SMEs and China: Much Opportunity but Little Room for Error

Many years ago, a friend of mine who helped head up the international division of a well-known United States multinational asked me how I thought her company should go into a Russia. I told her I would ask a very smart and sophisticated Russian friend of mine who really knew how things worked there. This Russian friend told me exactly how this multinational needed to enter and he assured me that if it did anything differently, it would encounter big problems.

My friend at the multinational told me that her company had never done what my Russian friend was proposing and it would not do that in this country either. It didn’t, and one year later my friend confessed to me that her company had made a big mistake by not doing what my friend had proposed and they actually hired my Russian friend as a consultant (which he had not even suggested in his original manifesto).  Within months, the multinational’s problems had disappeared and it is now very profitable in that country.

When I made my friend multinational take me out for an “I told you so lunch,” she downplayed everything, saying her company’s mistakes had “only” cost the company “one year and less than USD $3 million.” She was not the least bit troubled by the whole thing.

Many of my friends at BigLaw with China offices tell me their China operations are losing millions of dollars a year, but “they are in it for the long term and they need to be in China so they do not lose their existing clients to those who are already there.” I have heard countless stories of BigLaw (really though it’s not the top tier law firms to which this is happening but the mid-level firms) losing their shirts by discounting their rates in an effort to grab Chinese company business. They discount their rates to grab the client now, figuring they will be able to raise their rates on the next project. Instead, on its next project the Chinese company just finds another law firm willing to provide it with a deep discount.

I am always saying my firm is too small to be able to pursue money-losing business for chimerical long-term gains because we have to keep the lights on in the short term just to be in existence in the long term.

SMEs doing business in China or even with China are the same way; they simply cannot afford big mistakes. They typically must get things right the first time. Multinationals, on the other hand, have a wealth of resources available to them, including the ability to withstand failed experiments. SMEs do not have this luxury and our China lawyers have seen many SMEs lose big with China due to one mistake.

The following are the most common “lights out” mistakes we see with SMEs that are doing business in China or with China:

1. Purchasing products from China without a finely tailored Manufacturing Agreement. The SME gets a massive shipment of bad product from its Chinese supplier and it has no recourse because it has no real contract. It then has to shut down because it has insufficient resources to both secure new product and pay off its disgruntled customers. Oftentimes, the SME ends up getting sued by Sinosure just for good measure.

2. Failing to properly register key trademarks in China. If you do not register “your” trademarks in China, someone else will. And then when your largest shipment is a about to leave China, you will get a call from the company that registered “your” trademark to let you know that unless you pay them a massive licensing fee, your shipment will never leave China. This is the sort of thing that puts companies out of business.

3. Thinking that because you have gotten away with functioning illegally in China for years (or because you know someone else who has) that you will never get caught. My law firm was recently contacted by a company that had been in China for twelve years before it was unceremoniously shut down for not being properly registered. We were also contacted by a company that was allowed by the local government to operate a business for nine years against all zoning regulations, but then shut down one month after a new local administration took over. See China Foreign Company Compliance in These Tough Times.

4. Failing to have a written Chinese language employment agreements with all employees and failing to have an employee manual (again, in Chinese) explicitly setting out the grounds for termination.  Though I have yet to see a company have to close down for these mistakes, I have seen many instances where SMEs had to go through expensive and protracted litigation for these mistakes.

What have you seen out there?