1. INTRODUCTION
The Financial Times1 in a recently published article relates the problems of Mark Kitto, a foreign entrepreneur in China . Mark Kitto is the founder of That's Magazines, a very successful group of magazines for the expatriate community in China . By 2004 his group had achieved a yearly turnover of almost US$ 4 million and employed more than 100 staff. However, Mark Kitto was confronting a very critical situation that could endanger the continuation of his publications: in China foreigners are not allowed to own magazines. Foreigners can distribute and sell advertising but cannot be responsible for content. His company was in a kind of legal limbo. Mr. Kitto, in order to protect his investment, reached an agreement with a Chinese official to provide him with a license and therefore got the legal coverage he needed. The two started cooperating in July 2002. The license was to the Chinese official's name which left Kitto as a shadow partner of his own company. The Chinese partner provided a legal façade to the company. However, problems between them started to emerge. When the conflict between them escalated, the Chinese partner decided to take over the magazine asking Kitto to leave. To his surprise, Kitto found himself disposed of the company he had created. He is now entangled into a legal battle with little chances of winning.
This story is not uncommon, especially in those areas in which the government still keeps a strict limitation to foreign investors. Mr. Kitto saw an opportunity and took advantage of it by circumventing the law. That gave his Chinese partner the power to take advantage in case of conflict. Why did the Chinese authorities do not simply stop Mr. Kitto from starting his business in the first place? The Chinese authorities are sometimes lenient especially when they want to test new business areas to foreigners. However, this circumstance gives to unscrupulous "partners" the opportunity to take advantage of the irregular situation and take control of a business they didn't create.
In a way, the list of problems entrepreneurs and SMEs faces are somehow different from those faced by multinationals: MNCs have resources and influence that small companies don't have. If country managers of MNCs can be compared to orchestra directors with a team of professionals playing the instruments, foreign entrepreneurs are more similar to one-person orchestras, in which they compose the music, conduct the orchestra and play the instruments. International corporations have the benefit of the size, their management teams, the power of their brands and, last but not the least, their deep pockets. Entrepreneurs and SMEs lack these advantages, so they find themselves in disadvantage when confronting many of the same problems.
Let's list some of the typical problems that entrepreneurs may endure in China .
1. Bank financing
Getting bank financing to start your business is almost mission impossible. It is as difficult in China as anywhere else in the world. Most entrepreneurs start their businesses using their own funds and those of family and friends. A few still resort to Venture Capitalists. Getting bank loans to finance the company in its growth phase is also not easy in China. Banks are not professional enough to assess risks and usually resort to collaterals to protect their investments, which keeps start-ups and new companies out of the banks' business. A foreign entrepreneur exporting flowers to Europe once tried to get a bank loan. He finally got it approved but to his surprise, the bank branch manager asked for a 20% commission from him as a condition for delivering the funds. Other times, those bank managers directly ask for shares in the company their bank is financing. The main victims of this behavior are not foreign business people but mostly Chinese entrepreneurs. Of course, not all the bank managers are like this, banks in China are improving very rapidly and the situation will hopefully improve. The fact is that most foreign entrepreneurs use their own savings or the funds generated by the business to finance their operations.
2. Hiring and retaining talents
If the situation is difficult for MNCs, it is even worse for entrepreneurs. Small companies cannot offer international careers, lofty salaries, expensive training, and the prospect of becoming CEOs. They cannot offer a glamorous name to put in the business cards to impress relatives and classmates. All these factors make the war for talent a lost effort from the beginning.
3. Fighting bureaucracy
Entrepreneurs, when facing Chinese bureaucracy, don't have the power to influence decisions. Most investors remain at the mercy of the bureaucrats and their interpretation of the law. Officials can decide what is legal and what is not, they can have great power over the future of any venture. Of course, they are more cautious before using that power against the big MNCs but that is not the case with small businesses. The best advice, as one foreign entrepreneur told us, is to follow all the regulations as much as possible, and try to be under the radar. Do not attract attention by complaining too loudly or showing off on how much money you are making.
But bureaucrats represent another type of danger to the entrepreneur. It is not unusual that the government official becomes your direct competitor. Once these officials identify a successful business, they will try to enter in the competition with the advantage that they are playing on two sides as players and as referees. One entrepreneur in the passenger transportation service worked very hard to get a license to open a bus line between Beijing and Tianjin. Painstakingly, they managed to get the line approved by the authorities and started operating the route. When he proved the route was profitable, the same officials that granted him the license started their own bus company to serve the same route.
