China

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University of Nottingham

International Businesses Entry Mode in China

By

Zhanyuan Cai

MSc International Business

15/09/2006

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Abstract

Today economic globalization is more and more deepening and to develop the

domestic economy through utilization of foreign capitals is becoming every country’s

common consensus. Foreign investment becomes an essential part for the healthy growth

of the host country’s economy, but the attitudes and the policies taken by the host

countries especially the developing countries are varying. Therefore it is important to

learn and know the attitudes and policies of the host countries for foreign firms before

making investment. In addition, the country’s culture and market environment greatly

affect different types of entry modes. This dissertation explored the characters of

different types of entry modes and seeking through various aspects that affect the

decision making on choosing the right form of entry mode in China. Now China becomes

the largest country in attracting foreign capitals among developing countries. A

comprehensive examination and adjustment of China’s strategies in utilization of foreign

capitals has been an important topic that can not be ignored.

The dissertation has been divided mainly into seven parts: the first part is the

Introduction. The introduction for the topic and the definition of the basic concepts are

given. The second part is the Types of entry modes. In this part, four different types of

entry modes: Exporting, licensing, franchising, and FDI- Joint Venture are introduced

and described in details. The third part is the Chinese Culture. The aim for this part is to

point out how it affects the choice of entry mode in China and what are the advantages

and disadvantages of Chinese culture relating to different types of entry modes. The

fourth part is the Chinese regulations and policies against foreign firms (for different

types of entry modes). A case study of KFC is offered in the fifth part to confirm and

proof the concept of the dissertation. The sixth part is an interview of a foreign company

(Lvbang) in China. And the last part is the conclusion.

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Acknowledgement

Firstly, I would like to thank my Supervisor- Dr Tian Xiaowen, for his continuous

support for the writing up of my dissertation. Dr Tian Xiaowen is always there to listen

and to give advice. He taught me how to ask questions and express my ideas and how to

write the dissertation in the correct way. He showed me different ways to approach a

research problem and the need to be persistent to accomplish any goal.

During the writing up of this dissertation, I faced many problems and thanks to Dr

Tian, who is responsible for helping me to complete the dissertation. Without his

encouragement and constant guidance, I could have not finished this dissertation. He was

always there to meet and talk about my ideas and mark up my papers and chapters, giving

me advices and supports.

Beside my Supervisor, I also would like to thank Mr. Cai Rongzhuang, the

chairman of Lvbang international company Co., LTD. Thanks for his time and great

passionate support during the interview.

Last, but not least, I would like to thank my whole family. Without their support,

especially my parents, I can’t finish this dissertation on time.

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Content

Chapter1: Introduction................................................................…………….…………....6

1.1 China’s opening up……………………………………….……………......6

1.2 Chinese economy……………………………………………...............…...7

1.3 Why foreign investors choose China………………………………....…....8

Chapter 2: Types of entry modes …………………………………………………..……10

2.1 Introduction……………………………………………………………….10

2.2 Exporting………………………………………………………………….11

2.3 Licensing………………………………………………………………….11

2.4 Franchising………………………………………………………………..14

2.5 FDI- Joint venture………………………………………………………...15

Chapter 3: Chinese Culture ……………………………………………….……..........…22

3.1 Introduction………………………………………………….………….....22

3.2 Culture affects on Exporting………………………….…………………...26

3.3 Culture affects on Licensing and franchising……………………………..27

3.4 Culture affects on Joint venture (FDI)………………………….………....30

Chapter 4: Chinese regulations and policies against foreign firms ……………...........…34

4.1 Introduction……………………………………………………………….34

4.2 Exporting………………………………………………………………….36

4.3 Licensing and franchising ………………………………………………..42

4.4 Joint venture………………………………………………………………44

Chapter 5: A Case study (KFC).............................................................……….…...........49

5.1 Introduction……………………………………………………………….49

5.2 Internationalization of KFC………………………………………………50

5.3 Choosing the Chinese market…………………………………………….50

5.4 Recommendations………………………………………………………...51

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5.5 Market entry options…………………………………………………...…51

5.6 Recommended entry mode: Joint venture………………………………..52

5.7 Recommended location…………………………………………………..54

5.8 Central control versus local responsiveness……………………………...55

5.9 Conclusion………………………………………………………………..55

Chapter 6: Interview with a foreign company (Lvbang) in China .........................……...57

6.1 Introduction……………………………………………………………….57

6.2 Interview………………………………………………………………….57

Chapter 7: Conclusion ……………………………………………….………….....…….61

7.1 Chinese market environment…………………………………………......61

7.2 Comparing different forms of entry modes...………………………….…63

7.3 Best choice- Joint venture………………………………………………...65

References .................................................................................................................…....66

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Chapter 1

Introduction

1.1 China’s opening up

China is one of the most ancient countries in the world that has history of more

than 5000 years. Since the great Cultural Revolution from 1966 to 1976, China has

adopted a gradual approach to economic reform and opening up under the authority of

leader Deng Xiaoping. This approach leads China to open its door to the world and allow

foreign companies to run their businesses in this huge market with enormous potential for

development. Under the gradual development of economy approach, the country has set

up many restrictions and regulations against foreign firms and in the beginning, it was

very hard for them to set up and run their businesses in china. However, since China

joined WTO and the introduction of globalization lead China to change its policies and

regulations, and the economy in china has been hastily growing. This rapid growth of the

Chinese economy has attracted many foreign firms to come and invest in China. Because

china is still adopting the gradual development approach, it is important for foreign firms

to learn and know the Chinese government’s policies and the forms of entry modes that

are suitable for particular industries in China. Failure of doing that will result many

negative effects to foreign firms, such as losing of opportunities, profits, and even unable

to survive in the Chinese market. This dissertation will mainly introduce and discuss

different types of entry modes for different industries and various aspects that affect the

choice of entry modes in China, such as cultural and political. In addition, provide

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information for foreign companies of making decisions on choosing the right and most

suitable entry modes in China.

1.2 Chinese economy

From the UN’s world investment report in 2003, ‘China has become the world

number one that attracted 53 billion US dollar in 2003 and maintained the largest FDI

recipient globally. The economy of the People's Republic of China is the second largest

in the world when measured by Purchasing Power Parity, with a GDP (PPP) of US

$9.412 trillion in 2005. When measured in USD-exchange rate terms it is the 4th largest

in 2005 with approximately US $2.22 trillion, set to overtake the German economy by

2009. It is the world's fastest growing major economy, and its continued growth is vital to

the overall health of the world economy and to the benefit of its population of almost 1.3

billion (most of whom have yet to enjoy western style affluence). Its per capita GDP in

2005 was approximately US $1,703 (US $7,204 with PPP). As of 2005, 70% of China's

GDP is in the private sector. The smaller public sector is dominated by about 200 large

state enterprises concentrated mostly in utilities, heavy industries, and energy resources.

