresh water pearls cultivated in Dragon Lake itself.”  Yet one of the challenges that Abercrombie and others face elsewhere is receiving proper government support and certification.  According to him, “unfortunately the agritourism and ecotourism plans did not pan out in part because we did not have the clout and guanxi needed with local authorities and because we had intended to pay the students.  And once money is involved, taxes and regulations come into play.  And since we are foreigners trying to help spearhead this endeavor, it has unfortunately been tabled for the past year.”80 Thus his advice to foreigners and foreign NGOs is to make sure volunteer organizations remain completely Chinese led, treat it as a school or community project and do not involve profits or financial gains until later phases.

In terms of overcoming challenges, according to one NGO source I spoke with, “there are a few notable organizations that have obtained NGO status in China including Operation Smile, Roots n Shoots, World Wildlife Fund, Habitat for Humanity and Ciwei in Shenzhen.  There are several reasons why they have succeeded where others have not.  For instance, with the help of Jackie Chan’s celebrity status, Operation Smile was eventually granted permission to become an NGO.  Another reason is that there are issues that seem to be less sensitive – like the environment and animal protection (MarineDream, SeaTurtles911, EcoDesign Fair) – that have a little more wiggle room in terms of operating in the NGO segment on the mainland.   In addition, the role of the private sector in funding NGOs is relatively foreign.  Charity contributions and CSR (Corporate Social Responsibility) are still new ideas to companies in China so this may take some time to become accepted.  Another area is grassroots campaigns.  Over the past five years an increasing amount of Chinese students and younger people have begun looking for ways to do charity work.  BEAN and Greennovate are two examples of NGOs that have managed to reach into the Chinese community through Weibo and other social media.”  Ciwei Philanthropy Institute operates a school for 132 students whose parents are migrant workers and have been unable to receive a hukou (household registration) in Shenzhen.81 Only holders of certain hukou can have access to public institutions like schools.

And one other area for opportunities that Abercrombie discussed involves a nascent segment called agritourism in which tourists pay visits to farms and ranches – to experience a rural lifestyle.  While this is relatively non-existent on the mainland, for comparison, according to Rural Bounty, an agricultural membership organization, there are 65,000 farms and ranches that are open to the public in North America.82 A 2007 US Department of Agriculture estimated that 23,000 farms offered agritourism activities, “bringing in an average of $24,300 each in additional income.”8384 According to the same study, California which is the largest farm state in the US had, “nearly 700 farms averaging more than $50,000 in agritourism income.”  In fact, according to a survey from the University of California, “California farmers and ranchers hosted more than 2.4 million agricultural tourists in 2008.”85 And one farm in Florida charges $1,500 a night for groups to participate in culinary retreats that include, “handcrafted beds topped with bamboo sheets, a five-course organic dinner and breakfast and lessons on how to prepare meals using farm-raised, hormone-free livestock, eggs and produce.”86

Or in other words, Chinese farms and ranches such as those in Anhui are leaving a lot of money on the table by not utilizing this new type of tourism.

There are also nearly 900 US farms and ranches that participate in the germinating ‘farm stay’ subindustry – which are distinguishable from traditional bed & breakfasts as they include activities like farm-based cooking classes.  These classes “can cost $25 to $2,000 per person, depending on the location and chef—usually start in a field, barn or greenhouse. Students harvest vegetables, milk cows and goats, and gather eggs.”87 Thus entrepreneurs and businesspeople with experience in ecotourism and agritourism (e.g., guides to Nappa Valley wineries) may eventually find new opportunities on the mainland including rural Anhui.

Other areas of the mainland have accepted and adapted to this new industry.  According to China Daily, “[h]ouses have been built for tourists to rent in attractive locations in the countryside in Zhejiang province, more than 90 percent of which have received investment from private capital.  They make up to a 20 percent annual return.”88 Thus perhaps it may be only a matter of time until inland holdouts allow these tourism industries to grow as well.  Simultaneously firms that specialize in air purification and air treatment goods and services will find new opportunities as the goal of cleaner air is being pushed at all levels of Chinese society.89

Takeaway: The financial costs – and the burdens – for entitlement programs in the West offer an increasingly important illustration of the entitlements being offered in China as well.  Over the past several years Chinese policy makers have enacted a number of reforms that have increased spending on health care access and public pensions.  While both domestic and foreign firms can find new opportunities in this market, the sustainability and solvency of such government programs remains unclear.  At the same time, because of new laws passed over the past year, foreign experts looking to retire overseas now have fewer legal hurdles on the mainland than before.


Endnotes:

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  1. Even though there have been a number of pension reforms that purportedly affected state-owned enterprises and civil servants, the traditional “iron rice bowl” is still sought after.  See Iron Rice Bowl Redux: Official Jobs No. 1, Says Survey from The Wall Street Journal, Civil servants to lose ‘iron rice bowl’ from China Daily and ‘Iron rice bowl’ ban served up in another city from China Daily []
  2. The golden rice-bowl from The Economist []
  3. There are now approximately 10 million civil servants up from 3.7 million in 1978.  And a record number of applicants – 1.12 million – took the annual civil service exam in November 2012.  See China’s Civil Service Reform: An Update by Kjeld Erik Brodsgaard and Chen Gang and  Record number of hopefuls sit annual civil service exam from China Daily []
  4. Pension gap to hit $2.87 trillion from China Daily []
  5. According to UN projections India will likely eclipse China during this time frame in large part because its birth rate remains above the 2.1 babies per mother replacement mark.  In contrast, China’s birthrate is effectively 1.47 babies per mother.  See Age will weary the Chinese miracle from BusinessSpecator, China’s Achilles heal from The Economist, Birth rule could be relaxed from China Daily, Recession Big Factor as Birthrate Falls from The Wall Street Journal and One-child policy shift won’t usher in China baby boom from Reuters []
  6. Another area of potential impact that the one-child policy may have is on macro consumer behavior.  See Little Emperors: Behavioral Impacts of China’s One-Child Policy by L. Cameron et. al. []
  7. See Empower elderly to be active participants from People’s Daily and Rise in China’s Aging Poses Challenge to Beijing from The New York Times []
  8. See Proposal to push retirement age to 65 from China.org.cn and人社部专家建议退休年龄延至65岁 from Netease []
  9. Peak toil from The Economist []
  10. See Proposal to push retirement age to 65 from China.org.cn and人社部专家建议退休年龄延至65岁 from Netease []
  11. Age-old question raises a retirement dilemma from China Daily Asia Pacific []
  12. It should be noted that this crisis did not creep up as a surprise, rather this arguably illustrates that interest groups are just as self-interested and resistant to change in the East as they are in the West.  See A Simple Solution To China’s Pension Crisis by David Li and Ling Li and Retirement Promises Prove Iffy Under Chinese Communists from Bloomberg []
  13. As counterintuitive as it may seem, under a centrally planned economy and centrally planned health care system, “too much” medical equipment could be made (e.g., oversupply due to subsidized incentives) or “too few” doctors trained (e.g., shortages due to licensing).  There is no organic pricing mechanism to tell planners what should and should not be made or trained, thus all decisions are made arbitrarily.  See Economic Calculation in the Socialist Commonwealth by Ludwig von Mises []
  14. What’s Really Wrong with the Healthcare Industry by Vijay Boyapati []
  15. Universal healthcare is within reach from China Daily []
  16. Achievements of China’s medical reform from CCTV []
  17. The Chinese Medical Device Market from Insight []
  18. See Longevity and health care expenditures: the real reasons older people spend more by Yang et.al., and Out-of-Pocket Spending in the Last Five Years of Life by Kelley et.al. []
  19. See China tobacco bigger than Wal-Mart? from CNN and 10 Facts on Tobacco and Gender in China from the World Health Organization []
  20. WHO: 80% of China Deaths from Non-Communicable Diseases from The Wall Street Journal []
  21. Mainland Outlines Plans Cut Smoking Without Graphic Labels from South China Morning Post and MPower Report Prevalence from World Health Organization []
  22. China’s Tobacco Monopoly Bigger by Profit Than HSBC from Bloomberg []
  23. Buying ‘Double Happiness’ Reveals China’s Tobacco Battle from Bloomberg []
  24. Chinese tobacco firms’ tax payments surge from Xinhua []
  25. Buying ‘Double Happiness’ Reveals China’s Tobacco Battle from Bloomberg []
  26. Public health: Where there’s smoke from Nature []
  27. This statement was not intended to diminish the severity of HIV/AIDS in Africa.  See The Fiscal Dimension of HIV/AIDS in Botswana, South Africa, Swaziland, and Uganda from the World Bank []
  28. Secondhand Smoke Kills 42,000 Nonsmokers a Year in US from LiveScience []
  29. See Out-of-Pocket Spending in the Last Five Years of Life by Kelley et.al. and Health-Care Costs Hit the Elderly Hard, Diminish Financial Wellbeing from ScienceDaily []
  30. See Elderly population to surpass 200 mln in 2013 from Xinhua and Ageing China: Changes and challenges from BBC []
  31. WHO: 80% of China Deaths from Non-Communicable Diseases from The Wall Street Journal []
  32. Buying ‘Double Happiness’ Reveals China’s Tobacco Battle from Bloomberg []
  33. For a detailed, illustrative case study on filial piety in modern China see: In China, Betting It All on a Child in College from The New York Times []
  34. One-child policy leaves bereaved parents with broken hearts from Xinhua []
  35. Monks without a temple from The Economist []
  36. One third of all Alzheimer’s sufferers live in China.  Shanghai alone has 120,000 residents with Alzheimer’s or dementia.  See China in Alzheimer’s double bind from BBC and China, in a Shift, Takes On Its Alzheimer’s Problem from The New York Times []
  37. See China to allow some foreigners to retire there from Reuters, Shanghai may be delaying foreigners’ pension scheme: report from Reuters and Six Points on Social Insurance for Foreigners by Matthew Stinson []
  38. Foreigners Set For Social Benefits from Shanghai Daily []
  39. Foreigners to get key rights from China Daily []
  40. What’s Driving Americans to Retire Abroad? Money — or Lack of It from [email protected] []
  41. China to recruit foreign experts through Internet from People’s Daily []
  42. Foreign insurance companies in China from PriceWaterhouseCoopers []
  43. Where the state does too little from The Economist []
  44. China Life Insurance Company 2011 Annual Results from China Life []
  45. Growing pains from The Economist []
  46. The Financial Services Industry in the United States from US Department of Commerce []
  47. Insurance: Global Industry Almanac from Marketline []
  48. Foreign insurance companies in China from PriceWaterhouseCoopers []
  49. China’s Insurance Industry Faces Challenges, Regulator Says from Bloomberg []
  50. Ibid []
  51. China Firms Lose Interest in Insurance from The Wall Street Journal []
  52. Foreign insurance companies in China from PriceWaterhouseCoopers []
  53. China gets 76 bln yuan in donations for Sichuan quake from People’s Daily []
  54. County vows to correct misuse of post-disaster relief money from China Daily and Quake zone hit by yet another relief scandal from South China Morning Post []
  55. Red Cross donations not collected for 4 years from China Daily []
  56. See Businessman quits amid China Red Cross scandal from BBC, Scandal-hit China Red Cross changes leadership from China Daily, An Online Scandal Underscores Chinese Distrust of State Charities from The New York Times and Wife sacked amid graft probe from Shanghai Daily []
  57. Charity’s credibility from China Daily []
  58. Chinese charity donations fall 80 per cent from The Telegraph []
  59. See China’s Rapidly Growing Non-Governmental Organizations by Xu Ying and Zhao Litao and Chinese Nongovernmental Organizations by Amy Gadsden []
  60. PCDN []
  61. See Health damages from air pollution in China from MIT and China’s pollution puts a dent in its economy from MIT News []
  62. Some of the long-term health issues with the water pollution are that the industrial runoff (e.g., toxic chemicals) ends up downstream and because these streams are sometimes the only source for water, farmers must use it to water their produce.  As a consequence, several hundred “cancer villages” have sprung up outside of large industrial centers, where cancer rates are abnormally higher due to this runoff.  See Toxic Water: Across Much of China, Huge Harvests Irrigated with Industrial and Agricultural Runoff from Circle of Blue and China: Dirty Air, Dirtier Water? from Council on Foreign Relations []
  63. A silver lining in China’s grey skies from Reuters []
  64. Cost of Pollution in China from The World Bank []
  65. Air pollution also damages and destroys crops.  See China’s Urban Air Kills Rural Plants from Discovery []
  66. Of China’s 500 largest cities, less than 1% meets the World Health Organization’s (WHO) air quality standards.  Furthermore, 16 out of the 20 most-polluted cities globally are in China according to WHO.  And up to 40 percent of China’s rivers are seriously polluted.  Another recent estimate in February 2013 from the China Geological Survey is that 60% of ground water in Chinese cities are “severely polluted.”  See 7 of world’s 10 most polluted cities are in China: report from Want China Times, China’s Water Pollution Crisis from The Diplomat, China’s river pollution ‘a threat to people’s lives’ from People’s Daily, The groundwater of 90% of Chinese cities is polluted from Danwei, After China’s multibillion-dollar cleanup, water still unfit to drink from Reuters and Beijing Air Akin to Living in Smoking Lounge: Chart of the Day from Bloomberg []
  67. Beijing smog offers silver lining for some from Financial Times []
  68. See Beijing Air Akin to Living in Smoking Lounge: Chart of the Day from Bloomberg and Survey: Breathing bad air in Beijing like smoking 21 cigarettes from Asahi []
  69. See Hospital visits rise during Beijing’s choking smog from Agence France-Presse, Academic claims air pollution is more frightening than SARS virus from China Daily and Study: Toxic Organic Compounds Found in Beijing’s Smog from Caijing []
  70. Beijing’s air was not even the worst.  According to the Ministry of Environmental Protection, 6 out of the top 10 most heavily polluted cities were in neighboring Hebei province.  Beijing was 9th.  See Beijing ranks ninth among China’s top 10 polluted cities from South China Morning Post []
  71. Ibid []
  72. Ibid []
  73. See New in Beijing: pollution domes from Financial Times, Canned air for sale in China, as blanket of smog returns from The Sydney Morning Herald and For polluted Beijing, canned air from CNN []
  74. See Beijing’s heavy pollution a boon for air quality monitoring apps from IT World and Beijing Air Akin to Living in Smoking Lounge: Chart of the Day from Bloomberg []
  75. See Beijing Olympics Met or Exceeded Green Goals from Scientific American, A Stunning Visualization of China’s Air Pollution from The Atlantic and China’s countrymen struggling with a ‘sick’ Mother Earth from The Telegraph []
  76. China pledges $56 billion to cut air pollution from China Daily []
  77. See PM2.5 kills thousands, researchers say from China Daily and Beijing Air Akin to Living in Smoking Lounge: Chart of the Day from Bloomberg []
  78. In addition to selling “canned air” one other possibility could be to sell water purification devices like Slingshot created by Dean Kamen which purportedly can produce clean water from nearly any water source (irrespective of pollution).  See Worse Than Poisoned Water: Dwindling Water, in China’s North from International Herald Tribune, 57% China’s urban underground water polluted from Xinhua, Travellers unveil shocking truth about illegal waste water dumping from South China Morning Post, Deng Fei Launches Weibo Campaign to Share Images of Water Pollution from Tech In Asia and Dean Kamen aims to clean water, generate electricity with Slingshot machine from Engadget []
  79. China to contain increasingly severe soil pollution from Xinhua []
  80. According to Irvin Abercrombie one other limitation that foreigners should be aware of is administrative restrictions at local colleges.  For example, at one college he taught at he was informed that while he could help participate in an NGO, other foreign colleagues were asked not to participate in non-school sponsored extracurricular activities. []
  81. A work in progress from The Economist []
  82. Rural Bounty []
  83. Small U.S. Farms Find Profit in Tourism from The New York Times []
  84. The Demand for Agritourism in the United States by Carpio et al. []
  85. California farmers profit from agritourism from the University of California Cooperative Extension []
  86. Savvy farmers open the gate to agritourism from USA Today []
  87. See a list of participating farms at FarmStayU.S.  See also Cooking With Mr. Green Jeans from The Wall Street Journal and 5 common farmstay questions — answered! from CNN []
  88. Entrepreneurs turn to the land for profit from China Daily []
  89. Beijing’s ‘Crazy Bad’ Air Pollution Creates Investment Opportunities from The Wall Street Journal []