4. Finding reliable partners
As we saw in the opening story in this chapter, your Chinese partner can become your worst enemy. Partners, who help you to start the business and get the license on their name, may decide to get rid of you once the business is working well. Partners may transfer company funds to their private accounts or hire family members. It is not unusual that partners learn your technology and start a business next door to compete against you. Some foreign entrepreneurs have experienced the pitfalls, which should be learned by others.
5. IPR protection
MNCs have legal teams and other resources to fight counterfeiting and prevent piracy. Entrepreneurs, unfortunately, are usually helpless in the same situation. One foreign entrepreneur literally told me that he was leaving China after losing all his investment due to IPR problems. They copied his product and were selling it at such a low price that he could not make any profit. Another entrepreneur asked the authorities to inspect a company that was copying his product. He provided all the details for the convenience of inspection. The official in charge told him that his company was too small to bother and asked him to pay before taking any action against the infringer.
6. Dealing with local suppliers
Suppliers can be unreliable and, sometimes dangerous for the business. A case was reported by EuroBiz2 about a foreign entrepreneur who was producing furniture very successfully in China. The name of the company was Trayton Furniture. Simon Lichtenberg, founder of the company, bought leather for a total value of RMB 37 million from a company in Sichuan. Some of the material was defective so Lichtenberg returned it and asked for new material to be sent. As the Chinese company refused, the entrepreneur decided to hold back payment for RMB 3 million to make pressure on the supplier. Soon after he received a court order from a judge in the locality of the supplier freezing 3 million RMB of Trayton's accounts plus 4 million in company assets. The supplier was using his local guanxi to win the case. As Lichtenberg said, "You can have a contract but people might just not do things according to the contract, because they are not used to a society being regulated by law and contracts. At the end of the day, contracts give way to a good relationship, or connections with people in the power position." He concludes, "You might run into a supplier who says his factory is the biggest in China , and ˇ®we can do this and we can do that', but it might not even be his own factory, he's just an agent. There are tons of stories of this kind in China ."
7. Collecting payments
One of the most critical challenges for entrepreneurs is to get paid. For small business lack of payment means the death of the business.
Entrepreneurs must deal with many of the previous situations without the support of professional teams, they are practically alone. On top of that, they don't have the luxury of holidays or weekends. The work life of entrepreneurs is very demanding. One entrepreneur confessed to us that he had renounced having a family to dedicate all his energies to the business.
The previous list of problems may have seemed a little scary. However, being an entrepreneur is the lifestyle one chooses to have. Some of the problems are also common to entrepreneurs in many other countries. Besides, Chinese entrepreneurs are also facing similar challenges and problems and they are sometimes even weaker.
In the following case, you will have the opportunity to hear the real stories told by one foreign entrepreneur in China . This entrepreneur came to China as an expatriate and later became a supplier of his previous employer. Later, he started a new company quite successfully.
CASE STUDY: Personal reflections of a foreign entrepreneur in China
Robert A. Bilodeau
My name is Rob. I'm an American. I moved to Shanghai more than 12 years ago and started my first business here in 1996. That I took the path of an entrepreneur does not surprise me - it's almost a genetic trait. As a child I spent most of my summers either working at my father's own entrepreneurial businesses, or pursuing my own simple businesses- so it was inevitable that "like father, like son", I became an entrepreneur myself.
I didn't get to start my own business right after college however. I first graduated with my degree in Economics and subsequently joined the Executive Training program of a large US department store chain. I was trained initially as a Department Sales Manager and quickly moved up the ranks to the Merchandising Division as a Buyer. By the middle of my fourth year however, I had become disillusioned with "Corporate Life" and left to work for one of my suppliers. The new employer was a much smaller, family-owned company that manufactured small bags, gifts, and accessories, and whose initial success had come from early outsourcing of its production to China . In fact, the company had been fully engaged with China since the early 80's.
After working for the company's New York City office for several years, I was offered the opportunity to move to China and run the operations there in 1994. I had never anticipated such a transition, and the New York City lifestyle was addictive, but ultimately the timing was perfect. At the time I was 30 years old, recently divorced, and free of any binding obligations. China was most definitely considered a "hardship" assignment at the time, and it certainly didn't generate the "buzz" that it does today, but the challenge was too irresistible to forgo. Here was an opportunity to learn new skills, to explore an entirely new environment, and to do it with an employer that I respected and trusted. Moreover, while it still wasn't my "own" company, I did get too look forward to running my "own" operation within the company. I knew if I did not choose to accept the offer, I would have regretted it for the rest of my life. I packed my belongings and blindly moved to China within two months of the offer.