Current GDP per capita grew a paltry 17% in the Sixties, rising to 70% in the Seventies,

and China surged ahead of India registering a remarkable growth of 63% in the turbulent

Eighties and finally reaching a peak growth of 175% in the Nineties. However, Chinese

prosperity still remains concentrated in the coastal and southern provinces and efforts

have been made in recent years to expand the prosperity to the inner provinces and the

industrial North east rustbelt’. The graph below shows China’s GDP trend after the

reform until 2005:

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(http://www.unctad.org/templates/WebFlyer.asp?intItemID=2412&lang=1)

The Central Committee of the Chinese Communist Party recently has published

and approved the plan for the 11th 5-year plan for year 2006 to 2010. The plan stated that

the Chinese economy will run for a further 45% increase in GDP and 20% reduction in

energy intensity by 2010.

1.3Why foreign investors choose China

The great development of the Chinese economy has attracted large number of

foreign investors to come and invest in China with various forms of entry modes. Why

foreign firms go aboard and invest in China? The answer is obvious: firstly, foreign firms

need to over come the liability of foreignness. The inherent disadvantages foreign firms

experienced in China due to their non-native status such as numerous differences in both

formal and informal institutions (Regulations, Culture, Language, Policies and

environment, etc). Secondly, the tremendous market opportunities have stimulated

numerous foreign companies to expand their business in China. Lastly, globalization has

pushed firms to expand their businesses globally and China is a developing country. As a

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result, one of the most important objectives for China is to developing its economy

globally in order to merge the global market. Attracting foreign capital becomes the

major source for the rapid growth of the Chinese economy. The joining of WTO is the

latest accomplishment for China and raises its position in the global competition. From

above, it is obvious that studying and learning the forms of entry modes are significant

for foreign companies especially multinationals. Choosing the right and suitable entry

mode may help foreign investors to gain more profit with higher efficiency from their

investments. In addition, selecting the most suitable entry modes for the right industries

may achieve better government supports and face less negative cultural effects. In other

words, it can be stated that entry mode is the key for foreign investment, selecting an

entry mode is one of the most important strategic decisions that a firm has to make when

it enters a new market, which often determines that success or failure of the firm in the

new market. Foreign investors choosing the wrong entry modes may result to fatal failure.

This dissertation will mainly focus on four different types of entry modes:

exporting, licensing, franchising and Joint Venture. Each type of entry modes will be

inclusively defined and described under the framework of the Chinese economy. Then

each type of entry modes will be compared with the cultural and political aspects and

both advantages and disadvantages for all four types will be specified. It is important to

know that different companies should choose different forms of entry modes and its all

depend on individual circumstances. It is almost impossible to say that which form of

entry mode is better than another. There are many factors that affect the choice of the

right entry mode in China. However, after evaluation of each factor that affecting the

decision making of entry modes, conclusion can be made on which entry mode is better

for particular businesses in a given time in the Chinese business market.

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Chapter 2

Types of Entry Mode

2.1 Introduction

There are many forms of entry modes that a firm can choose from when entering

the Chinese market. Basically, they can be classified by two criteria: trade versus

investment; direct investment versus indirect investment. In the first criteria, trade

represents exporting and importing; investment corresponds to representative office,

assembling, processing, licensing, franchising, equity joint venture, cooperative joint

venture, and whole foreign owned subsidiaries. Each method will have its strengths and

weaknesses in general terms. Often the greatest obstacle for organizations when entering

foreign markets is the array of standards which the company has to meet, for example;

safety, environmental, packaging, labeling, patents, trademarks and copyrights, these

factors can make it hard for businesses to success in the Chinese market. This dissertation

will mainly discuss and investigate on exporting, licensing, franchising, and Joint

venture.

Since China opens its door, foreign investment becomes more favorable than

trade, Joint venture becomes more favored than partnership and assembling and

processing are more favored than licensing and franchising. Each of the entry modes has

it own advantages and disadvantages, therefore many multinational companies adopted a

combination of different entry modes to minimize the disadvantages and optimize the

advantages. Now the combination approach of different entry modes has been

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increasingly adopted by many MNCs in China. However, it is quit hard for them to

manage their businesses with many forms of entry modes and the risks for adopting

different types of entry modes are high.

2.2 Exporting

Exporting is the simplest form of trade that allows foreign companies to enter

Chinese market. Export is the provision of goods, services or knowledge across national

and international boundaries. Exporting is a traditional and simple method of entering

foreign markets. Because exporting does not require the production of goods in the target

country, therefore no investment in foreign production facilities is required, which

reduces risk if the project fails. In addition, exporting is usually seen as a low key method

of entering a foreign market as it avoids the often substantial cost of establishing

manufacturing operations in the host country such as, factories, machineries and

employees.

There are mainly two types of exporting; one is called direct export which means

export to a distributing importer and export using a commission agent, another is called

indirect export, which includes manufacture under licensing and franchising and project

management. The advantages for exporting embrace maximizing resources, optimizing

prices, increasing competitive advantage and combating foreign competition. The

approaching disadvantages for exporting are financial risks, intellectual property matters

and the risks associated with inadequate resources. The import and export license system

is a key governmental measure in China's foreign trade management.

2.3 Licensing

The definition of licensing is defined as ‘a business arrangement in which the

manufacturer of a product or a firm with proprietary rights over certain technology,

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trademarks, etc. grants permission to some other group or individual to manufacture that

product (or make use of that proprietary material) in return for specified royalties or other

payment’ (Web definitions from Google). Instead of selling products or services directly

to customers overseas, some small companies adopting exporting as an entry mode enter

foreign markets by allow licensees to use their patents, trademarks, copyrights,

technology, processes, or products. In return for licensing such assets, the small company

collects royalties from the sales of its foreign licenses. Licensing is a relatively simple

way for business to extend their assets into global markets. Small companies tend to

license their assets in order to enter foreign markets as they are less risky compared to

some large companies which decide to use foreign direct investment which requires

massive amounts of investment and can hold very high risks. In conclusion, licensing

mainly holds advantages for small companies as it allows them to enter foreign markets

quickly, easily, and with virtually no capital investment.

Licensing business was existed in China only a few years ago. The huge Chinese

economic market has provided an excellent circumstance for China to become the second

largest country with licensing market in Asia, even through the Licensing business

existed in China only a short period of time. ‘In 2001, the total retail sales of licensed

products reached 600 million US dollar, nearly the same as the combination of sales in all

East Asia economies’ (Licensing in China, Hong Kong trade development council 25

July 2003). However, the Chinese licensing market is still new and can be developed

further as the number one in Asia or even number one in the whole world.

Under the fast, strong economy development and rising consumption power, the

China’s licensing market has enormous growth potential. As the Chinese income raises,

the purchase of licensed products, especially higher end consumer goods leapfrog

significantly. ‘According to the state’s estimation report, by 2010, the Chinese licensing

market could reach approximately 1.5 billion US dollar a year. In high-income cities such

as Beijing, Shanghai, Guangzhou, Shenzhen and other major regions in the Pearl River

Delta and Yangtze River Delta, retail sales of licensed products for one person per year

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could rise to over 5 US dollar’ (Licensing in China, Hong Kong trade development

council 25 July 2003).