Chapter 19 – Health care

[Note: below is Chapter 19 from Great Wall of Numbers]

Another concern that foreign medical professionals probably do not have to worry about currently is trust; or rather they may be able to find an opportunity to rebuild the trust in the medical profession.  The reason this is important is that according to the former Ministry of Health, in 2010 there were “more than 17,000 “incidents” aimed at hospitals and their staff.”1 These sometimes violent encounters have markedly increased, up from 10,000 such “incidents” five years ago.

For example, in March 2012 a young intern at a hospital in Harbin was stabbed to death by a patient, a patient who also stabbed three other doctors during the same encounter.2 In September 2012 at a hospital in Shenzhen a doctor and nurse were both stabbed by a patient who also stabbed two others.3 In November 2012 two such incidents occurred.  The first, in Hefei, Anhui, a man with a knife entered the 2nd Affiliated Hospital at a medical university and stabbed five medical workers, killing the head nurse.4 According to a preliminary investigation he had received medical treatment from the same hospital.  And in Tianjin, near Beijing, a doctor was axed to death by a psychiatric patient.5 In fact, in 2011 up to “10 medical staff were murdered by patients.”6

Why is this occurring?  A significant portion of the frustration involves what The Lancet (a British medical journal) has called “Bribegate” – medical staff have been found to have received bribes and kickbacks for prescribing drugs to patients, even if the patients did not need the prescription (more on that below).7 For example, a recent survey found that “54% Chinese doctors acknowledge they have taken drug kickbacks from medicine dealers or manufacturers.”8

While they are not required to take the Hippocratic Oath, Chinese doctors have similar ethical standards that essentially promote the same ideals.9 Yet there are at least two problems that have created an atmosphere of mistrust: relatively low salaries (set by local governments) and peer-pressure.  According to an anonymous doctor at a hospital in Anhui, “I think the low salaries of doctors in China, which I can say don’t match the effort they make, are the major cause of this phenomenon; the kickback a doctor accepts is usually greater than his salary.  What’s more, it’s difficult for a doctor to refuse the kickback when all the other doctors accept it. It will alienate him or her from the others.”10

This dissonance between having “low salaries” and “work performed” is not just an isolated observation.  In August 2012, the Chinese Medical Doctors Association released a report that found 91.9% of the 3,704 doctors surveyed “said the job involves many sacrifices for low financial return.”11 In fact, according to a recent survey of 363 doctors, 61% reported they were unhappy with their profession due to a number of factors including compensation.12

What are the typical salaries like?  Depending on the city and size of the hospital doctors can earn as little as 5,000 yuan ($800) a month.  At larger hospitals in Tier 1 and Tier 2 cities this amount can be 10,000 yuan or more, yet still only a fraction compared to their Western counterparts.  For comparison, according to a 2011 report from the Bureau of Labor Statistics, the mean annual wage for physicians was $184,650 in the US.13 Simultaneously, doctors and nurses in China typically must see 60 to 100 patients during their 10-14 hour shifts.  As a consequence the average face time doctors have with patients can be as little as 5 minutes.  In contrast, the typical face time with a doctor in the US is 13-18 minutes.14 And as both the survey and Anhui doctor noted above, practitioners think that salaries do not correlate with the effort and performance.

This has led to another problem involving retention and future matriculation.  According to the Chinese Medical Doctor Association, “the proportion of doctors who hoped that their own children would enter the medical profession has decreased, from 11% in 2002 to 7% in 2011.”15 And based on an August 2012 report from Health Times in China, 96% of doctors said they were unsatisfied with their jobs and that “70 percent said they would not allow their children to enter the medical profession.”16

On the ground cases

I spoke with four Chinese doctors about this issue.  Maggie Li is an anesthesiologist who works for a large pharmaceutical company in Shanghai.  In her view, “the recent attack on medical staff in Anhui is a snapshot of the problems in the national health care system.  I empathize with these five medical professionals.  For them, I can see little hope in their seemingly futile effort to continue to be a doctor in China.  Based on my observations, doctors are not fully utilized in China because most doctors currently only treat physical, superficial diseases but cannot treat sick hearts – their psychological feelings.  However, we as medical professionals still need to have the courage to face this harsh reality and continue on because we are the foundation and real hope of the large majority of Chinese who have few options currently available to them.”

Psychological and mental health issues are an important predicament on the mainland in part because they are still a largely taboo topic.17 This despite the fact that The Lancet estimates that up to 17.5% of the adult population in China has some kind of mental ailment.18 In fact, because of cultural issues that have largely overlooked or even frowned upon this increasingly important sub industry, there are relatively few active professionals on the mainland.  In 2007 there were only 17,000 certified psychiatrists, “one-tenth the number in developed countries, in proportion to the population.”19 According to Tian Chenghua, a professor at Peking University, for every 100,000 people in China there are only “about 1.26 qualified psychiatrists, far lower than the global average of four.”20 Yet according to a recent Caixin report, the second-most commonly diagnosed disease on the mainland is depression, affecting 260 million Chinese people.21 Specifically, more than 287,000 people commit suicide each year in China, some of which stems from a shortage of mental health professionals.2223 In contrast to Western countries, more women commit suicide than men in China (by a factor of three to one) and it is also the leading cause of deaths by young women.24 In fact in 2009 each day an estimated 500 women committed suicide (the most recent year for detailed records).25

And while the suicide rate has itself purportedly halved over the past two decades (from 30 in 100,000 to 15), suicides in China still account for “more than 30 percent of the world’s total suicide cases.”26 While this rate is expected to drop due to suicide prevention awareness, the same Caixin report noted that “[m]ore than 88% of patients with mental disorders had never received professional help between 2001 and 2005.”  And that, “only 45% of the nation’s depression victims who saw mental health professionals had been treated in the previous six months.”  In contrast, the 2009 estimate for the suicide rate in the US was 12.4 in 100,000 (the highest in 15 years).27 Furthermore, a 2007 study found that annual productivity loses due to lost work days from depression amounted to “51.37 billion yuan [$6.39 billion], including 5.62 billion yuan in medical costs.”28 This then presents an opportunity for psychological and psychiatric professionals and NGOs such as the China-American Psychoanalytic Alliance from other countries to help a significant segment to heal what Li referred to as “sick hearts.”29

In November 2012 I spoke with Jenny Xu, a doctor at a public hospital in Zhongshan, Guangdong.  According to Xu, “I think most medical staff, regardless of where they may work on the mainland feel very overwhelmed.  We are required to work relatively long shifts in an increasingly stressful and even dangerous environment.  I personally have begun the immigration process to move to Canada where I plan to work as a nutritionist.  In the free time that I have, I am preparing for TOEFL and learning about North American culture because I do not feel the compensation and lifestyle as a medical professional in China is worth the amount of effort and work that most medical professionals are currently required to do.  The incentive structure is warped and some doctors that have received bribes in the past have created permanent problems for the medical community because many patients now do not listen to us.  And as a consequence some patients even take their frustrations out on everyone.”

