How to Evaluate Your China Risks

Should I stay in China or should I leave?  Should I enter the China market or is it too risky?  The answer to these questions is simple:  it depends.  The secret is understanding what those dependencies are and how your company strategically fits within them.

What follows is an oversimplified view of the playing field in China whose main purpose is to provide a high-level framework to think about where your company fits into the overall China market from a risk perspective.

The first step is understanding the context in which you will do business in China.  You need to accept the following as absolutes that will not change:

• China will not change its position on protecting intellectual property, if anything, it will further institutionalize and your risks of losing your IP will increase.
• China will not change its position on subsidizing and protecting state owned enterprises (SOE).
• China will not lessen its control of the Internet and the technology supporting it.

For many years the conventional wisdom was that China would soften on the above positions as it became more integrated into the global marketplace. That turns out to have been wishful thinking and now it is essential to face that reality.

It almost goes without saying that, even with the above realities, Western companies still want to do business in China.  See China Unfair, But We Don’t Really Care. It is also important to recognize that China actually does want Western companies to do business there as long as those companies play by China’s rules. See China’s New Company Tracking System: Comply, Comply, Comply.  So, the question becomes what types of companies can do business in China successfully with manageable risk and what sorts of companies are in the high-risk category.

On the lower end of the risk scale are marketing-driven and consumer-oriented companies in which intellectual property resides more in their marketing and product plans than in their technology. This type of intellectual property generally of less interest to the Chinese government and therefore considerably easier to protect. Also, on the lower end of the risk scale are many professional services consulting companies whose IP is largely in the brains and capabilities of the employees themselves.

The fact that there is lower risk doesn’t mean these types of companies will necessarily be successful, it just means the playing field for these sorts of companies will be more level and their risks more manageable. With its size, growth, and opportunity, the China market should deservedly be high on the strategic priority list for companies in the lower to medium risk categories.

Markets that have inherently greater risks are those that compete in industries where SOEs exist and in high technology markets with sophisticated hardware and/or software. Markets that are considered by the Chinese government to be strategically critical from an infrastructure or a technology standpoint will get the most scrutiny and carry the greatest risks.

SOEs are government owned and subsidized companies that are largely concentrated in key infrastructure related industries (steel, coal, utilities, energy, communications, mining, etc.) as well as financial services. If you are in a market that competes directly or indirectly with an SOE you will most definitely be on an uneven playing field and you will be swimming upstream to compete, if you are allowed to compete at all.

High technology companies risk the greatest damage from IP loss, but not all high-tech companies are created equal from a China risk profile. Of course, the China market isn’t even open to some technology companies, particularly those related to the internet or social media. Even within the high-tech sector there are areas of greater strategic interest to the government (like 5G and cutting edge semi-conductors) and those are of greatest risk.

It is the nature of most technology driven companies to think they are leading edge, but in reality, most are not. Most compete with me-too technology and differentiate themselves through marketing and product plans like CPG companies. These companies bear moderate risk, but their best ally is to out-execute the competition.

For those truly leading edge technology innovators the risk of doing business in China, or even with China, is enormous. This is especially true for those whose technology is a strategic focus for the China government. There are a number of strategies to potentially mitigate some of the risk for these companies (such as only manufacturing and selling older technology in China), but it is essential that these companies have no illusions about protecting the IP for products they sell in China.

The intent here was not to cover all the potential risks or market nuances, but to provide a general framework for thinking about risk in the context of your specific market. Too many discussions about China lump everyone together and don’t distinguish between the risk profiles (and associated opportunities) of vastly different markets companies may encounter.

Finally, there is no such thing as no risk in China. Even if you do everything right you may end up being investigated by the government because of a disaffected employee or you might find out your general manager is running a competing business on the side. Situations like this are common in China. However, having a balanced view of China’s overall cost/benefit/risk equation will help facilitate better decisions.

Note that this post primarily addresses commercial risks associated with selling in China.  Manufacturing and supply chain risks, though sometimes related, have quite different dynamics and warrant their own post, which will follow in a week or so.

The above is a guest post by Patrick O’Hara, an international business consultant with 25 years of high-level China business experience, with big public companies and private equity funded tech companies. I asked Patrick to write this post because our law firm’s China lawyers have worked with Patrick on many China matters and we view him him as one of the smartest and best prepared and easiest to work with clients ever. Our China WFOE lawyers worked with Patrick on setting up a WFOE in China and getting that WFOE operational and that WFOE set-up was easily one of the two or three smoothest, best run, and fastest WFOE formations we’ve ever done, and I attribute that largely to Patrick. He had lined up and prepared the right people to help every single step of the way in forming the WFOE and getting it operational. Our China WFOE lawyers are always asked: how long does it take to form a WFOE? Our answer invariably includes stating that the biggest factor in how long it takes to set-up a WFOE is you, the client, not us the WFOE lawyers, nor the Chinese government. A prepared client able to make quick decisions is key. I asked Patrick to write the above because I figured our readers could learn a lot from Patrick about how to leave China as well. For previous posts by Patrick on how to leave your China manufacturer, check out How To Terminate Your China Supplier: Very Carefully. And for how to leave China, check out Five Ways to Facilitate Leaving China. 

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.