Lots of foreign licensors and licensing agents from all over the world are attracted

by the China’s licensing market. this is because the Chinese market is still new and has

not meet the requirement for breeding large number of local licensors and licensing

agents, therefore it is an advantage for foreign licensing companies as they are

spearheading the development of the industry in China.

China’s licensing market is currently dominated by major foreign licensors such

as Warner Bros, Nike and Adidas, who are large international companies that existed in

China over long period of time and with dynamic energy to develop new products or

technologies or management to control the Chinese market. In China, more than 90% of

best selling licensed products are belongs to foreign companies. For example, most of

the well known cartoon products such as Mickey Mouse, Tom and Jerry, Snoopy, Hello

Kitty, etc. Child related goods with cartoon driven characters such as toys, games,

apparel, stationery and children’s goods are particularly popular in China, and therefore

foreign licensors paid huge attention design and produce these types of properties.

As stated above, licensing is still new for Chinese local companies and Chinese

still lack of experience on adopting licensing as an entry mode in the Chinese market in

the early time. Foreign companies, especially large international foreign enterprises play

the key role with their strong concept of globally standardized IPR protection and

business practices. At present, foreign investors have invested more than 60% of the

licensing companies in China; the majority of these companies are from Hong Kong, and

Taiwan. Foreign investors adopting licensing as an entry mode to China have high-

quality distributaries channels such as Carrefour or Wal-Mart that focused in the middle

range with lower price products.

Under the effects of rising popularity of licensed products in China, many local

Chinese firms have so far recognized the huge benefits of selling licensed products and

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the suitable and appropriate ways for building up for a licensing business. It is therefore

essential to educate the local Chinese licensees about the benefits and correct practices of

the licensing business and to build access to these potential local licensees with pro active

marketing strategies. Compared to licensees in other countries, especially in Asia

countries, Chinese licensees require greater support from licensors or licensing agents in

terms of product development, methods of promotion of their licensed products, and

business model formulation.

2.4 Franchising

The definition of franchising is defined as ‘a continuing relationship in which the

franchisor provides a licensed privilege to the franchisee to do business and offers

assistance in organizing, training, merchandising, marketing, and managing in return for

a consideration. Franchising is a form of business by which the owner (franchisor) of a

product, service, or method obtains distribution through affiliated dealers (franchisees)’.

(From Web definitions from Google)

Franchising is comparatively a very successful and intensifying method of

marketing, selling and distributing goods and services. ‘It combines the skills and

experience of the franchisor and the goodwill created by the brand. Correctly bringing

together the property rights and the extra financial resources provided, plus the

entrepreneurial skills and drive of the franchisee, achieves success. In addition,

franchising is also another method of entering a foreign market’ (From

www.Franchisetraining.co.uk). Over the past decade, a growing number of franchises

have been attracted to international markets to boost sales and profits as the domestic

market has become saturated with outlets.

‘In short, franchising is a strategic alliance between groups of people who have

specific relationships and responsibilities with a common goal to dominate markets, i.e.,

to get and keep more customers than their competitors. There are many misconceptions

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about franchising’ (http://www.china-markets.org/); a franchisor is not simply buying a

franchisee. In actuality, franchisors are investing their assets and resources under the

franchising agreement with franchisees to utilize the brand name, operating system and

ongoing support. Everyone under this agreement is licensed and permitted to use the

brand name and operating system. The business relationship is a joint commitment by all

franchisees to get and keep customers. Legally franchisees are bound to get and keep

them using the approved marketing strategies and operating systems from the franchisor.

Normally, foreign companies selecting franchising as an entry mode to entry the

Chinese market because they have already success their businesses in their home

countries, by teaching their franchisees, they believe their successful companies’

operations can be easily and quickly replicated to their franchisees without significantly

increase their debt.

In franchising, the brand identity or trade name is the most important aspect

affecting both franchisors and franchisees. Franchisors must set up franchise system with

precise methods to service and satisfy their customers. By documenting these practices,

the franchisor standardized and institutionalizes customer’s buying experience. Due to

unwillingness to surprises the consistency in operation, franchisors and franchisees build

loyalty to the brand.

2.5 Foreign direct investment- Joint Venture (FDI)

International investment means to expand businesses from a single country to

cross countries in aspect on production, management and distribution of goods and

services, and commerce areas.

FDI means foreign investors intended on control and managing the businesses and

seeking for profits with building long term ownerships for those businesses. The

definition of long term ownership can be varied from a few years to over 50 years. The

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most traditional form is to form foreign subsidiaries or joint ventures. The main reason

for FDI is to allow foreign investors to get control of the businesses they invested in.

The characteristics of FDI are numerous. Multinational companies are the main

responsible party for FDI. In China, the market is huge and the competition is high in

recent time, lots of foreign companies come and invest in China, and the large

multinationals have gradually swallowing the small local companies. Therefore it is quit

obvious that FDI in China requires large amount of capital which small private

companies are not usually affordable. The fields that foreign companies invested in China

are diversified and moving towards to technology, commerce and banking from

traditional manufactories and agricultures. This is because those fields are easier and

faster to access and profit gaining is much higher than traditional businesses.

FDI have mainly two types, one is called wholly ownership and another is called

partnership. Wholly owned ownership can be further divided into two types, green field

versus acquisition. Green field refers to starting a project from scratch, for example,

building a factory on a virgin site, in a host country. This type of wholly owned direct

investment is very time consuming and requires huge amount of capital and resources for

foreign investors. On the other hand, the pay back is 100%. Foreign investors adopting

green field strategy will gain fully control of the business in host country and gain all the

profits from it. Acquisition refers to entering a host country by purchasing an established

facility in that country, for example, an existing factory or an existing distribution

company. This type of foreign direct investment is easier and faster than green field,

however, it faces many problems such as cultural and political. Host government may not

support the acquired factory or local people may not accept the new factory that take over

by foreign investors. Wholly foreign owned enterprises is entirely owned and controlled

by a MNC, that is, a MNC holds 100% of the capital of the wholly foreign owned

enterprise and is liable to the wholly foreign owned enterprise to the extent of its

investment. The advantages for WFOE are MNC has full control over the subsidiary and

does not risk leakage of its technology to its local partner. The disadvantages for it are

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MNC cannot benefit from a local partner’s knowledge and the costs and risks cannot be

shared. In addition, MNC is subject to government restrictions and cannot enter certain

industries in China. Partnership includes Joint venture and alliances. From Wikipedia,

The definition of joint venture (often abbreviated JV) is ‘a legal entity formed between

two or more parties to undertake economic activity together. The parties agree to create a

new entity by both contributing equity, and they then share in the revenues, expenses, and

control of the enterprise. The venture can be for one specific project only, or a continuing

business relationship such as the Sony Ericsson joint venture. This is in contrast to a

strategic alliance, which involves no equity stake by the participants, and is a much less

rigid arrangement.’ (http://en.wikipedia.org/wiki/Joint_venture) For joint venture, foreign

companies may invest financial and other forms of resources or sign up contractual

agreements of profits and responsibilities such as research and development, production,

marketing, management, etc with local companies. Alliances are voluntary agreements

between firms involving exchange, sharing or co developing of products, technologies or

services. Since 1990, the second type of foreign direct investment-Joint venture has been

increasingly adopted by foreign investors due to the Chinese regulations and policies on

ownership restrictions. Wholly foreign owned enterprises can not enter certain industries

such as Banking and media businesses in China.