Xu may one day become part of the ‘brain drain’ (the emigration of skilled professionals) I briefly mentioned in Chapter 10.  In 2007, China became the leading contributor of emigrants globally.  Nearly 100,000 mainlanders received immigration or permanent status to the US, Canada and Australia in 2009.  Two year later, 87,000 Chinese immigrated to the US itself; the US now attracts more than half of all Chinese immigrants a year.30 Of the 1.21 million Chinese students and researchers (liúxuéshēng) who studied overseas between 1978 and 2007, only about 25% returned to the mainland after graduation.3132 In fact, 508,000 Chinese (typically wealthy and educated) emigrated abroad to OECD (developed) countries in 2010 alone, a 45% increase over 2000.33 And according to a 2011 report, “27% of Chinese entrepreneurs worth more than 100 million RMB ($15.9 million) have already emigrated, while another 47% say they are considering doing so.”34 More pointedly, two-thirds of all investment visas (EB-5) issued by the US in 2011 were to Chinese nationals and of the 7,641 investor visas granted in 2012, 80% were taken up by Chinese.353637 For comparison, since it implemented a new immigration program in 2004, there have been a total of 5,000 foreigners that have received a green card in China.38

This brain drain is not just endemic to China, as other developing countries such as India also have had comparable numbers emigrate abroad.39 In fact, it is estimated that Indian doctors now account for 5% of the medical workforce in developed countries.40 And an estimated 60,000 Indian physicians work in the US, the UK, Canada and Australia.  In the case of China, policy makers are beginning to try and stem the exodus with bonuses of up to 100,000 RMB ($15,896) to Chinese physicians who take part in visiting physician programs which will train and educate healthcare workers in rural areas that are lacking in medical professionals (e.g. to prevent the ‘overwhelmed’ feeling of Xu and her peers).41 In the meantime, perhaps you and your firm could provide immigration services to those looking to move abroad.

Compensation related to productivity is another issue that came up in a conversation I had in November 2012 with Lin Zhang.  Zhang is an iconographer (doctor who studies X-rays and CT scans) at a hospital in Shanghai.  She noted that “government bodies have instituted a new policy, a two-tier wage system of ‘ordinary’ and ‘famous’ specialists, yet the gap between these doctors is arbitrarily set.  Perhaps in future reforms, doctors can be paid according to other performance reviews and thus there may be a near-infinite amount of price points that they can be paid at, just like in the US.  And unfortunately ‘ordinary’ doctors currently do not have many opportunities to promote themselves in the work environment.  Thus, while the ‘ordinary’ doctors do most of the daily work, their compensation is relatively poor compared with the large quota requirements.  And because of the way this system is set up, they are often victims of violent incidents in hospitals.  In fact, one of the reasons why some patients have turned violent over the past few years is because of the little face time that these ‘ordinary’ doctors are allocated per patient.  Coupled with the low salary this has created a profession that is internally frustrated and externally looked down upon by customers and public opinion.”  I discuss the new ‘ordinary’ versus ‘famous’ specialists below.

Reforms and alternatives

Currently the break down for hospital revenue is in three portions: 40% of hospital revenues are typically generated by selling medicine, 40-50% comes from services like diagnostic tests and treatments and the remaining 10% comes from governments.  Because of their relatively low salaries (as noted above), in most hospitals, doctors are directly compensated by the “profits of the sales of medicine.”42 This sets in place the cycle noted above where some doctors will overprescribe medications knowing that they can in return, receive additional compensation.  To remove this incentive, as part of the reforms that began during the 11th Five year plan by which medicines and prescriptions as a whole will be reduced in price (e.g., ‘mark-ups’ as noted in Chapter 6), governmental bodies have recently introduced a “medical service” fee.

Because medicines will no longer be generating as much revenue, to bridge this revenue gap, this new “medical service” fee enables patients to pay a rate of 42 yuan ($6.72) to consult with an “ordinary” doctor and 100 yuan ($16) to consult with a “famous specialist.”43  Thus, creating some incentive for medical practitioners to focus away from overprescribing and towards providing services; as there is now an objective bridge linking performance and productivity to mandatory hours.44 Yet as noted by both Li and Zhang and the numerous surveys above, this is just one small step in the reform process.  Similarly, despite a concerted effort to remove pharmaceutical mark-ups (see below) these reforms have met resistance from hospitals.  For example, “[a]lthough more than 300 county-level hospitals have implemented the price reform since Chen announced it at the beginning of the year, only a dozen city-level hospitals – including two in Beijing and 10 in Shenzhen – have stopped charging the mark-ups.”45

Another area under reform is the “pay first” method (in contrast to the “pay after” service system in much of the West) which has sometimes left poorer patients in a bind.  For example, in August 2011, a doctor in Wuhan, Hubei province removed the stitches on a patient’s fingers immediately after surgery because the patient did not have enough money to pay the medical fees.46 Due to public criticism, a new “pay after” payment system is currently undergoing new trials across 20 provinces that will attempt to alleviate future problems.47

A Byzantine process and long-term opportunities

In December 2012 I took a CRH (mentioned in Chapter 10) and spoke with Yolanda Bo who works for a large pharmaceutical distributor that sells Chinese-made pharmaceuticals (usually reproductions of Western drugs like penicillin) to dealers in Nanjing, Jiangsu province.  She has been working in the industry for over five years and according to her, “the way the drug system works is rather complex.  On the supply side are factories, several hundred factories spread throughout the country.  They will produce a certain drug like an antibiotic and sell it to a company like ours for 15 RMB ($2.40) – a base price that fluctuates according to the tender price.  There are approximately 200 distributors in Nanjing alone and thousands across the country.  What we do is sell products to dealers (brokers) for usually around 17.5 RMB ($2.80) – and as the wholesaler this price point still provides a comfortable profit margin for us.  Dealers maintain relationships with four different entities: doctors, delivery companies, hospitals (specifically the purchasing department) and a unique group called a billing company.  The dealer will often pay them 8-12% of the price differences as a type of fee and then absorb the remaining profit.  Thus the dealer will only buy our product if they can make a profit margin of around three times the cost to them.”

The reason why the dealer markup is relatively high is that in this system he or she needs to build and maintain guanxi with each of those four entities who in turn require a certain margin to keep for themselves.  According to Bo, “for example, the delivery company which physically delivers the product to the hospital will buy the product for around 54.62 RMB ($8.75) from the dealer, this is based on an average 6% fee yet sometimes this fee can be up to 8% or more.  In turn the delivery company resells the product to hospitals for 58 RMB.  Hospitals in turn may add additional mark-ups depending on where they are located though generally they add about 15% more.  In poorer, rural regions, the hospitals might negotiate with the dealer and receive higher terms, perhaps 20-60% of the retail price.  Simultaneously, the dealer typically hires subcontractors to maintain relationships and connections with the head doctors (deans), administrators (purchase managers) and directors at each hospital.  Thus if a finished product sells for 100 RMB ($16) to the patient, some of the top doctors’ share typically amounts to around 20% (20 RMB).  To complicate matters further, because of numerous regulations and certification requirements (like warehouses, storage facilities and transportation that must meet certain standards and provide government authorized invoices) the delivery company itself actually must physically receive the product through another middle-man called the billing company typically located in Anhui due to the laxer regulations and price structure.”

Over the past decade various governmental entities have attempted to reform this business model due to the relatively high costs and low value added in the middle-man process.48 Yet while price ceilings are set, factories will simply stop producing the product because they can no longer charge the required amount for this incentivized model to continue.49 As a consequence those medications are no longer produced, thus to prevent this shortage from occurring government regulators have allowed a certain amount of rent-seeking to continue.5051

While these prices are essentially artificially inflated at each level, because of competitive pressures due to hundreds of factories producing identical pharmaceuticals, the wholesale prices themselves are purportedly “kept in check.”  Yet according to Bo, “wholesale prices do fluctuate every 2 years after mandatory governmental checks and reauthorizations which levy or remove fees.  We call it ‘inviting tenders’ or a proposal (RFP) and as a consequence new medicines percolate into hospitals while concurrently others will disappear from the market; it all depends on the government’s attempts to control prices.”52

In a nutshell, because of all the agents, middle-men and logistical movements (e.g., Coasian transactions costs53 ), a drug that costs 15 RMB to manufacture is often sold, according to Bo, to hospitals for 3-10 times the cost to end-users without any value-added in between.  As a consequence, Chinese consumers collectively spend more on pharmaceuticals as a percentage of GDP (2.26% in 2007) than compared to most other OECD countries.54 And because patients are increasingly aware of how this pharmaceutical business model operates it has led in part to the intense emotional venting surrounding ‘Bribegate’ discussed at the beginning of the chapter.

Another solution (and one where new business opportunities may be found) to this issue that one source said is being planned for pilot programs is to allow not just salaries to reflect market conditions, where prices fluctuate based on the supply of medical professionals but also the supply of pharmaceuticals based on the market demand and consumption by end-users (e.g., wholesalers selling directly to medical practitioners).  Or in other words, removing the artificial barriers, subsidies, the price ceilings and floors and letting market participants bid on scarce resources directly from the original suppliers (e.g., directly from factories and wholesalers or the skilled labor and per usage of medical equipment).  However as Bo and others I have interviewed noted that even though some of these pricing mechanisms have been liberalized and reformed, because various institutional bodies still set compensation rates and effectively create a quota system, they have removed other incentives for doctors to perform based on productivity.55 And in some cases, some hospitals still pay top doctors based on both the new “service fee” as well as a percentage of the pharmaceuticals sold.  The analogy Bo used to describe this process in our conversation was, “Rome was not built in one day, so it would be myopic to expect such an entrenched business model to be immediately reformed overnight.”  Thus according to her, while these reforms may take years and decades to become fully realized one of the long-term opportunities for both foreign and domestic firms is to continue establishing new factories that produce pharmaceuticals because of the demand by both an aging population and from a growing middle class.

Private and foreign owned facilities

Another opportunity for foreign medical professionals is that because of this general distrust among the populace towards Chinese medical professionals, those with means have begun turning towards private, Western-run hospitals.  Beginning in 2000, Chinese policy makers “officially permitted foreign companies to pursue hospital and clinic joint ventures but limited ownership to 70%.”56 In December 2010, as part of the health care reforms, foreign companies were now allowed to own 100% in hospitals.57 Foreign-owned and managed hospitals include United Family Healthcare (UFH which is owned by publicly traded Chindex: CHDX) and Parkway (a Singapore-based company) which have opened several locations throughout Tier 1 and Tier 2 cities.58 In fact, while the majority of clients used to be typically foreigners, wealthier Chinese now make up 50% of the patients at UFH locations.  As a consequence, after 15 years since they first started, UFH has grown to include 3 hospitals and 11 satellite clinics.  While the hospitals provide many common international services, satellite clinics typically handle immigration health checks for residents applying for visas abroad.

