The juicy Chinese market: an entrepreneur's trap

The typical failure of the French company in China can be summed up in this mindset: "my product is objectively better and that will have to be enough."

But everything has changed in thirty years. Importers made their fortunes in the 90s and 2000s, taking advantage of an empty market and a booming economy. The French label was enough to convince distributors and consumers: wine, cosmetics, dairy products, and soon luxury brands, industrial equipment: France has experienced twenty years of Eldorado but the market has filled with new players, foreign and local, giving the Chinese consumer access to an increasingly varied offer. Following this, what happens most naturally in economics happened: the market has evolved and is moving towards maturity. Only this evolution is so rapid in China that we can hardly perceive it from France. We hear it, we perhaps understand it, but we do not yet fully assimilate it. Today, and mainly thanks to online sales, the Chinese consumer has access to a very wide variety of products, probably even more than the European, and to a mass of information (price, composition, origin) that is merciless with brands. Diversified and transparent, the market has everything of a liberal market, or almost, because with its powerful and intransigent hand, the State can put an end to an entrepreneurial epic from one day to the next or reduce a segment or an entire market to nothing in the space of a month if it is in the interest of its major political orientations. Conversely, it can, with a wave of a magic wand, create a new gold rush for an industry that it wishes to encourage. The Chinese market is therefore liberal but under the conditions imposed by the general interest of the country, seen by the central government. In a diversified, transparent, and oriented market, to hope to prosper or develop in China, you must first be aware of the government's broad strategic guidelines and position yourself according to them, then be able to meet fierce competition in terms of products and marketing. No, being the best technically is no longer enough, nor is having the best brand image: you will have to combine the two, and you will even have to compromise on your prices because distributors are greedy. Chinese distribution networks are often complex and opaque: your partners will need enough margin on their prices to find their own resellers and let a few bribes slip. The right mindset would be "I believe in my product, it's the best, but I will have to constantly jostle for position so that consumers believe in it over time, and be flexible on my prices to convince distributors to help me".

Speed and responsiveness are two other characteristics necessary for a successful foreign company in China. During my business coordination missions, my job was basically to hurry the French, and to hold back and slow down the Chinese, explaining to them French restraint. The real cultural barrier that exists between France and China in the business world is neither language nor ethics, it is pace. The "thirty glorious Chinese years" took place roughly from 1990 to 2020: a period during which European countries became globally stagnant economies and victims of many consecutive crises. Based on this, the mindset of entrepreneurs in the two countries is completely different. The Chinese have only known this last period of crazy growth where crises only concerned others, where demand doubled supply, and where mediocrity did not prevent one from getting rich. In this context, there is no need to take too many precautions: "it will pass"; no need to worry about cash flow: "we will find financing". So when the French meet the Chinese, we find ourselves with very different dimensions and mindsets. The French, rightly so, will need time to assess all the risks, will prepare a business plan for each new product, will be reluctant to invest in new packaging without sales guarantees, will impose reassuring minimum orders (MoQ). The Chinese, on the other hand, will simply have a friend who told them about an opportunity to seize: they will want to jump at the chance so as not to be overtaken. They will not understand your pace, which they will take as a refusal. They will not wait, and will quickly turn to other alternatives. However, in the current competitive context, there is no shortage of alternatives. When working with the Chinese, you must get as close as possible to their pace, and actually take some risks. It is then up to you to assess whether the game is worth the candle.

Once we have assimilated these ideas, we can think about the “how”.

SMEs that come to China most often think of three options: working with a distributor, partnering with a local partner through a Joint Venture, or setting up themselves by creating their own independent entity in China. Each of these solutions naturally has its advantages and disadvantages: let's try to explain:

By choosing to go through one or more distributors, you are opting for the least expensive and most convenient option. In the best of all worlds, if you are lucky enough to find a reliable exclusive agent for the entire Chinese market, then you will only have to provide him with information and wait for his orders.

The condition of exclusivity will be asked of you almost systematically, and you will have to be ingenious to limit your risks. Information is difficult to access in China, and it will be difficult for you to find reliable proof of what a potential partner is saying. You will be suspicious, and you will probably be right: all the Chinese inflate their figures. Yes, I mean all of them. Or if I wanted to qualify, I would say all those I have had the opportunity to meet for business. Almost certainly, promises of colossal orders are false: they are a way for them to bait you or keep you in their pocket, and to flatter their ego: divide by two, or rather by three, and you will be close to the truth. Perhaps you will think about calling on a consulting firm to investigate for you? Be careful, small consulting firms that offer accessible services do not have much reliable information and large firms that buy vast databases are very expensive. Let's say you have found a partner you trust, my recommendation is still to grant only partial exclusivity: either geographical or sectoral; and/or, exclusivity for a limited period and renewable depending on the results.