My initial "assignment" was a handshake agreement for 2 years. The company's betting pool had me lasting only 6 months - in the end the assignment lasted 6 years. To this day, I feel especially fortunate to have had this opportunity. It let me explore a whole new world of business opportunities. It allowed me to earn and save the money that would become the capital for my own business. It taught me the skills I needed to successfully operate my own business.
When I arrived in 1994, all of the company's products were "assembled" in China , yet most of the raw materials were still imported from outside mainland China, in places such as U.S. , Japan , Taiwan , and Hong Kong. The majority of my first two years were spent developing, often from scratch, a local supply chain that could produce the quality we required. It was the "developing from scratch" that was particularly interesting- after all, if we were going to help set up new suppliers to achieve the quality/price objectives, then why not set one of these up by myself? I discussed the possibilities with some well-trusted Chinese friends and we determined it was not only possible, but a plausible win-win scenario for the company and ourselves.
When I first accepted the China assignment, my employer was aware that I would be barraged with opportunities, and asked only that I commit two years to the project without distraction. He even stated that after the initial two-year period, he'd be willing to look at participating in opportunities that I might propose. I approached him in 1996 with a proposal to open up a small factory to supply locally produced components for the accessories. In reality it was a mutually beneficial proposal - I would remain in China and devote the majority of my time to my current position, while establishing an independent supply factory on the side. This relationship would be considered unorthodox in many companies, but in this instance it was mutually advantageous- I received a great incentive to remain in China, and the company received a new "local" supplier that provided the quality needed at 10-40% lower prices.
So, with the full support of my employer, I started a small factory with two Chinese partners whom I knew I could trust implicitly. I supplied the startup capital and marketing capability, while my partners effectively "built" the factory and the management team. We registered the company as a Wholly Owned Foreign Invested Entreprise (WOFIE), shared ownership, and managed the company together. By the end of 1996, we had the factory up, a supply chain established, and we began taking orders. The company has since grown to 35+ employees and generates nearly $1 million USD in annual turnover. All of the partners were well-rewarded- not only in generating capital to be used for new ventures, but also in helping us to develop business methods that merged the best of the Western and Chinese ways of doing business.
My second business venture started as a simple friendship. Shortly after my arrival in 1994, I met a fellow American expatriate who was working for a large MNC. He too had a strong entrepreneurial streak, having built and sold several companies before taking on his current role. He returned to the US in 1996, where he had allied himself with a small US based specialty chemical supplier to the automotive industry.
We kept in touch, and by 2000 began discussing mutual business ideas. He had developed an interesting strategy that would catapult his new company into the "big leagues". I had reached the point in my company of having pretty much localized myself out of a job. The timing was right! I bought into my friend's strategy and using the capital I had saved in the past 6 years, I also bought into the company. Together we initially invested more than 1 million USD to grow the company from a small specialty chemical supplier to a large Tier I supplier to the automotive industry- a figure that has since grown more than tenfold.
The company's strategy hinged on the recognition that a global consolidation of automotive OEMs had forced a similar consolidation upon its supplier base. New vendors were shunned and existing vendors were cut or merged into preferred Tier I "mega-suppliers" that could support worldwide operations. This strategy did grow profits and yield stability for years, but innovation was stifled. As the consolidation opportunities evaporated and profits came under pressure, the mega-suppliers reacted "logically" by cutting overhead, slashing R&D, reducing customer support, raising prices, and discontinuing marginally profitable or niche markets.
Our strategy was to gain vendor status by stepping into those abandoned markets, and China was the ideal entry point. Although automotive specialty chemicals is a $1.2 Billion global market, the Tier I vendors supported only the largest segments of it in their China strategy- leaving numerous "niche" markets worth tens of millions of dollars "exposed". If the mega-suppliers even serviced these niche markets at all, then it was typically done on an import basis with "stepchild" status in the head offices. We would take advantage of this shortcoming by establishing a China subsidiary to supply high quality, domestically produced specialty chemicals to the automotive OEMs in China .