In November 2012 I spoke to Alan Kahn, Vice President of Marketing at UFH in Beijing.  According to him, “our secret for success is that we are patient centered, we try to provide the best services available to them.  As a consequence we invest a lot of capital into unseen quality of life amenities.  For example, almost certainly none of our patients will walk out of the hospital with a staph infection because there are strictly followed hygienic and sanitary protocols in place and each patient has their own individual room.  New mothers have their own privacy in an OBGYN wing which is guarded by a permanent security detail to prevent child theft, which can occur in certain areas of China.  We are also the only JCI quality accredited hospital on the mainland and spend a lot of time bringing international standards, new innovations and ‘best practices’ to our customers.  In fact we were the first to provide Western-style in-patient care on the mainland, which has been subsequently emulated by other companies and institutions.  We were also the first in a number of other service areas like pregnancy care and post-partum recovery which have also been copied and emulated by others.  And since we are not restricted by quotas – and are privately owned – we can continually change our services to meet the needs and demands of the customers.  This includes building specialized centers, like our new Rehabilitation Hospital which is one of the first of its kinds on the mainland.”59

Accidentally transmitting diseases like staph can still conceivably occur in any hospital in any country, yet in part because of inconsistent quality control and sanitation procedures occur more frequently in public facilities.  For example, in the fall of 2009 there was an outbreak of multidrug-resistant Acinetobacter baumannii (MDR-Ab) at a large public hospital in Beijing.  Twelve patients were infected and five died because the bronchoscopes had not been properly sterilized.60

And while the costs of their services may be more expensive than visiting a public hospital, one of the reasons Chinese customers are increasingly interested in private health care facilities is that, “they do not have to worry about trust or over-medication or trying to provide a hong bao (红包, a red envelope or bribe) in hopes of seeing a specific doctor.”  Or in other words, UFH and other private firms primarily focus on providing service in an industry – that because of its system as noted at the beginning of the chapter – has struggled to fully provide.

In my own experiences with public medical treatment on the mainland (I have not utilized UFH facilities), one of the problems is that while the doctors are typically well-trained and competent, because of long queues and short face time, there is still a tendency to overprescribe, for example, antibiotics.  In fact in November 2011 I learned firsthand of the consequences of receiving too much antibiotics when it was discovered I had very little bacteria left in my GI tract to digest food (e.g., there are billions of bacteria cells in your stomach which play a key role in digestion, using antibiotics kills the ‘bad’ infections as well as your useful stomach bacteria).61 This is not a startling revelation either, as nearly every month there is a news story about this phenomenon.62 In fact, according to the Ministry of Health (now the National Health and Family Planning Commission), “on average each Chinese person consumes 138 g of antibiotics per year — 10 times the amount consumed per capita in the U.S. Meanwhile, three times as many Chinese people are prescribed penicillin compared with the international standard.”63

Another reason for UFH’s success is that its founder, Roberta Lipson came to China in 1979, thus they are a first mover in an industry that takes years to set-up.64 Throughout the initial opening and reform during the 1980s, many policy makers and potential customers alike were suspicious and uncertain of privately owned health care facilities.  Just like Pizza Hut and KFC (see Chapter 16) were seen as curiosities that few could initially afford, private health care was a service that took adjusting to.  Yet after a number of VIPs, celebrities and thought leaders had a chance to visit and use private health care services, mainland media outlets took note and public opinion has been increasingly positive towards this seemingly foreign idea.

Another reason is that as Kahn explained, “up until the recent reforms, the public health care system was under immense systemic strains.  Because there were few modern healthcare facilities in the countryside and because most of the well-trained doctors worked in cities, rural residents would surge into cities’ overwhelming resources in order to wait in line to see the few doctors who could provide needed surgeries.  For example, if you needed life-saving gall bladder surgery there may only be a couple doctors in a big city like Kunming who could provide it.  So you and your family would move to the city for weeks and months, waiting in various lines and queues for 24 to 72 hours on end just to see a specialist for a few minutes.  As a consequence sometimes desperate families take every action possible, such as trying to present doctors with large gifts hong bao (红包) in hopes of receiving admission and service.”

How long are these waiting times?  According to the former Ministry of Health “waiting times at public hospitals are 30 times longer than private hospitals.”65 In fact, one public maternity hospital in Beijing alone receives 5,000 patients a day and “there is a line stretching back 200 meters from the window where patients have their blood tested every morning. A one-hour wait to have a blood test is normal.”6667

This is not to say that private hospitals in China do not have their own problems.  In fact, in 2012 a TV station utilized an undercover reporter who visited three private hospitals.  The reporter sent green tea in for analysis instead of urine.  The private hospitals did not notice it was tea and subsequently offered several expensive treatments including “surgery for calcification.”68 This was a repeat of a 2007 scandal in Hangzhou where reporters from a different TV station sent in green tea as well.  The subsequent investigation found that five hospitals (one of which was private) prescribed relatively expensive medicines for treatment.69 Another instance of medical negligence was uncovered in Liaoning, a northeastern province in February 2013.  A doctor at a privately run clinic infected as many as 95 patients with Hepatitis C which can cause cancer.70

In November 2012 I also spoke with a Chinese doctor at a private hospital in Pudong.  According to her, “foreign health care providers can now move to China to provide their services as there are more and more expatriates in China who usually feel more at ease and secure when they are seen by doctors from similar cultural and linguistic backgrounds.  Meanwhile, the administration departments at Chinese joint ventures and private hospitals continue to transform and integrate their hospital services to the level of so-called international standards.  Hence, foreign health care providers especially from advanced health systems will find many opportunities for reshaping and improving the management-side of the facilities.  In addition, the pay of foreign doctors is usually on-par with many facilities in their home countries and local accommodations and cost-of-living perks are almost always provided by the employer.  Needless to say, legal certificates and license are also required before practicing on the mainland.  Yet despite all of these inducements and known requirements, one major challenge facing foreign doctors could still be cultural issues in all aspects of working place.  For example, at international medical centers, different doctors from different countries and health systems may have different guidelines for both treatments and consultation approaches to patients.  Ultimately however, while they will need to take time to iron out the differences and reach a common ground, overall the medical principles, practices and ideas are typically similar at these private facilities.  Hence the increased popularity of their services.”

Yet while reforms of the public industry are still being carried out (as noted at the beginning of the chapter), Kahn and others I spoke with are of the opinion that the current reforms are relatively well thought out, that the overprescribing of medication can now be tracked and prevented by software that is being rolled out in pilot hospitals.  Similarly, he thinks the new changes in doctor training more in line with Western practices, (with China now piloting a 3 + 2 system for doctors to take 3 years in general practice medical study and 2 years of specialty application before being allowed to fully practice), will help prepare doctors that are better able to handle more maladies while boosting ER capabilities.  For example, prior to reforms, doctors were assigned to the ER, not because they had that particular skill – in fact many were specialists in other areas like internal medicine – but based on hospital administrative organizational management (e.g., politics).

And according to Kahn and others, one of the opportunities that health care professional can provide to all demographics in China is internationally recognized ‘best practices’ which mainland institutions are still incorporating and adjusting to.  Thus despite all of the issues, hurdles and problems there are still potential opportunities in a growing market.  After all, China’s healthcare industry is projected to reach $900 billion by 2020, up from $275 billion in 2010.71 For instance, last year two US firms (Medtronic and Stryker) purchased two Chinese medical companies (China Kanghui Holdings and Trauson Holdings) for nearly $1.6 billion.  Perhaps you and your company can provide consultations, services and training in this growing market or even acquire a local partner.

Medical tourism

Under the current reforms, the Ministry of Health has set a target to double the utilization rate and overall contribution of private facilities in China by 2015.  That is to say, the Ministry has set a goal by which private health care facilities will manage 20% of all inpatient and outpatient volume.72 Yet as Maggie Li also informed me, “for most Chinese people, they still trust local Tier 3 hospitals more than these foreign private hospitals currently because as a local residents can still oftentimes use a network [guanxi] to see the doctor that the patient would like.  For wealthier patients, they are also willing to choose to give birth to children in Hong Kong or in North America because these children would be the citizen of Hong Kong or US at the birth.  That is the dream of many families to give their children a foreign passport so that their children can choose freely where to study, live and work when they grow up.  Freedom is the best gift that parents can give to their children.”

Tier 3 hospitals are the largest and most sophisticated hospitals on the mainland (e.g., 500+ beds and advanced surgery and treatments).  According to one estimate, there are roughly 1200 Tier 3 hospitals now on the mainland.73

There is also a controversial ancillary service within medical tourism called birth tourism or maternity tourism.  For instance, more than a third of all births in Hong Kong in 2010 were to mainland mothers (32,653 babies) compared with just 620 in 2001.74 In 2011, this increased again as 44,000 mainland mothers had babies in Hong Kong.75  Yet beginning in 2013, Hong Kong policy makers have set a new, lower quota and will begin to bar mainland mothers from giving birth in the SAR.  For example, in October 2012, more than 400 mainland mothers were arrested for traveling to Hong Kong with the purpose of giving birth on the island and thereby gaining residency and access to services (e.g., birth right citizenship).76

In the US, while specific statistics are hard to come by, there are at least several independent maternity clinics that have sprouted up over the past several years to cater to Chinese mothers as part of the market for birth tourism.  While this is not illegal, it can be risky as there have been investigations and closures of several facilities.  For instance, a maternity clinic in Chino Hills, California was recently closed due zoning violations and another in San Gabriel was closed because “neighbors complained about noise from the babies.”77 Yet despite these known risks, many others cater to the increased demand.  According to one report from the Washington Post, the costs for this alternative route (flight, 3-month maternity stay, meals, delivery) is approximately $14,750; and the medical staff at some of the facilities speak Chinese.78 For example, a motel in Arcadia, California runs a makeshift maternity ward catering to Chinese mothers.  These women pay a China-based agency $25,000 “in fees for travel, medical, visa and other related expenses.”79 Another American business owner in New York interviewed by NBC runs a similar clinic and charges up to $30,000 for all expenses.80 The family of 4-month old Ada Lin, now in China, who was born in the now-shuttered clinic of Chino HIlls, paid $27,000 for all the expenses.81 And as noted in previous chapters, with a growing middle class, the 110,000 yuan price tag ($15,000) at many of these facilities is becoming increasingly affordable.8283

Again, while the legalities are still being sorted out and discussed, perhaps you and your firm can consult with potential clients.  After all, all of the Chinese women that do choose this option have received legal travel visas and are not a burden on welfare systems as their expenses are funded privately.  For example, according to NPR, some of these women and their families will use the occasion to buy luxury, foreign-made products (as noted in Chapter 11).  In one such instance, a mainland mother, “went to a conference in Las Vegas and bought eight pairs of designer shoes, for about $200 each, half the price they cost in China.”84 Another example was recently reported by NBC, who interviewed a new Chinese mother that had also gone shopping during this gestation period in the US and “bought an iPad, suits and dress clothing, luxury brand perfumes and baby clothes from brands like Polo by Ralph Lauren.”85 In fact, according to a 2008 McKinsey & Company report, between 60,000 to 85,000 medical tourists travel to the US each year to pay for and receive medical care out of pocket.8687 Perhaps you and your company can provide consultative services with these potential customers.

Takeaway:  Because of institutionalized incentives systems involving kickbacks and over-medication, there is a strenuous relationship between doctors and patients.  While a number of reforms to alleviate these strains have begun rolling out, other fundamental issues involving the calculation problem may place additional constraints on possible reforms and changes.  During this transition time foreign firms specializing in traditional health care may find a new consumer base – one that is increasingly wealthier – that is hesitant to trust domestic practitioners and institutions.