Joint venture has many advantages for investors; it spreads the costs and risks to

two parties and improves access to financial resources. Joint venture has the ability for

companies to access to new technologies and customers, access to innovative managerial

practices easily and quickly. The adoption of joint venture as an entry mode may lead to

economic of scale and advantages of size. In addition, joint venture can influences the

structural evolution of the industry, pre-empting competition, create of stronger

competitive units, Speed up to meet the market demand, and improved agility.

There are many concerns that influenced foreign investors on making decisions

on foreign investment, the most important concerns are: environmental concern, market

concern, labor force concern and strategic concern. Environmental concerned involves

the consideration of natural resources, looking for sufficient resources all over the world

to overcome the lack of resources in one country. This type of concern is suitable to

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maintain the equilibrium of usage and expenditure of natural resources and prevent large

instability of costs and prices of natural resources. The second concern is market concern.

This type of concern represents that the companies are looking for expanding their

products or services to international market. Under the market concern, foreign

companies may move into different countries and adopting localization to reduce the tax

and other additional costs. Labor force concern corresponds to foreign investors place

importance on labor force and labor cost by seeking cheap labor force in different places

in order to reduce costs and increase efficiency and profits. Developing countries have

competitively cheaper labor costs and larger labor force compared to developed countries,

therefore foreign investors always looking for suitable areas in developing countries to

set up their product production factories to reduce the costs. The fourth concern is

strategic concern. This type of concern is the combination and sublimation of the three. It

is hard to implement and risky. Foreign investors making investment based on world

competition for particular products or services.

Joint Venture has a number of advantages, the most obvious one is that,

companies selecting FDI- Joint venture as an entry mode have direct or indirect

ownership (unlike licensing) of the businesses which provide higher level of control in

the operation system and management system. Joint venture offers better ability to

understand and manage the customers and competitive environments.

One of the most prominent impacts of Joint venture on the Chinese economy is

due to the large population and labor abundant. Foreign Joint venture companies have

helped China to create millions of jobs. Both total employment and urban employment in

FDI firms in China has increased significantly. International joint venture companies

have paid higher wages, salaries, bonuses, and other fringe benefits to the local

employees than domestic firms. Apart from differences in the distribution of their

activities between wage sectors, Joint venture companies record higher labor productivity

and have higher capital intensity than their local competitors. In some cases, these higher

levels of productivity reflect a higher capital to labor ratio. Joint venture firms are also

larger than their local competitors and large firms usually pay higher wages than small

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firms. Most of the time, foreign firms may feel the need to ‘buy’ themselves into

unfamiliar labor markets or to attract workers away from competing employers. In

addition, foreign direct investment such as Joint venture also has upgraded skills. There

are more technical and professional employees and managerial staff in Joint Venture

firms than those in China’s domestic firms. Therefore it can be concluded that FDI firms

are more technically efficient in labor utilization in production because they put more of

their total labor force into direct production and less into non productive administrative

activities as compared to China’s domestic firms. In addition to that, foreign joint venture

firms have a higher level of labor quality in their employment composition than domestic

firms. They tend to hire more employees with university and higher education than

domestic firms, particularly in capital intensive and technology intensive industries. They

also tend to hire fewer employees with year 9 and lower education than domestic firms.

Because foreign Joint venture firms pay higher wages than domestic firms and employ a

higher level of labor than domestic local firms, there is a real risk, however, that more

and more quality labor will be drawn into foreign firms away from domestic firms. If this

is the case, then the spillover effects will regard to the transfer of technology and

managerial skills from foreign firms to domestic firms resulting from labor turnover may

be quite limited. FDI has increased domestic competition. As foreign direct investment

companies entered Chinese market, the domestic local firms need to find their own ways

for survive in the same market and various methods were adopted by local firms to

compete with large foreign companies.

However there are many disadvantages for Joint venture, the major disadvantage

being the high risk compared to other modes of entering foreign markets. Joint Venture

also requires higher amounts of resources and commitment as appose to other modes.

The joint venture patterns in china show a great disparity among regions. For the

period from 1983 to 1998, joint venture in the eastern region took up 87.8 percent while

the central region attracted 8.9 percent and the western region recorded only 3.3 percent.

This inequality stems from the FDI policies taken by the Chinese authority. The open

door has started with the creation of special economic zone (SEZs) and preferential

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regimes for fourteen coastal cities. This has resulted in an overwhelming concentration of

FDI-joint venture in the east. However, at the end of 1990s, the Chinese government has

paid huge attention on developing western areas and up to now, the FDI inflows in

western areas has increased dramatically. The central and western regions in terms of FDI

will be more promising as the development of infrastructure and further openness of the

market attracts more FDI into these regions. Their comparative advantages lie in

abundant natural resource, further opening up and development of the market. Since the

opening up of the state owned enterprises to foreign investors, more and more FDI,

especially joint venture companies could invest in these regions.

Since china launched the economic reforms and called for foreign capital

participation in its economy in 1979, China has received a large part of foreign direct

investment inflows. China has been the second largest FDI inflow recipient after United

States and the largest host country amount developing countries. For twenty years from

1979 to 1999, the total foreign direct investment inflow in China has reached 306 billion

US dollars which is equal to 10% of the world total FDI flows.

Theory classifies FDI into two categories, one is called market oriented FDI and

another is called export oriented FDI. In terms of market oriented FDI, the most

important factor to attract FDI is the size and growth of the host country. The export

oriented FDI mainly looks for cost competitiveness. ‘Market oriented FDI aims to set up

enterprises to supply goods and services to the local market. This kind of FDI may be

undertaken to exploit new markets. Apart from the traditional reason for circumventing

tariff barriers, the market size, prospects for market growth, and the degree of host

countries’ economic development are very important location factors for market oriented

FDI. The general implication is that host countries with larger market size, faster

economic growth and higher degree of economic development will provide more and

better opportunities for their industries to develop their ownership advantages and,

therefore, will attract more market oriented FDI. Even for export oriented FDI, the

market size of host countries is important because larger economies can provide larger

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economies of scale and spill over effects’ (The location determinants of foreign direct

investment in developing countries, Chen Chunlai, No. 97/12, 1997).

China has a population of almost 1.3 billion, with a vast potential for consumption.

Investors regard the Chinese market as the last enormous market that has not been fully

developed in the whole world. Over the past decades or more, the sale of China’s

economic reconstruction has been expanding increasingly, with the purchasing power of

the people strengthening rapidly and markets becoming increasingly brisk. Although

China’s per capita GDP is still very low, its rapid economic growth and continuously

increased purchasing power has made China attractive to market oriented FDI, such as in

the field of basic chemical, drinks, household electrical appliances, auto mobiles,

electronics, and pharmaceutical industries.

