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| Source: wsj.com |
Though China may look like a lucrative market,
it may soon be discovered that trading with this country may impose certain
risks in all areas due to the different values and priorities when it comes to
the rule of law, human rights, managing the conflict of interests among other
things. It is highly recommended for the western companies to do preliminary
research and be prepared for the potential risks they may face when investing
in China. It is also recommended to think what would happen in the worst case
scenario and consider the possible steps required to mitigate the risks and minimize
the exposure. The
different possible areas of risks that
businesses should expect when trading with China can be divided as follows.
Legal and regulatory risks
Though
China tries to play according to the open market rules, there is still a lot of
bureaucracy and approval of this or that process/document/idea may take quite a
while. Especially it is true when there is a need to get approval from several
different authorities who are in charge of the same regulation process (Hoenig, 2006). Moreover, before
entering into any agreements it is advisable to clearly understand how the
regulations are interpreted in this country and in what way they are applied to
your particular business.
On
top of that in case of any disputes it is quite risky to rely on the local
judicial system. Though there is a demand from the international business
community to become more transparent, the rule of law in China may not always
be on the foreign company’s side due to specific law interpretation and may be
subject to pressure from the local interest groups or government.
As
was mentioned by Rudy Dries, Specialist on Financial Logistics from Rabobank,
the easiest way to start business in China is through establishing of a Joint
Venture. But again in order to avoid legal problems, it is recommended to do
preliminary research and find out background information about the potential JV
partners, their financial situation, their relations with local authorities
etc., and only after a so-called screening enter into official business
relations (Dries, 2016).
Very
common legal problem is a weak intellectual property (IP) protection in China.
Western companies value IP rights of owners, producers and creators of various
goods and services. But that’s not always the case in China where there is a
high possibility of counterfeits and knock offs circulating the market. So
foreign investors are advised to apply strict IP protection policy and keep
sensitive information safe and secure. There were cases when after the
establishment of Joint Venture with the Chinese partner, one of his relatives
founded similar start-up company, creating competition on the market (Harris, 2016). As mentioned in Managing Business Risks article
published on China Business Review, a
thorough IP risk assessment must be conducted to determine the likelihood of IP
leakage and what impact it would have on the company, the brand, and the
company’s customers (Hoenig, 2006).
Production/fabrication risks
One
of the production risks in China is a potential non-compliance with the
international norms of work conditions, health and safety rules. For example, there
were cases when child labor was used or people were working in unsafe
environment without proper ventilation or blocked emergency exits. It goes
without saying that the leaking of such information might damage the reputation
of foreign companies working with the Chinese partners. That’s why regular
checks/visits can be arranged or corporate code of conduct may be developed
together with the manager of production facilities. However, the effectiveness
of such measures remains under question. Fake model factories can be used for
planned visits of foreign inspectors or the code of conduct regulations might
be violated due to the lack of control.
Another
risk is the possibility that the Chinese factory will produce low quality or
defective goods that do not meet the specifications. For example, as Gerwin van
Dijk shared with us during a Skype meeting, there was a situation when he once
received a container with leaking paper cups. So, how is it possible to
mitigate this risk? One can either ask for a pre-shipment testing sample or
hire independent third party in China for making proper tests on spot and
sending over the testing reports.
Delivery/transportation risks
What
might happen is that products are not delivered at all or delivered later than
it was agreed. Late delivery is even worse, for example in case of seasonal
products that can be sold only within a specific time frame (e.g. Christmas
goods). Moreover, there is a risk that goods might be damaged during the
delivery, or the ship might sink, or all cargo might be lost due to pirates’
attack. All abovementioned risks should be taken into account when the contract
is made and terms of delivery are determined based on Incoterms. Depending on
applied type of delivery (FOB, CIF, EW etc.) these risks should be insured and
covered either by a seller or a buyer.