Endnotes:

 

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  1. Heartless attacks from The Economist []
  2. Harbin court hears hospital attack case from Sina []
  3. Nurse and doctor stable in brutal stabbing from China Daily []
  4. Man killed 1, injured 4 at a hospital in E. China from Sina []
  5. See Doctor axed to death in N China hospital from China Daily and Female doctor axed to death in Chinese hospital from The Telegraph []
  6. See Patient-On-Doctor Violence In China Symptomatic Of A Sick And Crippled System from Economic Observer and Chinese man convicted of murder after stabbing four hospital staff from The Guardian []
  7. How to solve the crisis behind Bribegate for Chinese doctors from The Lancet []
  8. Survey shows 54% Chinese doctors take drug kickbacks from pharmaceutical dealers from HugChina []
  9. Sun Simiao was the Chinese “King of Medicine” whose text “On the Absolute Sincerity of Great Physicians” is required reading for Chinese physicians.  See Heal Thyself? from TIME []
  10. Netizen accuses Zhejiang doctors in new kickback scandal from China Daily []
  11. Patient’s knife attack raises security fears from China Daily []
  12. 调查称61%医生不喜欢自己职业 8成认为工资低 from ifeng []
  13. This number varies from state-to-state and specialty-to-specialty.  If other compensation and perks are added, this number increases as well.  See Occupational Employment and Wages, May 2011from Bureau of Labor Statistics and Physicians and Surgeons from Bureau of Labor Statistics []
  14. See Time Spent in Face-to-Face Patient Care and Work Outside the Examination Room by Andrew Gottschalk and Susan Flocke and National Ambulatory Medical Care Survey: 2003 Summary by Hing, et.al. []
  15. See New generations of Chinese doctors face crisis from The Lancet and 第四次医师执业状况调研报告 from the Chinese Medical Doctor Association []
  16. 医生职业满意度调查:七成医生不愿子女从医 from Sohu []
  17. See The Madness of China’s Mental Health System from Foreign Policy and Freud, psychiatry, and mental health in China by Evan Osnos []
  18. See Mental illness in China by Guo et al. and Mental Illness: Far More Chinese Have Mental Disorders Than Previously Reported, Study Finds from The New York Times []
  19. Mental health in China from The Economist []
  20. Plan to improve 550 psychiatric hospitals from China Daily []
  21. The heavy toll of depression in China from Caixin and失守抑郁症_专题频道_财新网 from Caixin []
  22. See 287,000 commit suicide in China each year from Xinhua and Care, Confusion and Depression’s Heavy Toll from Caixin []
  23. After heart disease and cancer, suicides are one of the leading causes of deaths in China.  Traffic-related accidents account for the largest amount of deaths of Chinese people under the age of 45.  In contrast, suicides have overtaken traffic-related accidents as the leading cause of injury deaths in the US.  For comparison, according to Xinhua “it estimated that there are 3.12 million new cases of cancer each year in China. There are 2.7 million cancer-caused deaths, which represents 13 percent of total deaths of Chinese people.”  Road Safety Problems Pose Dire Threat in China from The New York Times, Suicides Replace Auto Crashes as Top Cause of Injury Death from ABC News, Taking traffic regulations seriously from China Daily and Cancer in China influenced by pollution, poverty from Xinhua []
  24. The suicide rate for females was three times higher than for males.  See Women and suicide in rural China from World Health Organization and Alone but alive from Global Times []
  25. Meet the woman making China fashionable from The Independent []
  26. China’s suicide rate declines, but still poses a challenge from Xinhua []
  27. Facts and Figures from American Foundation for Suicide Prevention []
  28. Care, Confusion and Depression’s Heavy Toll from Caixin []
  29. China American Psychoanalytic Alliance []
  30. Report: US Tops China’s No.1 Immigration Destination from Caijing []
  31. See China’s Brain Drain at the High End by Cong Cao, China’s Brain Drain Dilemma: Elite Emigration from The Jamestown Foundation and China fears brain drain as its overseas students stay put from The Guardian []
  32. This trend seems to be changing however.  A more recent survey by Nankai University found that “[o]ut of 2.24 million overseas students from 1978 to 2011, 818,400 had returned after studies.”  And furthermore, “[a]mong those who had returned, more than half, or 429,300, had done so in just three years from 2009 to 2011. And 2011 alone registered 186,200 returned students.”  See Fewer Chinese overseas students staying abroad from Xinhua []
  33. See Rich Chinese want to buy happiness — by emigrating from Los Angeles Times and Wary of Future, Professionals Leave China in Record Numbers from The New York Times []
  34. The Real Reason China’s Super-Rich Are Packing Up and Moving Abroad from WorldCrunch []
  35. See More Wealthy Chinese Said to Prepare Exits from The Wall Street Journal and Fast track to the American dream from Chicago Tribune []
  36. Investors and investment companies should again, do their due diligence and be vigilant against scams.  For example, the SEC recently halted aninvestment scheme from an American (Anshoo Sethi) who fraudulently collected $11 million in fees from Chinese nationals seeking EB-5 visas.  See SEC Halts $150 Million Investment Scheme to Dupe Foreign Investors and Exploit Immigration Program from the SEC []
  37. This is not to say that all high-networth individuals (HNWI) become foreign citizens.  According to Boston Consulting Group, only 6% HNWI actually take up foreign citizenship.  One reason why is because of tax laws (e.g., US taxes income on a global level) and another is due to political considerations.  For instance, Zong Qinghou, one of the wealthiest persons in China gave up his US permanent residency after receiving criticism as having dual loyalties (he is a representative of the National People’s Congress).  It may also be cheaper to purchase investor visas and gain permanent residency through new programs offered in Europe (e.g., permanent residency in Cyprus is roughly $300,000 which is significantly cheaper than similar programs in the US and Canada).  See Why Some Chinese Should Rethink Value of Green Card from The Wall Street Journal and Why Wealthy Chinese Are Giving Up U.S. Green Cards from The Wall Street Journal []
  38. Foreigners to get key rights from China Daily []
  39. In his book The World is Flat, Thomas Friedman details the Indian brain-drain.  More than 100,000 Indians — most of whom are highly trained — emigrate to the United States each year.  A 2001 UN Development Report found that the “average total cost to India of educating each one of them was between $15,000 and $20,000.”  In turn, hundreds of these Indians create startups.  In fact, immigrants from India founded “more tech startups from 1995 to 2005 than people from the four next biggest sources — United Kingdom, China, Taiwan and Japan — combined.”  See Brain drain costs developing countries billions from CNN and Immigrants Behind 25 Percent of Startups from The Associated Press []
  40. 1,333 doctors migrated abroad last year from The Times of India []
  41. See China boosts investment in grassroots healthcare from China Daily and Are China’s Doctors About to Get a Major Salary Bump? from Asia Healthcare Blog []
  42. Heroes dare to cross from The Economist []
  43. Ibid []
  44. In Crisis of Abundance, Arnold Kling notes that when a patient has a cold or broken arm, that does not mean the patient necessarily needs to have immediate access to the most experienced doctor’s from the Mayo Clinic or Johns Hopkins.  Not every condition requires having a ‘Cadillac’ doctor.  And in many cases a patient could be fully served by a nurse or physician’s assistant – thus freeing scarce resources (doctor’s) to work with other patients.  Since medical professionals and medicines are all finite, scarce resources, allocating them has become the topic du jour.  A market-based allocation method involves prices and price signals that arise via interaction between market participants (entrepreneurs, investors, customers, suppliers) which continuously reflect supply and demand and would rationally allocate medical professionals in the most efficient manner (e.g., higher costs, lower usage; lower costs, higher usage).  Conversely, because central planners would subsidize and reduce the cost of an activity, more of those resources are being bid on – ultimately outstripping the supply of the resources.  Thus attempting to rationalize identical resources without organic prices effectively makes planners ‘blind’ – they cannot coordinate and know how, where or when to allocate resources.  All decisions would be made arbitrarily.  See What’s Really Wrong with the Healthcare Industry by Vijay Boyapati and Economic Calculation in the Socialist Commonwealth by Ludwig von Mises []
  45. Hospitals in China resist bid to reform drug sales from South China Morning Post []
  46. Doctor removes patient’s stitches immediately following surgery from Global Times []
  47. China plans new medical payment system from China Daily []
  48. In economic terms part of the costs are due to “rent-seeking” by monopolies and by other special interest groups through another term called “regulatory capture.”  See Rent Seeking: Some Conceptual Problems and Implications by E.C. Pasour and The Theory of Economic Regulation from George Stigler []
  49. Milton Friedman and other economists have explained that “price ceilings” (e.g., price controls) cannot inherently work due to the fact that the inputs and economic fundamentals underlying the demand for a product or service have not changed when artificial ceilings are implemented.  For example, if demand remains constant yet supply or the price at which suppliers are willing and able to provide a good or service decreases then a shortage will occur.  See An Interview with Milton Friedman by Russ Roberts and Price Controls by Hugh Rockoff []
  50. See Rent Seeking: Some Conceptual Problems and Implications by E.C. Pasour and Rent Seeking from David Henderson []
  51. Another source explained that many of these billing companies are set up in Anhui because its provincial tax codes are more competitive than others on the mainland with this specific industry.  This is different than the Anhui pricing model which was discussed in Anhui medicine wrong for China and The Stakeholders in China’s Hospital Reform both by Benjamin Shobert []
  52. Forty Centuries of Wage and Price Controls by Robert Schuettinger and Eamonn Butler []
  53. The Problem of Social Cost by Ronald Coase []
  54. China’s Pharmaceutical Price Policies and Practices by Ziyang Wang []
  55. This is very similar to how command economies of the Eastern Bloc and Soviet Union directly removed incentives like “profit,” replacing them with an arbitrarily set quota-based system. []
  56. China’s Medical Boom from TIME []
  57. See China opens door to foreign-owned hospitals from China.org.cn and China Opens the Door for Foreign Healthcare Providers from International Insurance News []
  58. United Family Healthcare and ParkwayHealth []
  59. Another industry first is a new home medical care service from UFH which includes doctor’s visits direct to customer homes.  See United Family Home Health []
  60. A bronchofiberoscopy-associated outbreak of multidrug-resistant Acinetobacter baumannii in an intensive care unit in Beijing, China from Xia et al. []
  61. See Antibiotics: Killing Off Beneficial Bacteria … for Good? from Wired, Gut-Bacteria Mapping Finds Three Global Varieties from Wired and The Wired Atlas of the Human Ecosystem from Wired []
  62. See Overuse of antibiotics concerns officials from Xinhua, Chinese ministry, WHO warn of antibiotic overuse from Associated Press, China further curbs overuse of antibiotics from China Daily, Government warns over antibiotic misuse from China Daily and Shanghai researchers discover how bacteria develop antibiotic resistance from South China Morning Post []
  63. When Penicillin Pays: Why China Loves Antibiotics a Little Too Much from TIME []
  64. Roberta Lipson, the founder of Chindex, was recently interviewed by AM 774 and noted that among other things, that it took some time to convince local doctors to give up their “iron rice bowl” (e.g., state employment for life) to work at the private facilities (xià hǎi).  Similarly it was a struggle at first to get Western medical practitioners to give-up their careers and move to Beijing and other UFH facilities.  See Thirty three years working within health care providing in China from AM 774 and The golden rice-bowl from The Economist []
  65. Private hospitals begin to nurse big ambitions from China Daily []
  66. Ibid []
  67. Another opportunity could be for manufacturers of ambulances and EMT equipment.  According to one report, Beijing needs 600 ambulances but is 100 short and thus ‘black ambulances’ have attempted to fill in this gap, much to the chagrin of various stakeholders.  See Shining a Light on Beijing’s Deadly ‘Black Ambulances’ from The Wall Street Journal []
  68. Private hospitals in China can’t tell tea from pee: report from Want China Times []
  69. Scandal brews over China tea-for-urine samples from Reuters []
  70. Doctor detained over NE China hepatitis C case from Xinhua []
  71. Chinese Healthcare Deals in Short Supply from The Wall Street Journal []
  72. See Healthcare in China: Entering uncharted waters from McKinsey & Co., Part 3: McKinsey Evaluates the Private Hospital market in China from Asia Healthcare Blog and Organized healthcare delivery should be the future of private healthcare, in China from Asia Healthcare Blog []
  73. Healthcare in China-A Trip to the Orient from Medical Tourism Magazine []
  74. Hong Kong to slam door on pregnant mainland Chinese from Reuters []
  75. Hong Kong to Limit Birth Quota for Mainland Chinese Mothers from NTD []
  76. Mainland Moms Get Jail Time in Hong Kong from The Wall Street Journal []
  77. Born in the U.S.A.: Birth tourists get instant U.S. citizenship for their newborns from NBC []
  78. See For many pregnant Chinese, a U.S. passport for baby remains a powerful lure from The Washington Post and Pregnant and Bound for America: Why Chinese Moms Want to Give Birth on U.S. Soil from TIME []
  79. Chinese birth tourism booms in Southern California from San Francisco Gate []
  80. Born in the U.S.A.: Birth tourists get instant U.S. citizenship for their newborns from NBC []
  81. “Maternity Tourism”: How Chinese couples buy U.S. citizenship for their babies from CBS []
  82. See High risks behind Chinese mothers’ giving birth in US from People’s Daily and Parents deliver US citizenship from China Daily []
  83. While the typical goal for this form of medical tourism is to provide an alternative educational and lifestyle plan for their children (e.g., allowing the easier access to US institutions) some of these children are actually raised on the mainland for many years while their parents work abroad.  See Left-behind American children in China from Offbeat China []
  84. Born In The U.S.A.? Some Chinese Plan It That Way from NPR []
  85. Born in the U.S.A.: Birth tourists get instant U.S. citizenship for their newborns from NBC []
  86. U.S. Hospitals Worth The Trip from Forbes []
  87. According to the National Center for Health Statistics, “births of babies on American soil to foreign mothers increased from 5,009 births in 2000 to 7,462 births in 2008.”  See Born in the U.S.A.: Birth tourists get instant U.S. citizenship for their newborns from NBC []

