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Selling and Distributing in China without a Legal Presence

Strategy

In this article Chris Devonshire-Ellis, of Dezan Shira & Associates, considers ways for SMEs (without decades of China-experience or an unlimited China-budget) to be successful at selling in China

As I travel a lot globally (last month India and the United States, this month China and Europe), I’m seeing a lot of potential new growth, albeit cautious, about selling and distributing products overseas. Companies from Idaho to the Czech Republic are all getting excited and starting to mentally gear up to do something they’ve never really done before – sell abroad. Part of this is born of a weak domestic market. Growth in the United States and European Union in 2010 is expected to be (depending on who you read) about 2 percent and 1 percent, respectively. Hardly great when faced with the opportunities emerging Asia presents, with China and India in particular charging along at 9 percent and 10 percent respectively. In short, Asia is buying while the Western markets remain dull.

This is having the effect of finally persuading the third and fourth tier manufacturers – smaller companies, often family owned, some smaller subsidiaries of larger, but still credit-wary parents – that they need to go and sell to Asia. China of course is often mentioned, both the United States and the European Union have considerable resources in China, and everyone knows someone that has done business there. However, a lack of investment dollars/euros kicks in, and executives are being pressured to sell to these markets without much budget and without many resources to do so. “Travel economy” is the mantra for many, and while that’s reasonable when money is tight, it can also manifest itself in being asked to perform a function with virtually little support. Selling to China can be a bit of a poisoned chalice. How to do it, with no experience and little budget?

Help, dear reader, is at hand. At my firm, Dezan Shira & Associates, we have long understood the constraints of small-medium enterprises, and acknowledge their lack of resources and requirements for perhaps more hand holding and price sensitive billing than the bigger China investors require. We have also long recognized one of the primary problems for SMEs was finding out what really is the best way to “Get into the China market.” We began closing this knowledge gap way back in 1999 with a complimentary newsletter called “China Briefing.” While China Briefing has now grown to include magazines and books, this news site you are currently reading is the natural successor to the original newsletter. We also work with a lot of governments in producing material for their own companies to read, learn from, and expand. One of the most successful of these projects has been the China Business Handbook which we helped produce (and mostly wrote) with the U.S. Department of Commerce. The entire book can be downloaded for free at the Asia Briefing Bookstore.

As I mentioned, one of the new common issues is how a company based overseas can sell and distribute its product to China without having a legal presence in the country. This book covers that, and I shall summarize the specific chapter content as follows:

Using an agent or distributor

Since WTO implementation, China has worked towards liberalizing its distribution system to provide full distribution rights for international firms. As it now stands, these companies are no longer required to use domestic import-export agents and distributors for their imported products. The implementation of distribution has greatly improved, reflecting the solution of licensing issues, while the continuing emergence of the foreign-invested enterprise (FIE) and foreign-invested commercial enterprise (FICE) model as a viable trading and distribution platform for foreign companies has also made the situation better. Trading and distribution are two separate issues and are, accordingly, covered separately by the WTO implementation documents. Trading covers the rights to import and export products to and from China. Distribution, on the other hand, covers the sale, either wholesale or retail, of products within China. There are several ways in which this can be accomplished:

Local agents

China has been witnessing an explosion in local sales agents who handle internal distribution and marketing. However, many of these businesses do not have import/export authorization. They are the next layer down the distribution chain, buying foreign products and importing them through entities that have an import/export license by paying a commission. They may be representative offices of Hong Kong or other foreign trading companies, or domestic Chinese firms with regional or national networks. Given China’s size and diversity, as well as the lack of agents with wide-reaching capabilities, it may make sense to engage several agents to cover different areas, and to be cautious when granting exclusive territories. China could be viewed as five major regions: the south, the east, the northeast, Central China and West China. In short, there is a need to find an appropriate agent – and there are almost certainly firms invested in from your own country that can assist. Your embassy’s commercial section or chamber of commerce may be able to make recommendations. Some products however may be more esoteric and that may require a more concentrated search for an experienced agent, or engaging with legal counsel. The issues to be aware of are the importation requirements for the product, what licenses are needed, the dutiable amount (which may be a deal maker of breaker on the exercise) and the potential liability you face back home should anything go wrong with a product imported and sold onto the China market by your business. You will need to engage friendly legal counsel in China to assist with these issues.