Currency risks
Currency
risks or, in other words, exchange rate risks are risks that exist when
financial transactions between parties are made in a currency different from
their home currency. In this case there is a risk to be in loss due to
fluctuating foreign exchange rates. In China the home currency is yuan. Local
Chinese manufacturers depending on their situation might demand to be paid
either in their local currency or in US dollars. If they source raw materials
from abroad, they would probably prefer to be paid in US dollars in order to be
able to pay their supplier without the need for currency conversion. On the
other hand, they might demand the payment in local currency in order to avoid
losses due to exchange rates. Sometimes, they add 10% on top of the price in
order to mitigate the exchange rate fluctuation risks (Dries, 2016).
Country/political risks
Country
risks are the risks arising from possible changes in the macro environment of
the country that may negatively affect operating profits or the value of assets
located in the country. Potential investors should always consider these risks
and analyze economic indicators in order to make informative strategic decisions.
When it comes to China, it is important to understand what the country’s strong
and weak points are. Speaking about strong points, it is worth to mention low
public and external debt, increasing market orientation, huge industrial base, solid growth prospects,
large domestic market. As for the weak points, one can name difficult business
environment, lack of business transparency, continued geopolitical tensions with
key countries in the region (Hermes, 2016). Indeed, China is very persistent in
its aspiration to recover lost territory in the South China Sea, so will it
lead to a new war in the Asian region? Or will the conflict be settled in a
peaceful way? I believe nobody has an answer to this question and this makes
the situation quite tricky.
Moreover,
there is also such aspect as culture
which may play a role in increasing a potential trade risk with China. As
Rudy Dries mentioned, one of the most important things that investors should
have when starting a company in China is patience. Business relations there are
not built overnight and sometimes it takes quite a while for the Chinese
partners to build trustful attitude towards foreign partners and let them into
their “guanxi” circle. Chinese businesses usually operate behind closed doors, out
of view of potential partner, investors, the judicial system etc. It may happen
that documentation on financial transactions, procurement operations,
subcontractor contracts are non-transparent or lacking at all, making it
difficult to assess the accuracy of information (Hoenig, 2006). The knowledge about the financial
health of a company may be concentrated in hands of one person, company’s
founder or CEO.
On
top of that, business ethics is a relatively new concept in China. China's own philosophical traditions encourage
favouring family members, relatives, buddies because of the feeling of
responsibility to family and close circle of friends (Schulman, 2006). This may lead to
situations when there are family connections between a general manager, an
accountant, a procurement manager and suppliers. Thus the conflict of interests
may occur when the purchase is made not from the best supplier, but from the
supplier who is your far relative. Such arrangements often lead to corrupt
practices, when the business is made with particular companies for personal
gain. Investors should be ready that fair play may not always be possible.
To
my mind the most important aspect that should be taken into account when
considering trade risks is the objectiveness of risk assessment. Potential
investors should keep it realistic and decide for themselves if the game is
worth the candle. Bearing this in mind I would recommend to identify the
potential risks in all areas, assess how likely it is that the worst case
scenario would happen and decide what measures could be already taken to
eliminate the risks. It is important to be prepared and always have Plan B, if
Plan A fails. It goes without saying that risk is part of our life and it is
impossible to predict all potential risks, but one needs to make sure that he
is pretty much aware of the real situation and would be able to manage it responsibly.
References
Dries,
R. (2016). Trade Risk Management (PP presentation).
Harris, D. (2016,
September 27). China Contract Risks: Not What You May Think. Retrieved
from http://www.chinalawblog.com: http://www.chinalawblog.com/2016/09/china-contract-risks-not-what-you-may-think.html
Hermes, E. (2016,
June 22). Country Risk Map. Retrieved from http://www.eulerhermes.com:
http://www.eulerhermes.com/economic-research/country-risks/Pages/country-reports-risk-map.aspx
Hoenig, J. (2006,
November 1). Managing business risks. Retrieved from
http://www.chinabusinessreview.com:
http://www.chinabusinessreview.com/managing-business-risks/
Schulman, M. (2006,
March 23). Business Ethics in China. Retrieved from https://www.scu.edu:
https://www.scu.edu/ethics/focus-areas/business-ethics/resources/business-ethics-in-china/