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Chapter 3

Chinese Culture

3.1 Introduction

There are many factors that a multinational company needs to consider when

opening a new branch in a new country or making investment overseas, including the

market, the government policies relating to the business of the company, environment

feedbacks, the economy of the country, religious of the citizen, resources, and etc.

However, all the factors are related and influenced by culture. As a result, culture is one

of the most significant factors that need to be considered by foreign investors.

The great Chinese culture has made both positive and negative effects for foreign

investors to come and invest in the Chinese market. Among those important effects,

Guanxi is the one that determines the success or failure of the investment for both foreign

and local companies. Guanxi is a well known neutral term referring to relationships and

connections that originated from China. It is now so pervasive and important in China.

Nowadays, it is clear that doing business in china requires Guanxi. Guanxi can be the

strength or weakness for Chinese business model. If a private company experience good

Guanxi with the local government officials, or the central governors, it will be benefited

by so many factors. However, in order to build this kind of Guanxi with the government

23

officials, there are things need to be traded, sometimes possibly will in the form of

bribery. Most of the time in China, Guanxi is generated on the ‘dinning table’. This

means that business men have to treat government official very expensive meals in top

ranking restaurants. It seems quit nonsense for people in developed countries such as

USA or UK, but it actually happened long time ago and still continuous in the same way

under the influence of traditional Chinese culture. While eating or drinking, the project

will be discussed between the government officials and private companies, and both sides

will conclude a satisfying deal. The private companies will get the project from the

government and the government officials will get some benefits in return. In developed

countries such as United Kingdom, business men from private companies don’t have to

build this type of Guanxi and it is inadequate for them to spend the time and money for

Guanxi. This is because the cultural differences between Asian and Europe. In Asian

countries, people turn to have more comradeship than European countries, and Asian

people, especially Chinese are homier than Europeans. For example, in china, parents

will nurture their children until they get married, and the children have to breed their

parents until them past away. On the contrary, Many British or American people will no

longer nurture their children since they are 18 years. Another thing that make Guanxi not

that significant in Europe or USA is because the constitutions and laws in developed

countries are comprehensive, private companies only need to follow the framework that

have already provided by the country and pay attention only on the market. Therefore no

matter what types of entry mode foreign investors choose to invest in the Chinese market,

Guanxi is always required to be existed and maintained for convenience and success.

The strength of Guanxi can be noticeable when private companies facing

problems and the government officials who have good Guanxi with them come for

support. Most of the time, private companies will save lots of time and money and

generate more profits from their businesses. In addition, good Guanxi with the officials

will also reduce the risks of doing business in China. Foreign direct investing companies

may receive many useful helps from Guanxi. On the other hand, Guanxi can be the vital

tool for private companies on eliminating their rivals and control their market. Guanxi is

contextual and may lead to bribery and corruption. In addition, Guanxi is also personal. It

24

is risky when there are personnel changes in the Guanxi network. Therefore Guanxi in

some circumstances is also one of the weaknesses of the Chinese business model. Guanxi

exists not only in china, but the whole Asia. Foreign investors need to take careful

consideration on the depth and width of building Guanxi with Chinese parties.

Beside the consideration of Guanxi, negotiation and communication with the local

people in China also affect the decision making for foreign investors to choose the right

form of entry mode. Negotiate with Chinese partners is far more complicated than with

western partners. This is because Chinese negotiators pay much attention to the

interpersonal trust and friendship, and tend to know their partners through informal

personal contacts and social activities before talking about the businesses. Chinese

business men usually build up this kind of relationship through dinning or drinking. They

believe that it will help to make a better Guanxi between each other. Beside the legal

contact of the business, Chinese belief that a good relationship and trustworthy between

them and their partners are more important than the management and marketing skills.

The Chinese will not do business with people that they don’t trust. This is under the

influence based on Chinese culture including Confuciasm, Sun Tzu strategies and holistic

way of thinking; political culture such as Mao’s bureaucratic heritage and Deng’s

pragmatism. Chinese customers are in fact price sensitive, and the Chinese firms compete

with each other in the Chinese market by cutting down the prices of products. As a result,

the price wars occurred in China. Now multinationals need to adopt discriminative

pricing strategy and predatory pricing strategy to control and success in the Chinese

market. Discriminative pricing is the set the prices of the same products differently in

various places to be able to compete with the other competitors. Predatory pricing refers

to lowering the prices of products to drive out all other rivals in the market and control

and dominate the market. This type of pricing strategy will loss money in the short but

gain experience curve in the long term. Chinese customers are more conservative than the

customers from other countries. They are not willing to purchase unfamiliar products;

therefore promotion strategy should also be applied in the Chinese market. Multinationals

can choose a ‘hero’ to present to the Chinese customers. This kind of ‘hero’ can be some

famous athletes or movies stars. Pepsi has signed a contract with many movie stars such

25

as Liming, and Faye Wang to promote its sales. In addition, Chinese customers also pay

high attention on corporate images, especially foreign firms.

In the multinational company, the organizational culture is vital as it directly

affects the business. This is especially true for multinational companies invest in China.

The definitions of organizational culture are defined by various authors, Schein states that:

“organizational culture is the climate and practices that organizations develop around

their handling of people or the espoused values and credo of an organization” .When a

company is doing business internationally, customers are not the only thing to be

considered. A good multinational company should also consider the organization of the

company itself and the influences on the employees as well. “Businesses are human

institutions, not plush buildings, bottom lines, strategic analysis, or five-year plans” (Deal

and Kennedy). It is important to know the culture of the local people as a multinational

company has to hire local people as their employees. “Culture can affect technology

transfer, managerial attitudes, and even business-government relations. Perhaps most

importantly, culture affects how people think and behave” (Hodgetts and Luthans, p.60).

Deal and Kennedy introduced corporate culture to measure and control the organization

of a company. Corporate culture is a “cohesion of values, myths, heroes and symbols”

which has come to “mean a great deal” to the employees of that corporation. Study of

corporate culture helps the company to manage the organization to a better level. A

strong corporate culture means each individual part of a meaningful whole with clear

core values. Strong culture leads to improved motivation, decision-making, and

company-loyalty. A weak culture means core values poorly expressed and not supported

by a consensus and individuals unsure about their role with little loyalty for employers.

The corporate culture can be controlled and changed by the leadership of the company.

Leadership is “the ability to step outside the culture that created the leader and to start

evolutionary changes processes that are more adaptive” (Schein, p.2). Company with

strong leadership provides strong culture and thus more advantages in doing businesses.

In addition, Deal and Kennedy also presented five alternative ways to change corporate

culture: consensus-building, create two-way trust, skill-building exercises, allowing

26

plenty of time, and be flexible about implementation. The adoption of those five methods

may also provide a stronger culture.

In this part, a detailed description on how culture affect each type of entry modes

(exporting, licensing, franchising, and Joint venture) and the advantages and

disadvantages for each entry mode with respect to culture are presented. In addition, how

Guanxi and negotiation with local Chinese for each type of entry modes significantly

influence the decision making for the suitable entry mode in China is also discussed.