Distribution

Given the complexities of the Chinese market, foreign companies should also consider using a domestic Chinese agent for both importing into China and marketing within China. With careful selection, training, and constant contact, an international exporter can obtain good market representation from a Chinese trading company, many of which are authorized to deal in a wide range of products. Some of the larger companies have offices around the world, as well as a network of offices and affiliates in China. However, given transportation and communication difficulties as well as regional peculiarities, most of these trading companies cannot provide diversified coverage throughout China. Again, there are a number of foreign invested businesses who can and do specialize and may be able to assist. Ask your embassy or consulate, or even refer to our firm to assist – we have been in China for 18 years and have a network of import agents and distributors we can connect you with. There’s no charge for that.

Trading companies

China’s regulations have seen an explosion of Chinese companies that if they have been properly registered and capitalized to RMB500,000 can obtain an import-export license. You can check out whether they really have this status and are not fly-by-nights by checking their business license. You should ask them to show you a copy (if they can’t, walk away). Foreign investors may also establish such companies, known as foreign-invested commercial enterprises, and again, some of these may be able to assist. As a result, both Chinese and foreign owned trading companies are competing to assist international firms with importing and exporting their products. Remaining restrictions in this sector are mainly product specific (books, newspapers, pharmaceuticals) and the bulk of imported goods must pass through Chinese customs inspections. The efficiency of these inspections has increased drastically in recent years, and again many are excellent. Contact us should you require assistance with introductions.

You can of course, also set this up yourself, but that does add to your costs. A simple import-export vehicle that gives a foreign investor the right to sell onto the China market is a useful thing to have, and the set up costs are relatively low. A typical scope of business would include both trading and distribution rights. Distribution covers:

1.    Commission agent services

2.    Wholesale services

3.    Retailing

Laws and regulations released by the Ministry of Commerce allow foreign companies to establish wholly-owned distribution entities for chemical fertilizers, processed oil and crude oil, as well as other imported and domestically produced products. Limits exist on products including books and periodicals, pharmaceutical products and pesticides. More details on setting up and going it alone can be found here.

Distribution and sales channels

In recent years, China has worked towards liberalizing its distribution system to provide full trading and distribution rights for international firms. Nearly full liberalization of this sector was achieved in 2006. New laws removed earlier restrictions on size requirements for trading and distribution firms, thus paving the way for competition from small businesses. Currently, the only inhibiting factor in the process is that foreign companies need to apply for approval from the local branch of the Ministry of Commerce before they can register with the local Administration of Industry and Commerce. There are different sales channels available to foreign companies selling in China, including trading companies, distributors, and local agents. Trading companies with import-export rights take care of customs formalities, distributors build sales channels and handle stock and inventory, and local agents retail products to consumers. However, an increasing number of foreign companies are working to control this distribution channel as much as possible, and local and international trading and distribution companies are consolidating to provide more of these services under one roof.

Franchising

Many foreign companies are beginning to establish multiple retail outlets under a variety of creative arrangements, including some of which for all practical purposes function like franchises. Virtually all of the foreign companies who franchise in China either manage the operations themselves with Chinese partners (typically establishing a different partner in each major city) or sell to a master franchisee, which then leases out and oversees several franchise areas within the territory. China also enacted new regulatory frameworks concerning franchising that reflects that the Chinese government is willing to adopt a more liberal regulatory system. That, of course, is a major step in the right direction. But there are still a lot of uncertainties foreign franchisers have to deal with. The two major changes are as follows:

1.    “No approval necessary”

The franchiser no longer needs to apply for an “approval franchise license” before starting to franchise in China. The new regulations only require a registration, meaning you just have to give notice to the provincial government or the Ministry of Commerce.

2.    No “joint-and-several-liability”

The franchisor is no longer jointly and severally liable for their suppliers’ products and services.

Direct marketing

Direct marketing is a type of business model involving the recruitment of direct marketing sales agents or promoters and the selling of products to end-consumers outside fixed business locations or outlets. As part of China’s WTO commitment, the Chinese government agreed to allow market access for “wholesale or retail trade services away from a fixed location” from December 11, 2004. Nine months after this commitment date China issued two long awaited regulations governing the sector on September 2, 2005. These new regulations are quite restrictive, however.

Multi-level marketing organizations are characterized as illegal pyramids, compensation is capped at 30 percent based on personal sales, and language exists that requires the construction of fixed location “service centers” in each area where sales occur. Significant barriers exist for new entrants, as evidenced by a three-year foreign experience rule, and a required RMB20-100 million bond deposit. Since the passage of this legislation, however, several major international companies have had success in overcoming these barriers.