Chapter 20 – VPN and infrastructure services

[Note: below is Chapter 20 from Great Wall of Numbers]

Any company wanting to conduct international business on the mainland, irrespective of whether it is local or foreign, must invariably factor in the additional costs of communicating electronically beyond the mainland.  Beginning in 1996 and launching in 1999, the Ministry of Public Security and other governmental organizations began implementing and enforcing a series of regulations involving data filtering that ultimately matured into what is commonly referred to as the “Great Firewall” (GFW).12 Collectively, the types of filtering techniques employed by the Ministry through Tier 1 ISPs (all SOEs as noted in Chapter 15) include: IP blocking, DNS filtering, URL filtering, packet filtering and connection resets.  Simultaneously, the Ministry maintains a continuously updated “black list” of websites that mainland users are unable to access through this dynamic filtering and blocking mechanism.

This presents an opportunity to virtual private network (VPN) providers overseas.  A VPN is a type of technology that effectively creates a secure tunnel from one computer to another, isolating its data stream from the surrounding traffic.  This can be done by means of encryption and as a consequence many banks, financial institutions and national security centers – irrespective of the region or hemisphere – typically use some form of VPN to securely communicate with outside parties (e.g., for wiring money, discussing trade secrets, or diplomacy).3

There is no shortage of VPN providers in Western countries and there are in fact, Chinese-based VPN providers as well – the efficacy and reliability of which is debatable.4 In my own anecdotal experience, even with a paid service based in a foreign country, data can still be throttled and your connection reset.5 One reason is that the GFW is not a passive system – it is continually tweaked and changed.  In an interview in 2011, Fang Binxing, the Father of the Great Firewall explained that he himself has “six VPNs on my home computer.”6 He uses them to “test which side wins: the GFW or the VPN.”  And in his opinion, “[s]o far, the GFW is lagging behind and still needs improvement.”7

One world, two internets

As I mentioned in Chapter 12, while there are any number of domestically made and managed counterparts and clones of foreign social media services (e.g., Sina Weibo is the equivalent to Twitter), there is still niche demand for foreign-based web services.  For example, as I mentioned in Chapter 9, there are now about a million Chinese students studying overseas each year; more than 190,000 Chinese students studied in the US this past year alone.8 In addition, 1.36 million Chinese tourists visited the US in 2011.9 What this means is that as I mentioned in Chapter 3, Chinese consumers are increasingly exposed to Western and in particular, American tastes and services.

Yet to temper the optimism that a VPN provider could immediately sell several million service packages to individual mainlanders, consider this rough facsimile: while we may never know the real number, Facebook’s own indirect estimate of mainland usage of its social network is close to 600,000.10 While there are a number of other niche services in demand, especially from financial service firms, this 600,000 number can be used as a proxy to estimate the general demand for VPNs.

It should also be noted that not all foreigners use Facebook in China nor do all foreigners want to pay for a VPN to access it.  Furthermore, based on my own anecdotal experience at various institutions, the average Chinese user does not currently have access to a VPN or other fan qiang (“Wall Climbing”) software such as UltraSurf or Hotspot.  In their mind, why should they have to pay to access foreign services when there is a similar Chinese version available for free?  This is not to say that they could not gain access to the services if they were motivated and inclined to do so.  In my own anecdotal experience virtually none of the several thousand students I have had at various cities on the mainland over the past four years have had active Facebook accounts.  A few however have had VPN accounts so they could play online games like World of Warcraft on servers outside the mainland (e.g., “gold farmers,” see Chapter 14).11

Assuming the number is around 600,000, how much can a foreign-based service provider expect to generate?  Currently, the average monthly rates at PandaPow, Astril and most others are roughly $10 a month.12 And because a large portion of a VPN package is based on software that is open-source and free, the initial setup costs are minimal.13 Yet bandwidth charges, hardware purchases, customer support labor and utilities charges all vary and will depend on how large you plan to scale your company to.  Thus before investing in this segment, do your due diligence.

Entrepreneurs should also consider this: Bill Bishop has cogently noted numerous times over the past several years that while mainland users are effectively prevented from using some foreign web services, the mainland equivalents are not only more easily accessible and relatively comparable (e.g. same features), but the interconnectivity issues (e.g., latency, bandwidth) with them are relatively muted.14  In other words, assuming you have access to a VPN, it is still more convenient for mainland based users to stream videos on Youku than it would be to stream from Youtube because of the increased bandwidth throughput and reduced lag due to closer proximities to the content delivery networks (CDNs) for Youku-like providers such as ChinaCache.15 David Wolf, a partner at Allison+Partners (a consulting firm) echoed similar reasoning recently in an interview with The Wall Street Journal, noting that “What they [national government] prefer is that Chinese users decide it is just too much trouble and by default use onshore sites, or sites that are mirrored onshore.”16 As a consequence, because of the sheer size of the Chinese-based internet (see Chapter 12 and Chapter 13), there is now “one world, two internets.”17

Climbing the wall

I spoke with security expert David Veksler (see also Chapter 13), CEO of CryptAByte, who has given security workshops and seminars about these issues.18 In his view, “the GFW presents a fundamental problem for domestic researchers.  Because significantly large portions of foreign-based information are blocked and denied, only researchers with VPNs are able to keep up-to-date with their foreign counterparts.  Those without VPNs are left trying to use Google which is frequently blocked and misdirected or Baidu, which outputs few useful or useable results.  Thus they become discouraged, often times quitting and are ultimately unable to do the necessary research – idea investigations – for innovation.”

How does this create opportunities?  According to Veksler, this ties into another Catch-22 that domestic firms find themselves in, this endless cycle of benchmarking and cloning.  That irrespective as to whether or not they want to innovate, they are in a prisoner’s dilemma, “every competitor on the mainland expects to have the lowest costs.  Yet if they increase their research and development – creating higher quality products – consumers do not believe them, because consumers also expect that domestic companies are cutting corners, so why pay extra for a product that is probably just the same as the rest?”

He also likens this dilemma to a game theory scenario: the first domestic company to make that leap into quality is punished because consumers simply do not trust the product quality due to a history of scandals.  Thus any firm that does it is unable to recoup the capital costs of the research and development.  In contrast, foreign companies have spent decades building up their brands and reputations based on quality control programs (e.g., Six Sigma) and as a consequence are readily more trusted on the mainland.  Yet he remains optimistic, “the first domestic company to make a concerted, long-term leap into quality will not only be monetarily successful, but will help end this never ending cycle of benchmarking and cloning.”

Thus Veksler thinks that foreign brand managers, experts like Matt Garner, will be able to find opportunities to work within the entire spectrum of industries as their participants build national and internationalization expansion plans.

Chicken and egg problem

It is hard to measure the impact that an apparatus like the GFW has on productivity and creativity which business start-ups should take into consideration.  Consider Silicon Valley and Moore’s Law.  Much like other projects and mian zi gong cheng, there have been several public initiatives to replicate Silicon Valley in China, such as Zhongguancun in Beijing.  And yet for every successful start-up like iQiyi or venture capitalist like Kai-Fu Lee (see Chapter 12), large quantities of resources have been misallocated towards supercomputers that when installed – while capturing headlines for theoretical peak performances – are unable to be fully utilized because there are not enough trained software engineers to develop the sophisticated machines.19 Similarly despite 2 billion RMB ($320 million) in investment since 2010, Jike, a new search engine developed by People’s Daily (an SOE) has managed to capture a mere 0.0001% marketshare forcing the organization to lay off 20% of its staff.20

Empirically speaking, if central planners were to be the creators of Silicon Valley, they would have created Silicon Valley.  If central planners were to be the creators of Moore’s Law, they would have created Moore’s Law.2122 For example, the Soviets spent decades and relatively large budgets to overtake the West in computing innovations, yet failed at every turn.  In fact, it was not just one or two half-hearted attempts, it was a concerted effort directed from the top.  Mikhail Gorbachev himself made advancements in microprocessor technology a cornerstone part of Perestroikain 1985 (encompassing the 14th Five Year Plan).

Just how much effort was put into their centrally planned machine industry? Consider what the USSR tech industry was like circa 1988:

Machine building is the sector of industry on which Gorbachev is relying to ensure the success of his [Perestroika] strategy.  The hub of Soviet [computing] industry, this complex employs over 16 million workers at more than 9,000 research institutes, design bureaus, and production and enterprises, and is responsible for designing, developing, and producing over one-fourth of the country’s industrial output.  Of the 17 industrial ministries that make up the machine-building complex (detailed in foldout at back of paper), nine — collectively referred to as the defense industry — specialize in military hardware. The other eight produce primarily consumer goods and equipment for investment in the civil sector.23

Gorbachev recognized that “a high-investment, high-growth strategy must, at a minimum, continue through at least the first few years of the period to renew the sector’s capital stock.”  Yet ultimately, the Soviets tried, consumed their capital base, and failed.2425 Instead, hundreds of private companies, entrepreneurs, venture capitalists, designers, and one relatively free market created a semiconductor industry that accounts for the number one export of the United States.26 Furthermore, this is not to say that technological activity will not take place in China, nor that Chinese institutions and researchers will not produce usable technology.  The question is rather, can it be cutting edge and innovative?  And if your firm hopes to tap into the innovation potential of the mainland, how does this impact your firms’ investment?

