China’s Golden Age for Foreign Companies is Over

Let the hate mail begin.

Whenever we write on how things are getting bad for foreign companies doing business in China and on how foreign companies should think long and hard before doing business in China, we get hate mail or hate comments (which we typically delete). Many of these come from China consultants accuse us of damaging their business. I have already received two angry emails for what I am about to write in this post. Those two emails came in response to what I said in the article this post will be discussing. The article, Is China’s ‘golden age’ of foreign investment over? examines whether China’s golden age of foreign investment is over.

China today is not nearly as favorable or easy for foreign companies as it was ten years ago. But that does not in any way mean there are not a wealth of opportunities for smart companies to make money in or from China or to save money by using Chinese manufacturers.

Based largely on what my own law firm’s China lawyers have seen over the last ten or so years, I divide China into the following three “eras” for foreign companies:

1. The Initial Era. This was until around 2008. During this era, many foreign companies operated completely illegally and off the grid in China and when we would tell them what would be involved in our getting them legal, many chose to continue operating illegally. There was a gold rush mentality and whether operating legally or illegally, nearly all our clients were thriving in China. Few companies understood or cared much about protecting their IP in China; they believed it was hopeless.

2. The Transition Era. This era was from around 2008 to 2013 or so. Of those who called our China attorneys about what it would take to start operating legally in China, most chose to make the necessary changes to get legal, with the remaining companies choosing to keep operating as they were, “at least for now.” Many foreign companies began realizing the importance of registering their trademarks, copyrights and patents in China.

3. The Current Era. This era started in roughly 2014. Virtually all foreign companies began realizing that they must get legal in China or leave — no more operating illegally “for now.” Virtually all companies came to understand the importance of protecting their IP in China and they chose to do so. They also came to understand the importance of having an enforceable China contract when doing business with Chinese companies.

So despite China constantly getting tougher on foreign companies and despite it making sense for more foreign companies to leave China or not go there at all, my law firm’s China practice continues to grow and — believe it or not — so does foreign investment into China. Why should this paradox be true?

Because what is happening with foreign investment into China is not so much a shrinking but a maturation. Call it the end of irrational exuberance if you like. But whatever you call it, those companies that never should have gone into China in the first place are now largely gone or in the process of leaving. And those companies now looking to go into China or to have their products manufactured there or to sell their own products and services there are looking into China for all the right reasons.

China still has 1.5 billion people and there are still countless companies that should and do salivate at selling their products and services to China. But there is also greater realization that doing so will not be easy, fast, risk-free or cheap. China is still the factory to the world, but it is not the only country in which it makes sense to manufacture and companies are increasingly realizing this and looking elsewhere. Our law firm has done more manufacturing deals involving Malaysia, India, Vietnam, Thailand, Indonesia, Taiwan, Brazil, and Mexico in the last year than in the three previous years combined.

Peter Ford’s article nicely reflects all this. It starts out focusing on Microsoft shutting down two of its China cell phone manufacturing facilities and moving that production to Vietnam. Ford describes this move as the “latest sign that for international companies, China is losing some of its luster after years of shining as the brightest star in global capital’s firmament.” But he quickly follows this up by noting that “China is still a huge, growing market that no global company can afford to ignore. In other words, China is no longer THE country for everything and everybody but it is still the country for many companies and for many things.

Ford then lists the following as some of the concerns foreign companies have about doing business in China:

  • Air quality.
  • Restrictive rules.
  • Higher costs.
  • Market access.
  • China has become a tougher place to do business.
  • China’s economy isn’t growing as rapidly.
  • Chinese laws are often arbitrarily applied.
  • China discriminates against foreign companies.
  • China blocks foreign companies from participating in many of China’s best investment opportunities.

Does anyone really dispute that all or almost all of the above list is accurate? What really determines whether a foreign company goes into China or stays in China is money. If the money is there and the foreign company can legally stay in China, it usually will. If the money is not there, it will eventually leave. Much of the above list has been true to some extent for ten years and nearly all of it has been true for five years. What has changed is that foreign companies are being hit with so much from so many angles that they are having to decide whether to stay or not.

What sorts of companies should stay or enter China and what sorts of companies should leave or not enter at all?

According to Ford, “Microsoft’s decision to decamp to Hanoi was doubtless influenced by lower production costs there. The Japanese trade agency JETRO found in 2012 that Vietnamese wages were around one third of Chinese wages.” Vietnam crushes China when it comes to wages. But if wages were the only factor in Western companies choosing where to locate, Microsoft would have moved its facilities to Yemen. Microsoft likely chose Vietnam for the same reasons Intel and so many large Japanese companies chose it years ago. Vietnam has a good workforce and a growing economy. Vietnam has political stability and it is a US ally. Vietnam has decent logistics. Vietnam has a growing consumer economy and it is a good base for selling into Cambodia and Laos and Myanmar. Hanoi and Saigon are considerably cheaper cities for expats than Shanghai or Beijing.

The article quotes me regarding American companies moving from China to Vietnam:

Lawyer Dan Harris, who helps small and medium sized foreign companies operate in China, says that most of the businesses he has helped to wind up in China closed because of disappointing local sales, not because they are moving elsewhere.

Smaller firms cannot afford to move abroad because they have made big investments to establish themselves in China, Mr. Harris says. Nor are they big enough to take sufficient advantage of lower per-unit production costs to make a move from China to Vietnam worthwhile, as it has been for Microsoft, Intel and Samsung, among other global firms.

“But if the big companies go, the feeder firms will want to go too,” says Harris. “Eventually our clients will have to follow them.”

In my interview with Ford I talked about how Vietnam is great for huge companies like Panasonic and Canon and Toyota, which all have massive facilities outside Hanoi. It is also great for a massive company like Intel which by all accounts is doing well in Vietnam. Those companies have the resources to figure out Vietnam and to work with the government to make things work for them there. Those companies essentially bring in or create in place much of the infrastructure they need.

SMEs on the other hand typically need a fair amount of outside help to navigate Vietnam initially and so at first Vietnam can be more difficult than China. China has made it easy for foreign companies. Vietnam is still working at that. If a client asks me for a good China supply chain person, I can give them a list in a heartbeat. If a client asks me for a good China sourcing person, I have lists ready to go, depending on the product. If a client asks me for a Beijing based accountant who knows both US and China accounting. I have a list for that too.

Vietnam can be more difficult. I have had American companies come to me to draft their manufacturing contracts to have kitchen products or shoes or t-shirts or toys made in China they could have made in Vietnam at a lower cost. When I ask why they chose China rather than Vietnam their response is often something like “we would love to go into Vietnam but we really don’t know how to do it and we have this guy we trust who has already done xyz in China and so it will be easier and cheaper in the short run for us to just go to China.” But we are also seeing some of our medium-size manufacturing clients whose manufacturing costs are rising in China looking to Vietnam or elsewhere to replace or supplant their China facilities. We are also seeing some of our clients that are doing well in selling their products or services in China looking to Vietnam to expand.

I could go on and on about China versus Vietnam and what sorts of companies should be choosing which country, but I wil instead conclude with the conclusion to Ford’s article:

“A company puts its resources where it thinks its future market will be,” says Mr. Brennan. “China is not going away, but it is becoming just one market among others.”

“So far, companies have been focusing on China,” Brennan adds. “Now they are looking at southeast Asia and India too. We are seeing a groundswell shift in what companies are spending their time on.”

For more on where to locate your international business, check out the following article I recently wrote for Forbes Magazine, Where to Locate Your Business in Asia.