Electronic commerce

The Chinese government has adopted a relatively open attitude towards the advent of e-commerce in China. Both Chinese and international businesses have been active in investing and establishing online sales channels. China surpassed the United States in 2008 as the country with the most Internet users and by the end of 2009, had reached 384 million. Investment in e-commerce business is risky, however, due to the absence of clearly defined regulatory powers over the industry and a lack of an effective Chinese certificate authentication system.

While e-commerce in China has great potential, three major impediments still remain:

1.    China is still a cash-based society and use of credit cards remains limited

2.    Local distribution channels are not well developed for the delivery of items purchased over the Internet

3.    Limited awareness of the need for appropriate Internet security software

But several Chinese Internet companies have been very successful in adapting to the local market and developing an effective cash-on-delivery e-commerce model in the major cities. In addition, the Chinese government is making strides in enhancing Internet security. The Law on Electronic Signatures has already taken effect and enhanced the safety of online transactions, while the People’s Bank of China has issued e-payment instructions. These regulations will continue to contribute to the standardization of China’s e-commerce environment.

Trade promotion and advertising

Advertising in China is regulated by the Advertising Law of the People’s Republic of China, passed in 1994. This law outlines content prohibitions and advertisers’ responsibilities. Advertising should “be good for the physical and mental health of the people” as well as “conform to social, public and professional ethics and safeguard the dignity and interests of the state.” Specific rules include a prohibition on the use of national symbols and government images, and advertisements that are obscene, superstitious, discriminatory and/or dangerous to social stability. The advertising industry in China is heavily regulated, and the government still exercises ultimate control over content. The Advertising Law is not completely transparent, therefore, interpretation and enforcement may be arbitrary and varied, and legislation usually favors consumer protection over business promotion.

The State Administration for Industry and Commerce is the primary regulatory organization for the advertising sector, but many other organizations such as the Ministry of Culture and the State Administration of Radio, Film and Television, play an active role in controlling print or television content. China’s retail boom and increasing competition among retailers is causing China’s advertising industry to grow even faster than the economy as a whole. According to market information provider CTR Market Research, China’s total advertising expenditure jumped 13.5 percent to US$74 billion in 2009. In accordance with China’s WTO commitments, wholly foreign-owned enterprises in advertising services were permitted under the Management Rules on Foreign-Invested Advertising Companies, issued by the SAIC and the Ministry of Commerce in September 2008 and effective from October 1, 2008. All of the major international advertising firms are present in China.

Now that China is in the midst of a consumer revolution, foreign products, complete with advanced marketing, advertising and research techniques, are leading the way. Brand awareness is increasingly important and sophisticated advertising is beginning to play a key role in charming the Chinese consumer. Foreign products are expected to continue making inroads despite 1999 regulations calling for more control over customer surveys that help foreign firms enhance their marketing effectiveness.

Trade shows and missions

Thousands of exhibitions are now held annually in China and can be excellent venues to gauge market interest, develop leads and make sales. Most are sponsored or co-sponsored by government agencies, professional societies, or the China Council for the Promotion of International Trade. Show participation costs are sometimes high, and some shows may reach only a local audience, so companies are advised to scrutinize shows.

Pricing

Most Chinese consumers are sensitive to price and will usually choose the less expensive product unless they can be swayed by better after-sales service or significantly better product quality. However, the younger Chinese consumer is very brand conscious, and brand advertising is commonly used to effectively increase the perceived value of a product.

This article was contributed to by the U.S. Department of Commerce and updated by Dezan Shira & Associates. The U.S. Department of Commerce, U.S. Commercial Service has a presence in 19 major cities across China. To make the dynamic markets and untapped markets of China’s first and second tier cities accessible to U.S. exporters, U.S. Commercial Service experts work in partnership with China’s national trade association, CCPIT, to help U.S. exporters identify potential markets, develop partners and distribution networks, and connect with key decision makers. Their export wing may be contacted here and has an extensive network throughout China.

Chris Devonshire-Ellis is the principal and founding partner of Dezan Shira & Associates, establishing the firm’s China practice in 1992. The firm now has 10 offices in China and are corporate members of the American Chamber of Commerce in China and the European Chamber of Commerce in China. For advice over China strategy, trade, investment, legal and tax matters please contact the firm at info@dezshira.com.