Establishing the company itself was a relatively straightforward process. Both of the companies I've established are registered as wholly foreign owned enterprise (WFOE) - a decision made very simple by the fact that we could handle by ourselves. Foreign invested Joint-Ventures (JV) are riskier because of difficulties in finding a reliable partner and challenges in bridging different business "styles", not to mention the time limitations typically imposed on a JV contract. (Typically JV's are undertaken now only in specific situations where the government requires.) Setting up the legal structures was bureaucratic but not necessarily difficult. China has a lot of qualified agents, lawyers and consultants that are able to provide the varying levels of service required. Read all the regulations and documents thoroughly in order to make sure you are aware of all the limitations and representations. While rules may be "bent" in order to make something happen - you have to be very careful that these different interpretations don't impose some future unforeseen liabilities on the company.
We also had the advantage that as a relatively small enterprise, our company was "under the radar". Our business was not directly involved in any of the sectors that China deemed "critical", so we weren't subject to the extra levels of provincial and national approvals that the Telecoms, Banks, Insurance companies, and of course, the Auto OEMs had to endure. Nonetheless, as a chemical provider, we still have to comply with the environmental and safety regulations. This is a manageable task as we established our factory to Western standards; but contrary to common belief, China does have a strict regulatory regimen on the books. While enforcement may be spotty, as the economy matures it is becoming increasingly thorough. When presented with the temptation to ignore a regulation, always keep in mind that this "oversight" can very well come back and club you later!
Ultimately we invested in the China operation and quickly began providing localized production with both " US quality" and the "China Price"- the very same strategy used in my first company. With a now booming market, and a lack of competitive offerings from the global suppliers, our product was welcomed. In fact, we acquired our very first customer as a result of a cold call - the customer had just been irritated by its former supplier who had decided to enter the customer's line of business and compete directly. In this case, we were welcomed not only because of our product portfolio, but for our ethics. As it happens, it was a U.S. company and through the relationship we also sold to its U.S. operations.
In this respect, the China operation was established not only as a profitable stand-alone company, but also as a backdoor entry to an otherwise "closed" customer base. In fact, our China operation generated a great deal of opportunities in US. As we secured OEM approvals in China , we were able to use that established vendor status to bring our business back to the home markets. These new relationships were then used as a launching pad for additional products (many of them developed or tested in China ) through the same channels. In some segments of our business, as much as 90% of our US business can be traced back to the relationship we first established in China . I now spend a healthy part of my time in US visiting these clients, whom we may have never acquired had it not been for our China initiative.
Ultimately however, the China business is the launching pad for the domestic China market. The automotive market has grown from the 500,000 vehicles annually when we started business, to more than 5 million vehicles it will produce in 2006. China is already the third largest manufacturer of automobiles behind US and Japan , and just recently overtook Japan as the #2 consumer market. The China company already exceeds $1,000,000 USD in annual turnover, even as much of the attention is still focused on its support of the US business. The business is growing fast, and since the China market will likely exceed 50 million vehicles/year, we expect high compounded growth rates for many years to come.
We have since expanded our operations in China and established a wholly-owned R&D center in the University area of Beijing . This facility not only develops new products for the China business, but is also instrumental in the development of innovative products and technologies for our US customer base. Of course "cost" was an important consideration in choosing China over the US , but ultimately the decision was based on China 's deep pool of highly qualified personnel. Even more importantly was that in our years of experience here, we had also met the one "right" person to manage it. For a company of our size, we may have been "early to the game", but we've already seen the payoffs from the investment with low operating costs, diligent project management, and rapid development.
China offers the entrepreneur unparalleled opportunities, but in order to succeed, it helps to know the "rules". A friend from Vancouver once joked to me, "Before I moved to China , I thought the drivers in Richmond (a predominately Chinese section of Vancouver ) were crazy drivers. But now that I've lived here, I realized it's just that I didn't know the "rules" they were driving by". You must both understand and accept that they may be very different from what you are used to.
In order to understand the rules, it definitely helps to speak Chinese at least conversationally. I never studied Chinese prior to the assignment, but once accepting the offer I was able to manage several weeks of intensive language training before making the move. The training gave me enough understanding of the basic grammar and pronunciation that I was then able to focus on learning the vocabulary. Since I was the only foreigner in the workplace- I had no choice but to learn the language quickly. Interestingly enough it was this learning process which helped build the friendships that would become so important later on, and it was the best way to build the respect of my colleagues and helped me to get inside the mind of the way things worked in China . It was the beginning of the process of developing "guanxi".
When I first arrived, everybody talked about "guanxi." Guanxi simply refers to combined business/personal relationships that entail a sort of positively reinforced "tit for tat", but it can also carry the connotation of "corruption". While I found that the guanxi based on personal relationships could be very helpful, the "guanxi" offered up for sale was typically over-promised and over-rated. The best success came from politely declining such offers and instead focus on building our own network of genuine relationships and opening business channels that way. I feel relationships that form the basis of "guanxi" are important - after all a "trusted" supplier is treasured in even the most advanced economies- but I also feel that the corrupted form of guanxi is becoming less and less important.
