In the Chinese business environment, it is necessary for American companies to have a well-planned strategy. The following list of tips for doing business in China is not comprehensive, but a guideline for an initial market evaluation. Companies entering the China market should consider the following:

1. Have Clear Contract Terms
2. Make Certain Your Project is Economically Viable
3. Know Your Partner
4. Know the Rules
5. Search for Problems Before They Materialize
6. Do a Thorough Risk Analysis
7. Mind the Store
8. Expect Virulent Competition, Pricing Pressure
9. Get Paid
10. Watch Your Intellectual Property Rights

1. Have Clear Contract Terms

Everything in China is constantly changing. China’s consistent 8 percent economic growth leads to continuous rapid transformations in the domestic economy. Nothing is fixed. Thus, when entering into a contract with a Chinese partner you must be careful to plan for all reasonable contingencies. Do not attempt to enter into an agreement without sound legal advice. Have your own legal counsel. Pay your lawyer a little to ensure a clear contract; or pay your lawyer a lot more later when you have a dispute. In your contracts, specify exact terms of payment, and performance standards. Set time lines. Pay careful attention to details, such as initialing pages of contracts and signing properly. Scrupulously follow the contract yourself – or expect to pay a high price. Do not rely on the legal advice from your Chinese partner. Beware of claims that the Chinese law requires specific covenants in your contract. Verify this with your own counsel. Do not agree to provisions in a contract that are not under your control. For example, if your client or partner wants you to specify in the contract that they must visit your production facilities in the United States, remember that you cannot guarantee that they will receive a visa. A visa denial could invalidate your contract. Do not assume that local or provincial officials actually have the authority to give you permits and permissions. Verify their claims of authority from independent sources. Question ALL such claims.

Profitability of a project or the sale of goods and services should be based on sound economic criteria. Do not rely on promises of subsidies, incentives, special considerations, or non-market related sources of income to create a profit. If incentives are offered, they should be used to augment profit, not create it. Make certain your partner has the authority to offer incentives and assure yourself from independent sources that the incentives will actually be paid. Look for examples of companies which have actually received such benefits. Viability may look very different over the short, medium and longer term. Many Chinese partners will insisit you look at the longer term potential of the market and sacrifice your profit in the early stages. This is treacherous. Your floor becomes their ceiling. In China, as in any high growth economy, it is difficult to predict the future, so, make sure that you can reach profitability in the foreseeable future and can build a sustainable model for the medium and longer term.

Do your "due diligence," and do it well. Make certain that your partner is not a shell subsidiary of a larger company. If they default, do you have the ability to collect from the parent company? Specify this in your contract. Remember that the best contracts are those that do not have to be enforced i.e both partners have the same motivations. Be sure that your negotiating partner has the authority to make a decision. Establish ground rules at the outset of negotiations, including keeping minutes. Be prepared for protracted negotiations. Make certain your partner is able and willing to do all they say they will do in the contract. Assure yourself that it is in their best interest to perform as agreed. If the project is not "win-win" you can expect that enforcement of your contract will be difficult – regardless of your legal rights. If you have to go to court to enforce your contract, it is already too late. Is it in their interest to assist you to protect your brand and/or other intellectual property rights? Be careful that your partner is allowed by law to fulfill the promises in the contract. Check the reliability of the data on your partner or customer from independent sources. Avoid being "stovepiped" - talking only to those people to whom your partner or buyer directs you. You can lose a lot of money if you make a great deal with the wrong partner.

Beware of offers to bend them in your favor. American companies have often entered into agreements with promises from local officials that central government rules will not be enforced in the provinces. Indeed, often they are not. Problems arise when these regulations are suddenly applied - sometimes retroactively - leaving the company with little recourse. You must be ready to obey all Chinese laws and regulations, even if you initially can successfully avoid them. Seriously question any agreement where you are told you can ignore or avoid the law. Also, make sure that your managers (or agents and distributors) know all relevant American laws such as the U.S. Foreign Corrupt Practices Act (FCPA). You should be aware that China is also cracking down on corruption. You do not want your business to be associated with corrupt officials or illegal practices. Many American companies have reported that their Chinese partners respect their requirement to be in compliance with the FCPA and do not expect American companies to pay bribes. Also, be aware of U.S. Bureau of Industry and Security (BIS) regulations on the transfer of dual use technology to China. American law prohibits transfer of some sensitive technologies without a license. For more information on BIS regulations, please check http://www.bis.doc.gov/.

In addition to creating pro forma balance sheets, spend some time at the beginning of a project to create scenarios of what you will do if things go wrong. Try to anticipate possible problem areas. If you can't find any, you are not looking hard enough. Create a strategy to deal with potential problems. Know your limits on losses as well. Be sure to limit your exposure. Set milestones in the project for performance. Have an escape strategy for each stage of the project, even though you do not plan to use it. In China, personal relationships are very important and sometimes partners may not be completely truthful about problems or potential problems if they feel it may have a negative impact on the personal relationship. Chinese partners may also be under pressure from government or party bureaucrats (as well as business associates) to compromise ethical standards. When problems arise, you should have excellent contacts among officials at the local, provincial and central level governments to manage the issue.

Be realistic about how much risk you are willing to accept in your business venture. Make sure you use reliable sources for this assessment. Use more than news media sources or your immediate partners to evaluate the market. Do not have a corporate risk analysis policy for China that is different than you would have for any other country. If a project is too risky, do not do it - even though it is in China. The majority of American companies currently in trouble in China have been caught up in "Chinaeurhoria" and have not performed a thorough risk analysis, assuming that China is, somehow, different. When it comes to taking undue risk, it is not.

