Our clients in many industries that sell their products and/or services to Chinese state-owned (SOEs) and city owned companies are reporting increasing roadblocks to their sales. They are telling us that the Chinese government is increasingly favoring Chinese domestic companies over them, based on “orders” they are getting from on high. The Chinese government has always discriminated against foreign companies, but that has increased over the years and as tensions between the United States and China and the EU and China continue to escalate, we expect Chinese government discrimination against foreign companies to increase as well.
Is there anything your company can do to fight against this tide? There is and it lies in trying to make yourself more local.
More than a decade ago, a highly successful niche software company in the finance industry (broadly defined) contacted us to form a WFOE in China for them. They started out talking about how their sales to China had been rapidly increasing and how well things were going for them in China. They told me that they sold their software for about $2 million and then charged about $1 million a year to keep it updated. I expressed surprise that their buyers were paying the yearly update fees and was told “that they had to because without daily software updates the software becomes pretty much completely useless in less than a week.
I then asked why they wanted a WFOE, which was my way of asking why if it ain’t broke are they interested in spending money to fix it. I explained how the two main reasons (by far) for needing a WFOE in China are if you want to be able to get paid in RMB or if you need to hire employees in China. See Doing Business in China Without a WFOE: Will the Defendant Please Rise. They told me that neither of those things mattered to them; they needed a WFOE because a number of their Chinese government owned customers had told them that they were getting big pressure to switch their buying to an inferior but Chinese domestic product.
This company had been told by their customers that forming a WFOE would “make them look more Chinese” and would allow them to continue buying American and not Chinese. We formed a WFOE and the customers stayed.
Our China lawyers have done a lot of legal work for medical device makers and other companies that supply product and services to Chinese hospitals and we often find ourselves telling those companies the following:
China hospitals are under government pressure to buy local, but in the end, they generally do want the best product at the cheapest price. What this means is that if your product is truly the best and the cheapest product by a wide margin you will probably get the sale. But what this also means is that if your product is just marginally better than a Chinese competitor product and your product is a little bit more expensive you may not get the sale. What can you do to increase your chances of making the sale? Try to look more local.
What does it mean to “look local”? This means that the procedure for the sale to the Chinese hospital must look the same as a purchase from a Chinese manufacturer. The more the sale appears to be domestic, the better your chance of making the sale. This means the purchase must be denominated in RMB and the purchase must be made from a Chinese company. If you force the hospital to pay in dollars for a direct purchase from a foreign manufacturer, your chances of succeeding in selling your product or your services to a Chinese government owned hospital will decline. This advice of ours holds true for any China industry with heavy Chinese government involvement.
In more detail, there are (roughly) the following levels of “local” for making a sale in China, starting with the least local:
1. No China presence. No China distributor or sales agent. No China agent. Just your company based in Toledo, Ohio, making products and trying to sell those products to China.
2. Your company is in the United States or the EU or Australasia, but it has a China distributor or sales agent that imports your products into China and then sells them in RMB.
3. You form a China joint venture and that JV company sells your U.S. made products in China.
4. You form a China WFOE and that company sells your U.S. made products in China.
5. You form a China WFOE and that company uses a domestic Chinese distributor or sales agent to sell your products in China.
6. You form a China WFOE and that company actually makes your products and sells them in China. Since a WFOE is a Chinese legal person, the sale would constitute a sale of a Chinese product by a Chinese company.
7. You form a China WFOE and that company actually makes your products and uses a Chinese distributor or sales agent to sell your products in China.
8. You form a China joint venture and that company actually makes your products and sells them in China.
9. You form a China joint venture and that company actually makes your products and uses a Chinese distributor or sales agent to sell your product to China’s hospitals.
10. You license the manufacturing of your products to a Chinese manufacturer. The Chinese manufacturer manufactures your products, makes the sales in China and pays you a royalty on each sale or via some other method. See China IP Licensing Deals.
This last approach is the most “local.” It is also the result the Chinese government most wants when it makes its “buy local” announcements. The idea is to use its purchasing power to pressure foreign companies to transfer their technology to Chinese companies.
If you are selling your product or service to Chinese government companies or even to Chinese companies concerned about maintaining good relations with the Chinese government (there are a ton of these), you should seek to become as local as reasonably possible. Those who are serious about entering the China market should even consider the licensed manufacture alternative, since in some circumstances this may be the only way to make significant sales in China. See also Why NOW Is a Good Time to Double Down on Doing Business IN China.