Hiring the right people is essential to the company's success, both in navigating the circles of guanxi and Chinese business practices, but also in understanding and implementing your development strategy. Alas, find that "right" person is as much an art as it is a science. When a company is small, it is like a family- every time you add a new employee, you need to make sure he (or she) works well with the others because a faulty hire can quickly spoil the morale for the entire group. It's always better to find the one outstanding performer, compensate him well, and retain him- than it is to hire a handful of average performers. The "right" person will add to your management resources, whereas average performers will inevitably be a drain on them. In fact, the "right" person becomes a key asset in recruiting and establishing the rest of the management team.
In our case, my General Manager is a Chinese woman whom I have known and worked with for more than 10 years. While I first met her at a "labor market" when she applied for a position at my old company; she was a clear standout from all the other interviewees. For a young woman just out of college, she had remarkable confidence, impressive English skills, and an extremely well-organized thought process. Although she didn't know it at the time, our team had effectively made the decision to hire her within five minutes of meeting her- a decision that we never regretted once. It comes as no surprise that I recruited her for my new company as soon as she became available. The lesson learned is not about "where" or "how" to hire the right individual, but rather the importance of looking for the right person, recognizing when he/she is available, and then doing everything possible to retain that person.
Of course, entrepreneurial life is not always so easy. Establishing a company, funding it, staffing it, developing a customer base, and turning a profit are difficult challenges in and of themselves. Doing it in a foreign country as an entrepreneur, takes the mission to an entirely new level!
It might best be compared to "being in a war." You battle every day for survival against a powerful foe, and at the end of the day you often feel lucky to be left standing. An entrepreneur doesn't jump intentionally into this war-zone, but the battle is usually brought to the doorstep by circumstances beyond his control. Yet, as in any battle, he faces the odds, forges new tactics, establishes unique alliances, and develops innovative strategies that give him the upper hand. Then suddenly (and perhaps unexpectedly) the fighting stops, the war is over, and victory is at hand. It's only then that he begins to really to grasp the struggles he has endured, and it's only then that he really begins to enjoy the things he has fought for so hard.
I can honestly say that if asked 6 years ago to do what I have already done- my reply would have been "No way. It's impossible". But looking back- I can't think of it being possible any other way. The entrepreneurial challenge is a true test of spirit that pits you against your own fears, drains you incredibly, yet still somehow concludes leaving you fully charged!
Now, when offered senior positions in other companies- I can, in good conscience, politely and quickly decline. I recognize all too well, that while stability and monetary compensation are nice, they simply can't compensate for the "thrill of the ride" that one experiences as an entrepreneur. At a certain point, financial compensation is no longer important for the comforts it can provide; rather it is important simply as a tool to measure your ability to provide. In other words, a measurement of your ability to succeed in creating something new. If someone were to come along and offer to buy the company for 5-10 million USD, I'd decline because I recognize the inherent value of the company as it commercializes more of its technologies in the coming years, is worth many multiples of that. If the offer were for 100 million USD- I'd be more inclined to take up the offer but the "payout" would simply become the capital to take advantage of the next opportunity- this time only bigger, better, and hopefully just as exciting.
After more than 12 years, China , and Shanghai in particular, still excites and energizes me. I feel lucky to be a part of it. There is a line in the movie "2010" (the 1984 sequel to Stanley Kubrick's 2001: Space Odyssey) where the Hal 9000 computer converses with the deified spirit of his former commander "Dave":
Hal 9000 asks: "What is going to happen, Dave".
Dave replies simply: "Something wonderful."
Those individuals, who have seen the movie and recognize the enormous understatement in the reply, will understand when I describe that "This is often the way I feel about Shanghai ." I'm never quite sure what is going to happen, but I am always sure that it will be
"Something Wonderful."
Note:
1 Richard McGregor, FT May 3, 2005
2 The China Factor by Cameron Wilson, EuroBi z October 2005
Dr. Juan A. Fernandez is Professor of Management at CEIBS. Dr. Shengjun Liu is the Assistant Director of Case Development Centre of CEIBS. The article is an excerpt from China CEO: A Case Guide for Business Leaders in China, Chapter 9, "Foreign Entrepreneurs: Chasing the China Dream".