3.2 Exporting

Exporting is the type of entry mode that existing the longest period of time

compared with other forms of entry modes in China. There are numerous advantages and

disadvantages for it. As mentioned above, Exporting is the simplest form of trade that

allows foreign companies to enter Chinese market. ‘It is a traditional and well established

method of reaching foreign markets. Since exporting does not require the goods to be

produced in the target country, and no investment is required in foreign production

facilities, which reduces risk if the project fails. In addition, exporting is usually seen as a

low key method of entering a foreign market as it avoids the often substantial cost of

establishing manufacturing operations in the host country such as, factories, machineries

and employees’ (The global entrepreneur: taking your business international, Foley

James F) .

As China joined World trade organization, the regulations and laws against

foreign exporting to China is comprehensive and fairly perfect toward global

standardization. However, Chinese people still carrying their traditional cultural

behaviors and philosophies. It is well known that the counterfeit in China is extremely

severe. Chinese domestic companies have the superb skill of copying brand name

products, and some fake products are even better than the proper one with the cheaper

price. This is the nightmare for private companies, especially foreign international

27

companies who adopting exporting as an entry mode to enter the Chinese market.

Chinese local firms may copy imported products very easily at a cheaper price; this may

significantly affects foreign exporting companies losing the market. The severe

counterfeit in China is occurred because the Chinese market environment. China has

lower production costs and labor costs compared with most of the countries in the world.

These are the biggest advantages for Chinese local firms to produce counterfeits to

compete with foreign companies at a cheaper price. Only a few categories of products are

suitable for exporting to China, such as those products need unique production resources

that not sufficiently existed in China, products that required high technologies to be

produced, products that can not be produced in China, and high quality luxury products.

Foreign companies adopting exporting as an entry mode face severe obstacles against

counterfeits in China. This is one of the disadvantages for choosing exporting as an entry

mode in China. In order to prevent or minimize the amount of counterfeits, foreign

investors need to protect its manufacturing know-how and improve its marketing

strategies, simultaneously, building up good Guanxi with the government and local

companies to control the scale of counterfeits of the products.

Another disadvantage for foreign exporting of particular types of products to

China is the poor after sale service. According Chinese culture, Chinese people have their

own ways of thinking and doing things that are differently compared to Europeans or

Americans. When foreign exporting companies sale their products to Chinese local firms

via exporting, the Chinese firms are not fully considering the after sale service for that

products as they think they don’t have such responsibility for it. For example, Japanese

popular brand Sony sales their notebooks to Chinese local firms by exporting and receive

money directly after the products arrived in local firms’ hands. The Chinese local firms

are responsibility for sale their imported products in the Chinese computer market.

However, the Chinese local firms are only considering on marketing for the products and

ignored the after sale service. As a result, after the products are all sold out to the

customers, there are possibilities for failure or replacement of parts of the products and

lack of after sale service will generate many problems such as products repair or

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replacement delay. Customers may dissatisfied with the after sale service of Sony which

will influence foreign companies’ images.

Because there are no productions and distributions of products for exporting in

China, foreign companies only sell their products to the Chinese market via exporting,

therefore Guanxi is less important for exporting compared to licensing, franchising or

Joint venture.

It is quit obvious that beside the advantages for foreign firms to export their

products to China, there are abundant negative feedbacks resulted from Chinese culture

for it. Foreign investors need to take careful consideration on Chinese culture which

affects foreign exporting in various aspects.

3.3 Licensing and Franchising

Licensing and franchising are two similar forms of entry modes that foreign

investors may choose when entering the Chinese market. Licensing refers to an

arrangement whereby a licensor entitles a licensee to use its intangible property for a

specific period, and in return, the licensor receives royalties from the licensee. Royalties

can be calculated as a percentage of sales or as a fixed amount per unit sold. Intangible

property includes patents, inventions, formulas, process, designs, copyrights, and

trademark. Franchising is similar to licensing, or in other words, it is a special form of

licensing. The franchiser usually provides the franchisee with the whole business system,

including trademark, services, management know-how, standardized operating

procedures, and sometimes even facilities, equipment and materials.

‘China currently has 1900 franchise systems, with 82000 outlets, growing 49%

annually. Nearly 60 industries have applied for franchise operations, including traditional

sections such as catering, retailing, and individual services, as well as some newly

developed fields of education, commercial services, family services and automotive care.

29

Nearly half of top 100 restaurants in China are utilizing franchise business models, and

their business earnings significantly surpass those independent local operated companies’

(Peeling the onion, Lehman Brown, October 2005).

However, this type of entry mode is the most dangerous form when entering the

Chinese market. This is basically because of the Chinese culture as some Chinese people

now still think about themselves first and focus on their own benefits in running

businesses with foreign partners. If a large international companies outside China choose

Licensing or franchising with a Chinese local company, an agreed contract will have to

be signed by the two companies for an agreed period of time. During this period of time,

Chinese firm will continuously build up itself with the support from foreign company that

is bigger and stronger than it. When the contract ends, the Chinese companies may take

over the existing market and run the business by their own. In Chinese, this is called

DuanQiao, which means to cut off the bridge. After learning from foreign companies,

Chinese companies understand the whole business system and are able to run the

businesses by themselves, and then they may cut all the connections with foreign

companies and either enter the market directly or wait until the contract ends. Foreign

companies only receive profits temporarily and will lose control to the business and lose

the market to local firms. Licensing or franchising doest not give multinational

companies tight control over production, marketing, and product quality and, therefore,

may damage the firm’s reputation if the licensee does not perform well. For instance, an

American fast food company Kenney’s Roast Ribs signed a licensing contract with a

Chinese local fast food company to open subsidiary branches in China. After a few years,

the Chinese partner has learnt all the business system and know-how, and opened a new

fast food company to compete with Kenny’s Roast Ribs. From this example, it is

noticeable that Guanxi is extremely significant for foreign investors adopting licensing or

franchising. A good relationship with local partner brings long term partnerships between

both parties and continuously achieving profits and benefits with good reputations. For

licensing and franchising, negotiation with local partners are the key for building good

Guanxi. A careful study of Chinese culture is necessary for foreign companies to success

30

its businesses and face less problems when adopting licensing or franchising as an entry

mode in China.

Licensing and franchising are often chosen by foreign investors when a

multinational company has strong core competencies in technology and design, or

intellectual property rights are well protected in a host country, or tariff and non tariff

trade barriers are high in a host country, or political risks are too high to invest indirectly

in a host country. In the current situation, it is quit obvious that Licensing and franchising

are the most unreliable forms of entry modes due to the influences of Chinese cultural

aspects.

3.4 FDI- Joint Venture

The establishment of new enterprises such as new foreign funded and joint

venture companies has been the main mode of absorbing FDI into China. ‘During the

period from 1979 to 1997, equity joint ventures took the lion’s share of inward direct

investment inflows (61.3% in terms of the number of contracts and 46% in terms of the

contracted amounts). Wholly foreign owned enterprises took 24.7% of FDI in terms of

the contract number and 30% in terms of the contracted amounts. Contractual joint

ventures have been the third most important mode. As mergers and acquisitions have

become the popular mode of global FDI with more than 60% share, this entry mode

presents great potential for the future expansion of FDI in China’ (A guide to doing

business in China and information on current economic conditions, US embassy in China,

2000). Also, the share of wholly foreign owned enterprises is expected to increase as

China implements its WTO commitments. Recent trends show that FDI tends to be more

and more direct into wholly foreign owned enterprises, which accounted for more than

half of total commitments in 1999.