From there, give him a margin that satisfies him, and he will make the sales efforts to create the market for you. Here are some caveats, however, and not the least: In the current competitive environment, to interest a distributor (exclusive or not), you will have to leave him enough margin to distil in his sales network which is typically more complex, more opaque, and includes more levels than in Europe. The margin that you leave him will then have to be enough to satisfy him, but also to potentially feed several downstream players. Distributors are not generally experts in the products they represent, and all your efforts to convince them of the superiority of your product risk being largely eclipsed by the strength of the prices. In addition, the complexity and opacity of Chinese distribution chains can pose significant communication problems, and many of those who have tried it before you will tell you, it is not easy to obtain information from your distributors and communication is very ineffective. In concrete terms, it could happen to you that sales are at their lowest, and that your Chinese partner does not tell you about it, does not explain the reasons, that he promises you the moon in terms of figures to keep you in his pocket while waiting to find something better, or that he forgets to tell you that one of his agents only placed his last orders with "red envelope" encouragements that cannot persuade the entire hierarchy of a company in the long term. During all this time when you thought that everything was going well, because in France we say: "no news is good news", you did not think about an alternative strategy, and in the best case, you will have lost months, or more. We are never completely safe from being kept secret, but we can try to stay as close as possible to our partners by following them closely if necessary, either by hiring a salesperson on site by creating a company or a representative office, or by using the services of an independent worker. You can also go through a so-called "consulting" company that offers this type of service, but having been a consultant myself, in my humble opinion, this last solution is the most expensive and not necessarily the most effective.

The sales power implemented is obviously linked to the results, and it may seem that linking up with a local company that already has a solid sales network would minimize the worry about your figures. The Joint Venture, by pooling the interests of two companies, is indeed a reliable solution and potentially resulting in 1+1=3; in theory. In practice, if you do not have the backing of a multinational, you risk a lot. The typical partnership consists of the technical or technological contribution of the French entity to a Chinese structure that will produce and, or, make the effort to sell on the market. For example, if a French company that we will call "Béret" has advanced know-how in the production of intelligent pressure cookers, and whose logical strategic follow-up is to attack the Chinese market, then perhaps at a household appliances show in Paris, a flattering but confident businessman from the other side of the world will have come to approach it at its stand. This man, clearly not very interested in fashion, will be introduced by his interpreter as Mr. Wang, director of the company "Pousse-pousse", a producer of kitchen appliance parts well established on the market. The director of Béret, Mr. Levert, is present at his stand. A seasoned entrepreneur, he has already met Chinese people, and even already sells in China through a distributor who does not really satisfy him because "with such a market and such a product, there should be more potential". The interpreter of Pousse-pousse, works as best he can to translate the presentation and proposals of his director. Experienced in business, Mr. Levert listens attentively and remains wary. He asks crucial questions, questions that assess the credibility of a company: the right questions, for a French company. Mr. Wang is not disconcerted and, dressed in pleasantries, answers the interrogation with brilliance and confidence. Messrs. Levert and Wang will meet again a few months later in China, at the headquarters of Pousse-pousse in Guangzhou. Relations are very cordial. We share rich and copious meals with pleasure and a form of friendship is created. The factories visited please Mr. Levert who tells his partner with kindness and a little surprise: "they do good work!" The analyses and plans proposed by Mr. Wang's teams hold up: Pousse-pousse already has a lively distribution network and mature production tools. After two days of visits and during the last meal, Mr. Wang makes his final proposal: he enthusiastically suggests that Béret and Pousse-pousse launch a Joint Venture: Béret will bring his know-how, and Pousse-pousse will produce and sell. Reluctant to the idea of producing everything in China at the risk of letting his know-how slip away, Mr. Levert, standing firm, does not lose his bearings, immediately returns to his businessman's mind, and specifies that he will keep the technical production in France, and that the assembly will be done in China. Mr. Wang accepted, seeming to have understood his host's concern. Having set this condition, Mr. Levert continued: "And how much should we put in?" The stay had come to an end, and it had been determined that Béret would have 49% of the shares in the joint entity, but that it would not have to make any financial investment, apart from sharing administrative costs: the French contribution would only be technological.

At this stage of this caricatured tale, you should know that marrying a Chinese company through a Joint Venture implies that you will open a joint entity on Chinese territory with shared capital. Some of the famous China experts, experienced from their soft Parisian armchairs, believe and will tell you that you will be required to leave at least 50% of the shares to the partner: this is only true for the automobile industry. For the rest, 25% to the Chinese company is the minimum required. But let's get back to our hens...

Mr. Levert, back in France, decides to think carefully about the matter and to call on his contacts for some advice. He is rightly warned of the possible scams and the difficulties in resolving a dispute in the Chinese courts and he learns that it is common to open the Joint Venture in Hong Kong where the jurisdiction is less opaque. The Hong Kong entity will then become an intermediary company that will then invest in mainland China. This solution seems reassuring. The plan is generally well thought out and the risks reduced. Mr. Levert calls on a specialized law firm to help him with the administrative procedures, orders a market study from a consulting firm to confirm the potential, and the adventure begins.