Many of these artificial technology and science research parks conflate cause and effect.  For example, during World War II, the Allies used Pacific islands as forward operating bases to protect their overseas supply routes.  On many of the islands the Allied forces built airstrips, including one on Vanuatu.  Following post-war demilitarization, most of these islands were vacated as the warring militaries returned home.  On Vanuatu, many of the islanders wanted the supply ships to return and provide modern goods to their pre-industrial society.  As a consequence, the islanders staged “drills” and “marches” with mock soldiers while others attempted to man the airstrips – all under the belief that it is these superficial motions and actions that originally brought the Western supplies.  Richard Feynman dubbed this “cargo cultism” (e.g., a cult that dreamt of Western cargo).27

In November 2012 I spoke with Mark Thornton, an economist at the Ludwig von Mises Institute and an expert in the boom-bust investment cycle.28  According to him, “Research parks are all about inventing technology for commercial and other purposes. Generally we are speaking of higher order goods, the types of goods associated with the boom phase of the business cycle. Therefore we would expect that research park projects tend to be established during booms when profits are high, the cost of capital is low, and where retained earnings are more than sufficient to support additional projects. If research parks are established at or near the peak in the business cycle then it would be wise to avoid contracting with research parks that have few tenants.  Traditionally one of the main benefits of research parks is synergy.  If your research park has no tenants then you do not have the type of synergies that successful research parks generate.  New companies, new technologies and products, as well as successful research parks (e.g. Stanford Research Park and Research Triangle Park) tend to get their starts during bad economic times.  During recessions land, labor, capital are cheaper and budding entrepreneurs are more abundant.”  In economic terms, higher order goods are goods used to produce consumer goods (e.g., those which require a long-term investment such as building a factory which in turn creates consumer goods).29

Similarly, many of these research parks and endeavors – not just in China – arguably exhibit patterns of modern-day cargo cultism.  Thornton noted that, “The next Silicon Valley will not look like Silicon Valley.  It will have some new features and not have all the same features as Silicon Valley.  You cannot just build “it” and expect them to come.  Silicon Valley is more than just Stanford Research Park and Stanford University. There are tangible and intangible factors that matter. They include things like the weather, demographics, culture, and relatively limited regulatory impact from the government. Even some factors we just do not know. Government can subsidize research parks but it takes a free market and entrepreneurs to actually weave the fibers of something extremely complex like Silicon Valley.”

In fact, in the US, nearly every state has erected several tech parks with the hopes of “creating” another Silicon Valley; there are dozens of research and technology centers across the country.  This raises the question: if you build it, will they (the creative classes) come?

In February 2013 I spoke with Becky Wu a native of Jiangsu province and a project manager at Xi-Tong Scientific & Technology Industrial Park located in Nantong, Jiangsu province.30 The primary task of her job is attracting and relocating foreign firms so that they will build and setup operations in the industrial park.  According to her, “we provide incentives and subsidies to attract firms from abroad.  For example, if land prices were with 230,000 RMB per mu, depending on how promising the project is and what industry your firm is in we can lower the price to 200,000 RMB or even 150,000 per mu.  This helps attract firms, enticing them to construct their new offices in the park.  We will also provide free temporary offices for new companies for up to 6 months while their new office is being built.  The utilities are also free of charge as well.”  As noted earlier in Chapter 3, a mu is 1/6th of an acre.

Wu also explained that there are other rebates and training subsidies that firms can receive.  She noted that, “we also offer new companies subsidies for research and to train personnel that can be allocated and spent without strings attached.  For example, we can provide up to $1,000 a year per person, up to 10 people to help offset training and research costs.  In terms of income taxes, we provide rebates to specific workers, typically managers and high-level executives for 3-5 years.  The way this works is that if you have to pay 100 RMB in taxes, 60% goes to the central government, 8% goes to the provincial government, the remaining portion goes to Nantong, thus we at the park can reimburse the remaining 32% back to you.”  Clients such as Caterpillar, BIC, Accuma and Kopron have taken advantage of these incentives over the past several years.

Does the return-on-investment pay for the capital expenditures which were originally expended?  While it is impossible to say yes or no for all the cases, what can be said is that the GFW itself probably does not create innovation, foster creativity or act as an incentive to attracting outside talent.  If it did, the Chinese computing industry would not be reliant on Western semiconductors, Western software and foreign know-how.31 And as a consequence, mainlanders conducting research are left using a virtual straw in order to access, view and communicate with the outside world.

How is this relevant and how does this affect your company?  Without virtual openness to new ideas, the domestic, indigenous engineering industries – while not autarchic – will probably always be laggards due to what Veksler noted above (e.g., getting frustrated and quitting).  To this point, last year the American Chamber of Commerce in Beijing conducted a survey of its members, “nearly three-quarters of about 300 businesses it surveyed said unstable Internet access impedes their efficiency. About 40% said China’s censorship efforts have a negative business impact.”32 Similarly, economist Arthur Kroeber, founder of Dragonomics research noted in March 2013 that one obstacle to growth is the GFW.  In his view, innovation in the modern world today comes from “the sharing of knowledge and information across a variety of fields.  Innovation comes when you take knowledge in one area and it migrates over to another area and someone comes up with a new way of using it.  China seems to have a political system that mentally at its core is opposed to those networks ever becoming viable.”33 Thus, in addition to the issues raised in Chapter 15, this obstacle is another consideration that all firms looking to recruit talent must take account for.34

While there are occasional opportunities and projects like “1,000 talents” (mentioned in Chapter 9 and Chapter 15) that provide monetary and other perks and incentives to relocate, these well-intentioned plans may be unable to offset the hurdles created by the GFW and as a consequence there has been a “brain drain” that all firms and HR departments should be aware of.35

Yet to be even handed, Larry Chang mentions that he works within this system on purpose because it is “an untapped opportunity.”  He only hires fresh mainland graduates with the sole purpose of building an indigenous software industry.  And in his opinion, with more than 6 million college students graduating each year, there are bound to be creative, outside-the-box thinkers.  Similarly, at the 2013 Unleashing Innovation conference recently held in Singapore, Ya-Qin Zhang, chairman of Microsoft’s Asia Pacific research and development group, noted that “Chinese engineers are well equipped to produce the kind of innovative work that their more illustrious American rivals are renowned for” and continued with, “[t]he scale of innovators and the scale of the market will converge and eventually make China a key [innovation] center in the region.”36 Thus it may just be a matter of time before the right combination of inputs brings about the transition up the value chain as described in Chapter 7.

Opportunities in the rough

Again, even with these seemingly insurmountable challenges there are also opportunities.  For example, as I noted in Chapter 17, foreign architects are in high demand to help build and design buildings, bridges and even office parks.  Perhaps your firm can find new revenue streams by helping to build out domestic content delivery networks (CDNs) and cloud computing initiatives that are part of these technology parks.  As I mentioned in Chapter 13, according to IDC, $286 million was spent on cloud-computing infrastructure in China in 2011 and this is expected to increase to $1 billion by 2016.37 And this segment is quickly professionalizing, for example, ChinaCache is the largest CDN on the mainland with 53% of the marketshare.38 It was initially funded by the likes of Intel and is now listed on NASDAQ.

Another opportunity is with corporate VPNs.  While the individual market may seem like a logical way to establish a steady revenue stream, according to David Veksler, corporate enterprises – both domestic and foreign – will eventually want and need to have VPNs to secure their communication with clients, vendors and essentially anyone.  Irrespective of the GFW, Veksler’s own estimate is that there is an unlimited amount of potential growth for VPNs because very few domestic firms currently recognize the need to protect their assets.  But Veskler suggests, “this attitude will probably change, due to the increasing security vulnerabilities publicly acknowledged by even the largest of enterprises.”

But there is also a challenge regarding foreign owned and run VPNs on the mainland, as the Global Times recently quoted Fang Binxing (father of the GFW as noted above) that, “[u]nregistered VPN service providers are not protected by Chinese laws, and any company running a VPN business should realize they have a responsibility to register.”39 More directly, an employee in the Ministry of Industry and Information Technology pointed out in the same report that, “only Chinese companies and Sino-foreign joint ventures can apply to establish a VPN business.”  This is not to say that is illegal to connect to a VPN outside of the mainland.  Currently there are no laws which prohibit users in China from connecting to an overseas VPN.40

In December 2012 I spoke with an American executive at a large IT company that provides dedicated internet connections to enterprises and institutions primarily in Tier 1 cities.  According to him, “no foreign IT company and few domestic companies advertise their VPN services yet many of them will bundle it as part of a package to corporate clients.  Furthermore, Chinese regulators typically permit VPNs so as long as it is privately – not publicly – accessible as well as the stipulation that consumers use leased-lines.  A typical dedicated leased-line will cost over 3,000 RMB a month for 1 mb/s, this scales linearly (e.g., if you need 4 mb/s you are charged around 12,000 RMB), thus this option is typically out of reach by most consumers outside of the corporate and foreign communities.  In addition, you can find a number of local firms that will provide point-to-point VPN services within the mainland.  So if you are an expat that works for a foreign company that operates a VPN network elsewhere, then you will be able to securely connect from your local VPN to their secure environment overseas.”

Similarly, as an entrepreneur you can utilize these tech parks in China since they are not going to disappear overnight, if ever.  For example, Larry Chang merged all company divisions under one roof in a research park located on a campus of a local college in Changning, Shanghai.  His firm was provided incentives such as reduced rental rates for doing so.  Similarly, Richard Qi mentioned that a new area in Shanghai called Cloud City – a tech park – provides perks and benefits to foreign software, engineering and IT firms.  For example, Cloud City provides discounted office property, assistance in communicating with governmental organizations, stipends form the government and as the name-sake suggests, access to cloud services.  Prior to relocating to this tech park, Qi mentioned that it was often difficult as a foreign service provider to issue invoices because of unclear laws (e.g., Shanghai and other municipalities are currently transitioning from a business tax to a VAT) and it was hard to find the government contacts needed to settle these transactions.  In addition, perhaps your software or semiconductor firm can also take advantage of these inducements created by the 2011 policy which provides a tax holiday for several years, reduces the subsequent tax rates and provides exemptions on profits.41

Takeaway:  Due to a variety of regulations and policies on the mainland, certain telecommunication restrictions have germinated into a formidable barrier called the GFW.  And with several million technologically-inclined consumers familiar with Western tastes and styles, there exists a potentially new customer base for VPN service providers.  Yet just because there is potential for growth does not necessarily mean that the potential customers will purchase your goods and services (e.g., “if you build it, will they come?”).