One of the most important factors that attract foreign joint ventures in China is the

advantage in the competitive production factors, such as labor forces, land, and natural

31

resources. The degree of development of host country is often considered one of the most

important determinants of FDI inflows in China because it is positively related to

domestic entrepreneurship, education level, and local infrastructure.

With the world’s largest population of 13 billion, China has adequate resources of

labor, with average salaries of works remaining at relatively a low level. China has paid

great attention of the education of its people such as nine year universal compulsory

education. Therefore Chinese labors are relatively highly skilled with comparatively high

quality. However, there are some fields are still in short supply, such as experienced

managers, engineers, and technicians. This results a huge market with various advantages

for both local and international companies to run their businesses in China. In addition,

beside the large population support, China is also very rich in energy reserve. Chinese

production of oil, its predominant fuel, is among the top of the world in spite the fact that

China imports oil and fuels for high its own consumption. China is the largest producer of

coal, roughly one third of the world total production. With the globalization of the world

economy and the liberalization of international trade and the giant strides in technological

innovation, the advantages of cheap labor force has become less important for foreign

investors. China’s disadvantages in terms of technological gaps and lack of labor

qualification in some areas are existed and still need time for improvement.

Beside the adequate labor force with high skill and cheap costs, Joint ventures in

China also provide abundant opportunities for employment. This is one of the advantages

and reasons that many Chinese are welcoming foreign direct investment such as joint

venture companies to China. The Chinese culture offers hard working and loyalty

personalities and this may benefit foreign joint venture companies. Compared to licensing

and franchising, Joint venture is another form of entry mode that needs the help of

Guanxi. Because Joint venture involves investing money or assets to China and managing

the key things in areas such as finance, marketing, distribution, advertising, etc,

negotiation with local people is unavoidable and extremely vital. Investors must pay high

attention to every segment in the businesses and build good comprehensive Guanxi with

32

people in each segment. Lack of Guanxi in any segment may result many impediments

for foreign Joint ventures in China.

China has a huge population and the most of the people have low incomes

compared with developed countries. In the beginning of the reform and opening up,

china’s own products were under huge pressure from foreign brands that flowed into

china. Now Chinese firms have fought back and developed their own brand names such

as Haier, Lining, that are competing with foreign brand names both domestically and

internationally. The main reason for the accomplishment of the Chinese firms is the

cheap price. The labor cost in china is extremely cheap, and this is why many large

multinational companies moved their factories in to china, such as Nokia and Nike. The

cheap labor cost becomes the most popular and attractive spot for business men all over

the world and this is the strength for the Chinese business model. Foreign companies

adopting Joint venture with Chinese partners will enjoy the benefits from it. The high

population in china also result some disadvantages for foreign business men. For instance,

high population in urban areas affects the cost of land usage. The price for renting a

house in urban areas such as Beijing or shanghai is very expensive. Therefore investing

or running business in urban areas in china may be costly. On the other hand, many rural

areas in china have not been fully developed by the government and this may be the

beneficial opportunities for foreign companies to invest or run their businesses in rural

areas rather than urban areas.

A most outstanding issue faced by multinational companies in China is

localization of sourcing. Theoretically, it is cheaper for companies to purchase its

materials and parts for producing the final product in the local country than imported

from a foreign country. It is beneficial for multinational companies to buy resources from

local suppliers. In addition, the Chinese government, especially the local government

encourages foreign companies to localize its resources from local firms as it helps to

create employment and benefits the local citizen. Therefore foreign Joint venture

companies receive plentiful benefits from cultural, political, and environmental aspects.

However, it is not easy for do so under the unique circumstances in China. Multinational

33

companies facing many difficulties in localization of sourcing such as the level of

technology in the local firms are still quit low and the quality of the local produced

products are still poor; the local protectionism block the foreign companies to choose

local suppliers. Therefore multinational companies need to solve the big problem of

localization of sourcing before they lose the benefits from it.

One of the most important things for Joint venture is to select a capable local

partner. The Chinese local partner must be capable, reliable, responsible, and feasible for

joint venturing with foreign investors. Choosing the right and suitable partner will help

foreign investors to build up good Guanxi and obtain high-quality communications with

the locals.

Comparing Joint venture with other forms of entry modes in the cultural aspects,

it requires the highest level of Guanxi and negotiation with the local peoples. However,

Joint venture enjoys the advantages in the competitive production factors and the cheap

and plentiful labor forces and resources. In addition, there are less influences on cultural

dangerous such as ‘Duanqiao’ or Counterfeits for Joint venture compared with exporting,

licensing, and franchising.

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Chapter 4

Chinese Regulations and Policies against Foreign

Firms

4.1 Introduction

The revolution of the Chinese culture began since 1966 to 1976. The internal

predicament during the Cultural Revolution in fact has stopped the development of the

Chinese economy and the Chinese were in hot water. After the Cultural Revolution, Deng

Xiaoping and others began to establish law and order to drive the Chinese economy on

the right track. However, it takes a long time for the Chinese government to create a

comprehensive and appropriate constitution that suits both domestic private companies

and the large multinational foreign companies all over the world, and the engendered

problems from the existing constitution indicated the deficient system of the Chinese

business model since China opened its door to the world. After three times of amendment

on the constitution, China has a better political system and economic system than the past.

In political system, ‘the basic task of the nation is to concentrate its efforts on socialist

modernization along the road of building socialism with Chinese characteristics’, and

achieve this ‘under the leadership of the communist party of china’ (1999). In economic

system, ‘ the basis of the socialist economic system of the people’s republic of china is

35

socialist public ownership of the means of production, namely, ownership by the whole

people and collective ownership by the working people’ (1999). This means that

everyone in the country should be treated the same and has the same right for doing

things.

Country’s laws and regulations are the most crucial factors that affect the

economy in every country. Every country uses laws and regulations to control and

stimulate its economy, protect and maintain its benefits. Foreign investors must

understand their target country’s regulations and laws before taking any action on

investments and making decisions of choosing the right types of entry modes. For foreign

investors who are looking for invest in the Chinese market, fully understanding of

Chinese regulations and laws against foreign investors is essential. Up to now, ‘China has

instituted a fairly perfect foreign trade legal system with the Foreign Trade Law as the

core, involving management of foreign trade dealers, import and export commodities and

technology, foreign exchange, customers control, import and export commodity

inspection, animal and plant quarantine, protection of intellectual property rights, and

economic and trade arbitration related to foreign interests and proceedings’

(http://en.chinanasdaq.com/). This section will state some of the Chinese laws and

regulations that significantly influenced different types of entry modes.