Projects and sales in China require constant attention and clear lines of communication. Do not assume they will run themselves. There is often a gap between perceptions of the individuals managing your product or project and headquarters in the United States. U.S. based managers must visit often to evaluate the situation on the ground. Developing and nurturing personal relationships are important. Be prepared to provide good training and technical assistance to assure product and management quality. Keep an eye on the the company’s account books, or if licensing, on the licensee’s account books. Neglect of oversight can result in compromised product quality and lead to a struggle for management control as well as possible unethical activity. When things go wrong, you cannot rely on the court to offer a clear or consistent legal settlement in a manner that would be consistent with U.S. practice and or other parts of the developed world.

Recent economic analysis suggests that over 80 percent of China’s industrial markets are in oversupply. There are terrible competitive pressures. Chinese brands are strong and getting stronger in many sectors. In many Chinese markets there is a constant downward trend on prices. Chinese competitors, particularly those from the state-owned sector, often enjoy a very low cost of capital. Thus, they can enter markets quickly and they can expect to receive strong encouragement from the government for their efforts. The Chinese government makes no secret of its support for state owned enterprises (SOEs). Foreign companies should not expect a level playing field. Rather, the field is downward sloping for SOEs. It is level for private Chinese companies. The field is upward sloping for all foreign firms.

A contract with an insolvent partner or customer is worthless. Pay careful attention to how you get paid, when you get paid, and in which currency. Check with legal counsel to determine the specific payment terms that are customary for a certain type of transaction. If you want to be paid in U.S. dollars, be certain you are able to convert profits and remit funds. Use letters of credit with international banks, and other financial instruments to protect yourself. If you do not want to use a letter of credit, require your partner to make advance payment. Remember that Chinese companies usually do not use terms that allow unsecured payments after delivery of the product. For example, payment terms of "30%letter of credit, 70% payment 120 days after delivery," would not be customary in China. For most large projects, terms of "70% advance payment, 30% letter of credit," would be common. Offering payment after delivery tells your partner that you do not know how business is done in China and makes you look easy to deceive. NEVER agree to unsecured payments after delivery.

It has been said that, in China, if a product or service can profitably be copied; it will be. Also, foreign IPR holders (whether they are in the China market or not) suffer enormous losses to Chinese pirates in the China market and, increasingly, in third country markets. It [behooves] all traders and investors to take aggressive measures to minimize their potential IPR vulnerability in the market. For trademarks, at you must file with the State Administration of Industry and Commerce to receive protection. You should also notify Customs. For patents, you must file with the State Intellectual Proerty Organization (SIPO) to receive protection. At a minimum, it is advisable to register copyrights in China, even though you may theoretically receive protection under the Berne Convention. Confirm this with your legal counsel, as the copyright treatment across industries is not identical. You should also notify customs. Taking the above procedural steps is insufficient. You must also closely monitor the markets on a constant basis. Monitoring and enforcement in China require considerable expense. IPR infringing goods also also flooding out of China to all regions of the world and therefore vigilence in third countries is also strongly advised. Many foreign companies have lost their IPR with the active connivance of emplyees of their partner. To the extent possible, make sure that your partner’s interests and yours are fully alligned.

Representative offices are the easiest type of offices for foreign firms to set up in China, but these offices are limited by Chinese law to performing "liaison" activities. As such, they cannot sign sales contracts or directly bill customers or supply parts and after-sales services for a fee, although most representative offices perform these activities in the name of their parent companies. Despite limitations on its scope of business activities, this form of business has proved very successful for many U.S. companies as it allows the business to remain foreign-controlled.

China's Company Law, which has been in effect since July 1, 1994, permits the opening of branches by foreign companies but, as a policy matter, China still restricts this entry approach to selected banks, insurance companies, accounting and law firms. While representative offices are given a registration certificate, branch offices obtain an actual operating or business license and can engage in profit-making activities.

Establishing a representative office gives a company increased control over a dedicated sales force and permits greater utilization of its specialized technical expertise. The cost of supporting a modest representative office ranges from [US$]250,000 to [US$]500,000 per year, depending on its size and how it is staffed. The largest expenses are rent for office space and housing, expatriate salaries and benefits.

On May 19, 2004, the Chinese State Council published its decision to cancel and adjust the administrative approval on organizations. Starting July 1, 2004, foreign trading companies, manufacturers, forwarding companies, contractors, consulting firms, advertising firms, investment companies, leasing companies and other economic and trade organizations can register their representative offices directly with AICs without prior approval from the Foreign Economic Relation and Trade Commission.

A locally-incorporated equity or cooperative joint venture with one or more Chinese partners, or a wholly foreign-owned enterprise (WFOE, often pronounced "woofy"), may be the final step in developing markets for a company's products. In-country production avoids import restrictions - including relatively high tariffs - and provides U.S. firms with greater control over both intellectual property and marketing. The establishment of a WFOE in China has gained in popularity among U.S. firms as a result of an easing of restrictions, directly attributed to China’s accession to the WTO.

The role of the Chinese partner in the success or failure of a joint venture cannot be over-emphasized. A good Chinese partner will have the connections to help smooth over red tape and obstructive bureaucrats; a bad partner, on the other hand, can make even the most promising venture fail. Common investor complaints concern conflicts of interest (e.g., the partner setting up competing businesses), bureaucracy and violations of confidentiality). The protection of intellectual property, no matter the form of cooperation, is one of the most pressing matters for U.S. firms doing business in China. American companies should bear in mind that joint ventures are time-consuming and resource demanding, and will involve constant and prudent monitoring of critical areas such as finance, personnel and basic operations in order for them to be a success.

Source: U.S. Commercial Service China

Editor’s note: A previous version of the U.S. Commercial Service’s Essential China Advice was printed in the March 2003 and March 2004 issues of China Insight.