Endnotes:

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  1. According to Fang Binxing, the ‘Father of the Great Firewall,’ it was “reportedly launched in 1998 [and] came online about 2003.”  See Great Firewall father speaks out from Global Times []
  2. Splinternet Behind the Great Firewall of China from Association for Computing Machinery []
  3. To bypass copyright restrictions, VPN uptake has increased over the past several years in several Western countries, as consumers move to alternative methods for downloading copyrighted content.  According to a study from Lund University in Sweden, there has “been a 40% rise in the number of 15 to 25-year-olds using such [VPN] services since 2009.”  See File-sharers look to VPNs to overcome Pirate Bay ban from BBC []
  4. Even with encryption algorithms like AES, third parties which have direct access to even one end of a data stream can conduct packet sniffing and other “side channel” attacks. []
  5. See Five Myths about the Chinese Internet from Foreign Policy and Florida pet spa mystery link to China’s great firewall from New Scientist []
  6. Great Firewall father speaks out from Global Times []
  7. In January 2013, Han Weili, a software instructor at Fudan University in Shanghai publicly solicited applications for employment to improve the GFW.  In his view there are two problems with the GFW technology, “The first is a lack of transparency in strategy, the second is that Great Firewall strategy execution has a false-report rate that is too high.”  See Great Firewall Engineer Han Weili Calls for Job Applications from Fei Chang Dao []
  8. 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 []
  9. Chinese tourists spend more in US in 2011 from China Daily []
  10. No, Facebook does not have 63.5 million active users in China from The Next Web []
  11. Approximately half of World of Warcraft’s 10-12 million userbase is estimated to be from mainland China.  See “Gold Farming”: Real-World Production in Developing Countries for the Virtual Economies of Online Games by Richard Heeks and Converting the Virtual Economy into Development Potential: Knowledge Map of the Virtual Economy from the World Bank []
  12. Disclosure: I do not currently have any stakes in these products, services or companies.  See Testing five VPNs that’ll get you back on YouTube, Facebook in China from c|net []
  13. A user can remotely set up their own VPN practically anywhere using software such as OpenVPN.  The primary key issue is locating a computer outside of the mainland where it can be installed on and reliably connected to. []
  14. Sinocism []
  15. To better understand the importance of CDNs see, Google and Netflix Make Land Grab On Edge Of Internet from Wired []
  16. China’s ‘Wall’ Hits Business from The Wall Street Journal []
  17. See One World, Two Internets by Bill Bishop and Iran’s network in a bottle from The Boston Globe []
  18. CryptAByte []
  19. According to one estimate regarding software application investment for supercomputers in China, “Less than 10% of supercomputing funding goes to developing such applications, said Chinese researchers who complain that political leaders press them to build headline-grabbing new machines rather than focus on whether they are used to their full capabilities.”  See China’s Not-So-Super Computers from The Wall Street Journal []
  20. See People’s Search Engine Denies Layoff Rumors; Says More Jobs Open from Caijing, Jike’s attempt to censor news about its 0.0001% market share has backfired from Shanghaiist and You’ve been Jiked! from China Media Project []
  21. Debt as Tall as Dubai, or How the Singularity Is Not a Guaranteed Phenomenon by Tim Swanson []
  22. They cannot a priori due to the economic calculation problem.  See Economic Calculation In The Socialist Commonwealth by Ludwig von Mises []
  23. The Soviet Machine-Building Complex: Perestroyka’s Sputtering Engine from the Office of Soviet Analysis published by the Directorate of Intelligence []
  24. Throughout its existence the Soviet Union tried to incorporate technology in its Pyatiletka — Five Year Plans.  They even tried to recreate Silicon Valley through the construction of numerous science and research parks called Naukograd.  Numerous other countries have also tried to emulate the success of the Bay Area with little measurable return-on-investment; this includes Silicon Taiga in Novosibirsk.  The Soviet Union was unable to incubate something akin to Moore’s Law for the same reason the Soviet Union ultimately failed: without prices, you cannot make efficient allocation decisions.  Prices only arise from market interactions, through profit and loss — which signal to entrepreneurs when to buy, sell, trade, and invest capital.  Without this organic knowledge Soviet planners were left using arbitrary coefficients to plug into their various economic models with the net result: planned chaos.  See Planned Chaos by Ludwig von Mises. []
  25. One frequently cited myth regarding Japan is that it was successful in its attempts to centrally plan scientific innovation.  This is untrue.  See The Fifth Generation Fallacy by J. Marshall Unger.  See also Chapter 9 in Animal Spirits with Chinese Characteristics by Mark DeWeaver []
  26. According to the Semiconductor Industry Association, “three quarters” of all semiconductor design and manufacturing takes place in the United States and that 82% of semiconductor sales are outside the United States.  See America’s #1 Export Industry Applauds Passage of Free Trade Agreements from the Semiconductor Industry Association []
  27. See Cargo Cult Science by Richard Feynman and In John They Trust from Smithsonian []
  28. Skyscrapers and Business Cycles by Mark Thornton []
  29. See Chapter 1 in Principles of Economics by Carl Menger and Chapter 16 in Human Action by Ludwig von Mises []
  30. Xi-Tong Scientific & Technology Industrial Park []
  31. According to recent reports, Chinese policy makers are attempting to build a 100-petaflop supercomputer which would be five times faster than the current record holder (Titan).  As part of this plan, Zhang Yunquan, a professor at the Institute of Software Chinese Academy of Sciences, noted that domestically designed chips may be used.  These domestic chips, called Loongson are based on MIPS, a chip design developed by a Sunnyvalle-based technology firm (MIPS Technologies).  Similarly, Chinese policy makers are frustrated by the fact that Android (which is managed by Google) has the lion’s share of marketshare and would prefer to have a domestic, homegrown OS used by smartphone makers instead.  See China is building a 100-petaflop supercomputer from IT World, China’s godson gamble from IEEE SpectrumWhy China Can’t Make Its Own Mobile OS from Tech In Asia and Google controls too much of China’s smartphone sector: ministry from Reuters []
  32. China’s ‘Wall’ Hits Business from The Wall Street Journal []
  33. Economist: China Plenty Creative, Just Not in Right Ways from The Wall Street Journal []
  34. China’s self-defeating war with information by Andy Yee []
  35. See Rich Chinese want to buy happiness — by emigrating from Los Angeles Times and Wary of Future, Professionals Leave China in Record Numbers from The New York Times []
  36. Microsoft’s Zhang Sees China as Asia’s Innovation Center from The Wall Street Journal []
  37. Cloud computing investment ‘to hit $1b’ from China Daily []
  38. ChinaCache investor relations []
  39. Foreign-run VPNs illegal in China: govt from Global Times []
  40. Adding Some Key Facts In WSJ.com’s China’s Internet ‘Wall’ Hits Business Article from VPN Instructions []
  41. China offers new incentives to further boost software and semiconductor industries by Peng Tao []

Chapter 21 – Synthesis and implementation

[Note: below is Chapter 21 from Great Wall of Numbers]

Now that you have seen a snapshot of the mainland economy and have had a chance to become acquainted with a number of industries, it is time to figure out how to transform this knowledge and information into a practical business plan.

After you begin to do your due diligence by conducting market research and performing a SWOT analysis (strengths, weaknesses, opportunities and threats), the very next step you can immediately take is to set up social media accounts as described in Chapter 12.  If you are unable to read Chinese, there are a number of free online tutorials that will guide you through a step-by-step process.  For example, it is highly recommended that you create a Sina Weibo account because it is the 2nd largest microblog (with over 500 million accounts) and also because Twitter is currently blocked on the mainland.12 And even though it is more person-to-person (in contrast to the mass publication ability of Weibo) because of its rapid adoption, foreign firms are also encouraged to set up a WeChat (Weixin) account due to the huge penetration rate (300 million users just over 2 years).3 In addition, you can download and use the English version of QQ instant messenger.4 As I noted in Chapter 12, QQ is the world’s largest instant messaging tool, with over 700 million users.

Once you have these two tools, you can begin to communicate with an entirely new customer base about your goods and services.  And as I detailed in Chapter 12 your marketing team may even be able to utilize other sites like Youku (the leading video streaming site) as well as Pinterest (and its many clones) to help promote your brand and wares.

In addition, for other perspectives, there are several resources published the China-based foreign business community, including the American Chamber of Commerce in Shanghai, the American Chamber of Commerce in Beijing and the European Union Chamber of Commerce.5 Each of these organizations publishes insights, surveys and original research that helps illustrate the market conditions – the opportunities and challenges – on the mainland.

Questions and answers

The very first question at the beginning of this book was, should you and your company come to China?

While your own perception of the mainland may be influenced by both bullish and bearish commentary, the real answer to this question differs from case to case.  There is no a priori answer for entrepreneurs.  In addition, there are several other questions that you should ask before you and your company make any significant decisions.

For instance, what goods or services does your company produce that someone in China would want?  What is the return-on-investment of opening a hotel, restaurant or retailer on the mainland?  What are the licensing requirements for foreign businesses?6 What are some of the legal risks and uncertainties that foreign firms commonly face?

And again, while I provided a number of statistics, stories and anecdotes to address these questions, I would encourage all foreign companies to also consider these Do’s and Don’ts.

–          If you hire outside consultants to conduct market research on the mainland, do your own in-house-based research as well.  You do not get heart surgery without a second opinion, nor should you invest capital based on one report.

–          Do not invest in China just because you heard an analyst on TV or the radio tell you too.  Many analysts “talk their own book” and have other interests at play (e.g., cui bono).  Wishful thinking can be a powerful opiate; and those predicting absolute certain futures would be wise to pay heed to what Niels Bohr once quipped: prediction is very difficult, especially about the future.7

–          If you plan to actually do anything on the mainland that involves contracts, technology transfers or corporate structures, be sure to consult with a legal expert (see Chapter 10).  Do not risk losing your assets or being cut out by suppliers because you think you understand the Chinese legal system.

–          Do not invest on the mainland simply because you want to diversify due to recessions in other parts of the world or merely because hope it will be better elsewhere.  Your ventures and stakes are not a guaranteed success merely because the geographical location is different.  Why risk your capital without doing the due diligence first?

While you may feel the urge to jump headfirst into this new marketplace, recall what the late Coach Wooden said: failing to prepare is simply preparing to fail.  And if you recall the first story in Chapter 1 from Jim Chanos, even with due diligence and cultural fluency you may run into challenges that are seemingly insurmountable.  While there may be any number of other cliché truisms to repeat, there are arguably no long-term downsides to being over prepared – better safe than sorry.

Flowchart

You and your management team can, in the space of an hour, put together a simple step-by-step guide to moving into the Chinese marketplace.  Below is an example of commonly asked questions and answers that based on several chapters of this book.  The numbering and order is entirely arbitrary and will change depending on each company and market segment.

Figure 1:

Flowchart

There can be any number of other questions and decision trees.  This is merely an illustration of the thought processes you and your colleagues can consider as you put together a China strategy.

And finally, recall the Voltaire quote at the beginning of the book, about “the best.”  You and your company do not have to be the best nor do you have to create the best business model.  In some cases you can just be good enough.  After all, your new local competition has succeeded and they did that without – by and large – attending professional Western business schools.  If they can do that, perhaps you can too.

Takeaway: With the information, cases and examples provided in the preceding chapters, the transition from knowledge to practice is now paramount.  And while there any number of ways to practice and implement a plan, fully understanding you and your company’s comparative strengths, weaknesses, opportunities and threats in a new marketplace is both risky and potentially rewarding.  Tempering your enthusiasm with not just statistical facts but also advice from experienced professionals should be part of the strategic plan of any firm wanting to do business in China.


Endnotes:

 

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  1. For a step-by-step guide to setting up a Sina Weibo account for your brand, see: Creating an account on Sina Weibo and How to sign up for Sina Weibo blog []
  2. Monetizing your companies fan base from social media sites like Sina Weibo is a challenge recently discussed by Ken Hong, the general manager of the Sina Weibo platform at Sina.  See Turning Brand Fans into BFFs from Thoughtful China []
  3. See Tencent’s WeChat messaging app passes 300m users, adding its latest 100m in just 4 months from The Next Web, Tencent: WeChat App Set to Surpass 300 Million Users Next Month from Tech In Asia and Weixin Users Exceeded 200 Million from China Internet Watch []
  4. The default language is English: QQ international []
  5. For references see: AmCham Shanghai, AmCham Beijing,