After six months of paperwork and tough discussions, the structure is set up, the business is launched. Assembly and part of the production starts in one of the available Pousse-pousse factories and negotiations with a distributor are completed. A year later, the distributor's sales have increased but are starting to stagnate, and it seems difficult to find other alternatives. Another year goes by: sales are becoming rarer, and Mr. Wang is still doing well but seems to feel less and less concerned. The investment was not very heavy so Mr. Levert is not overly exasperated, however he expected better, and begins to question the market context. With a view to helping his Chinese partners and, incidentally, to form his own opinion on the current situation, he asks another consulting firm for a new study. The good news is that the market does exist. The bad news is that a new competitor offering a product almost exactly identical to the Béret pressure cookers has been established for a year... Coincidence? We dig a little deeper, and we discover that a certain Mr. Wang is the founder of this strange competitor. It all makes sense, Mr. Levert has been fooled: "they opened the joint venture, set up another business for him by copying my pressure cookers! And of course they kept all the customers!" He calls his lawyer to explain the situation, he fully intends to make Pousse-pousse pay. Mr. Wang no longer responds, legal proceedings are initiated. Three long years go by, Mr. Wang finally gives in, he will pay penalties, but will not drop his new brand of pressure cooker or simply change the name. Mr. Levert has wasted four years, he has lost the Chinese market, he has created a hostile competitor, the dispute has cost him, he will not try the adventure again any time soon.

Mr. Levert won his case, he managed to make justice work. So it's not that you won't find a solution in court with China, it's that with solutions you would waste too much time, and therefore money.

This case study is just a crude parody, but it is understandable that JVs are not to be taken lightly. It is not impossible that you will find a trustworthy and loyal Chinese partner, and it would be insulting to generalize my point, but this story, although parodic, is inspired by real experiences.

A Chinese expression says: "Do not have bad intentions, and protect yourself from bad intentions" (害人之心不可有，防人之心不可无). If your instinct and your investigations lead you to trust a Chinese partner, the JV can be fruitful and it may even be the most interesting solution because you will benefit from the strength of a company already established in a complex environment. However, trust does not prevent prevention. Make yourself indispensable to your counterpart, and never relax your attention: if you have copyable technology, keep it at home and do not give up, but do not underestimate Chinese engineers; if your product requires remote digital management, keep all the software at your side, even if it means wasting time on after-sales service; make sure that your brand is recognized for itself in China; also bring local customers to the JV who will have to become an important part of the results; etc.

Then you have the option of creating your own structure in China. This solution is the most expensive in terms of initial investment. Creating a company with 100% foreign capital (Wholly Foreign-Owned Enterprise structure: WFOE) is possible and is not very expensive in itself, however the time spent on administration, the tricks to know to avoid detours and the daily worries of Chinese paperwork require a lot of time and experience. You will need the help of an agent who, in itself, should not cost too much. On the other hand, if you decide to go solo, you will also have to rent an office, employ at least one employee, and manage the accounting and administration on a daily basis. All this will represent an investment of at least one hundred thousand euros for the first year. That said, in this configuration, you will have solid control over your brand in China, your Chinese team will work exclusively for your development, you will have direct and live feedback from the market, you will have increased credibility with your Chinese and foreign customers, and above all, you will be sufficiently lively and responsive to keep up with the Chinese pace.

The question of Chinese human resources will then arise for you. Hiring a French expatriate to manage the Chinese entity seems to be a reassuring solution and yet this type of configuration often leads to bitter failures. If many companies prefer a compatriot as a regional referent, it is because people will more easily trust a French person, because they have the same codes. Many French or Westerners have been living in China for a decade or more, but very few have been able to integrate deeply into the country. On the contrary, the oldest, often senior executives, live in bubbles of comfort, do not need to string together three words of Chinese and spend their Friday evenings at the Bar Rouge or the Café des Stagiaires. With a nice, well-polished CV and managerial experience in several renowned companies, they will be able to tell you about China, but when it comes to ordering in a restaurant, they will not be any more advanced than you because after so many years, they will not have found it essential to learn Chinese. A few exceptions exist, and you will find a handful of expatriates who are well integrated into the Chinese community and who have created a network, but be aware that being married to a Chinese woman does not equal integration, and that having worked for years in China does not equal understanding: true experts in the field are rare and are often entrepreneurs themselves. Opting for a Chinese regional director may be the best solution: first of all, the Chinese are increasingly qualified, and you will be surprised to find brilliant, multilingual, trustworthy candidates who will understand Western methods while having grown up in the Chinese world. This type of profile is less and less rare, but there are some caveats to be made. First, Chinese salaries have increased significantly, and a manager will not cost you much less than an expatriate if you take into account employer and social security contributions, which are very high (around 50%). Then, the job market is very dynamic, and for a young Chinese worker, staying in a company for more than three years is already an achievement; in China, you increase your salary by changing companies. You will then need to know how to retain your Chinese employee(s) by offering them solid development opportunities.

In the end, this solution of setting up in China with your own structure will cost you economically, that's for sure, launching yourself is a risk that you have to accept. But it is also, in my opinion, the only real long-term solution. The time when you could win the market by going through a smart and connected distributor without investing anything is over. If you want a place in China, you will have to put the means there and put your "foot in it". Take the Chinese adventure as a risky bet but with a high potential for reward.

Geoffrey Wu-Perrot

geoffreywp@doublelink-consulting.com