China’s ministry of Commerce tightened its supervision over foreign investors’

acquisition of local companies in a modified regulation issued in Beijing recently

(reported from XinHua News). It was stated that foreign investors should abide by

Chinese laws and policies in their acquisition of domestic companies and should not

affect competition rules of the market or lead to loss of state assets. Foreign investors

should follow local policies on industrial development, land and environment protection,

according to the regulation. For industries not allowed for solely foreign operation,

foreign investors can not have fully ownership of the company purchased. Companies

required to be dominated by Chinese share holders should remain controlled by the

Chinese side even if they are purchased by foreign investors, says the regulation. In

addition, this regulation also forbids foreign capitals to buy companies in industries

36

where foreign operation is not allowed in China. On the contrary, China welcomes

qualified foreign companies that are willing to legally invest in particular industries. For

instance, ‘china welcomes qualified foreign companies willing to legally invest in the

country’s internet services’, said an official with the ministry of information industry in

Beijing recently. The government was willing to offer consultations on concerned

policies, according to its commitment to the world trade organization; china’s value

added telecom market has been opened to foreign capitals. Qualified foreign companies

can apply for internet operation license following china’s regulations.

In china, the government officials have extremely power that affects all types of

businesses. This is because China has its unique system that is different compared to

other countries. The imperfect laws and constitutions generate opportunities for the

government officials to use their competencies to help private companies for generating

profits and in return, the private companies must pay a respectable recompense either in

the form of money or goods. For example, a gang headed by Lai Changxing in Xiamen

smuggled a total of 6.28 billion US dollar worth of goods from 1996 to 1999, they bribed

hundred of government officials both at local and central levels. Even through the

corruption in china will be punished by the government seriously, sometimes even to

death, it still exists all over the country from local government officials to the central

governors. It can be concluded that bribery and corruption are still unavoidable in

developing countries especially in China.

There are many restrictions on marketing in China. Some marketing practices

were prohibited by the regulatory restrictions such as direct selling. It is important for

business men to learn and understand the government policies and restrictions. In

Chinese business model, one of the weaknesses is the unstable and unpredictable

government policies.

4.2 Exporting

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From the China’s business report, the Chinese government has issued a law

against foreign trade named the "Interim Regulations on Foreign Trade Management''.

This law has stated that ‘while importing and exporting any goods, the importer and

exporter must apply to their local foreign trade administrative department for an import

and export license’ (http://www.china-markets.org/). This issue represents the

establishment and beginning of the import and export license system after the

establishment of the People’s Republic of China.

From 1959 to 1979, the Chinese government set numerous restrictions and laws to

protect the nation; all the imports and exports existed in China during that period of time

were belong to the special import and export companies that belong to the Chinese

government and under control of the former ministry of foreign trade. The existed

imports and exports were severely under the Chinese government’s policies and

strategies by these companies, therefore the function of import and export licenses was

reduced. During this period of time, the Chinese government only interested and planned

to import certain goods for particular purposes, and export small amount of non- trade

commodities to other countries. However, after China opened its door to the world and

adopting the policy for reform, the development of Chinese foreign trade was noticeably

constant and the number of special import and export national companies is decreasing

and more and more individual private companies outside the ministry of foreign trade

started to import and export goods in China. This evident has resulted losses to the

Chinese government on various aspects, therefore further action has made to reinstitute

and strengthen the import and export license system.

Later in 1984, the Chinese government issued the ‘interim regulations of the

People’s Republic of China on license system for imported and exported goods’. In these

interim regulations, it is stated that ‘for the import of all goods that require licenses to

import according national regulations, it is necessary to apply for import licenses in

advance and only then orders could be placed with the relevant foreign trade companies.

In addition to that, the ministry of foreign trade and economic relations was responsible

to sketch and adjusts the list of goods whose import calls for licenses’. During this period

38

of time, the control from the government was enforced on all foreign trade companies

dealing with import and export business in China. As china moves toward globalization

and internalization, since 1992, the control over import was gradually relaxed by the

Chinese government. Later in January 1994, the Chinese ministry of foreign trade once

again released the ‘interim provisions regarding import quota control over commonplace

commodities’. These new approach made by the Chinese government indicated that the

Chinese laws and regulations on foreign trade system was in line with global

standardization. In year 1998, China removed control by import licenses and import

quotas over the great majority of commodities that required licenses to be imported

formerly, at the same time, only continuing to enforce import license control for a small

number or variety of products in infant industries and major industries that are required

for special protection.

From 1950 to 1998, China has modified its laws and regulations on China’s

import and export several times according to the high speed development of the Chinese

economy and increasingly high degree of opening up. In 1998, China’s import and

exports reached 323.93 billion US dollars. Export exceeded 183 billion and import

surpassed 140 billion, with an annual trade surplus of 43.59 billion US dollars, ranking

11th place in total imports and exports among chief trading countries over the world,

ranking 10th place in imports and 9th place in exports. Now a day, the implementation of

exporting has been widely adopted by many foreign companies due to the low cost of

investment in foreign production facilities and minimizes risks if the project fails.

The Chinese government imposed many restrictions on the import or export of

goods and technologies in various circumstances to control, manage and protect the

Chinese economy and environment. For example, ‘the import or export in China shall be

restricted in order to protect and defend the national security or public interests. Export

shall be controlled on account of domestic shortage in supply or effective protection of

exhaustible domestic resources. In addition, export shall be constrained due to the limited

market capacity of the importing country or region. Import shall be restricted in order to

launch or accelerate the establishment of a particular domestic industry, and import of

39

particular industries such as agricultural, animal husbandry or fishery products in any

form shall be restricted and controlled. Beside to that, the national international financial

status and the balance of international payments must be ensured and maintained by the

restriction on import, as the international treaties or agreements to which the people’s

Republic of China is a contracting party or participating party require, the import or

export shall be restricted. In addition, Chinese government also set many restrictions or

prohibitions on import or export of goods or technologies in China, such as those goods

or technologies will endanger national security or public interests and may disrupt or

disturb the ecological environment. Therefore, for the import or export of such goods or

technologies must be forbidden or banned in order to protect human life and health, and

in accordance with the provisions of international treaties or agreements to which the

People's Republic of China is a contracting party or a participating party’ (China Trade

Global Trade Directory Import and Export Companies Service Organizations

Administrative Organizations Policies & Regulations Exhibitions & Fairs 2000 and

Regulations Foreign Trade Law of the People's Republic of China Adopted at the

Seventh Session of the Standing Committee of the Eighth National People's Congress on

May 12, 1994).

It is important for foreign investors to know the current situation for the Chinese

government and the trend for the changes on regulations for exporting in the future.

Different company should choose different modes in different fields according to the

government’s unstable regulations and policies. In addition, the decision making is also

dependent with time. A suitable entry mode for a particular industry in China may vary

from exporting to licensing or Joint venture for different period of time according to the

Chinese government’s direction.

Since China jointed with WTO, it has reduced the import tariff and quantity, and

cancelled certain economic restrictions. There are thousands of laws and regulations have

been drafted and revised to ensure the Chinese law and organizational structure is

corresponding to international standard. After five years of transition period with WTO,

in the end of 2006, China will complete the administration adjustment and set up

40

comprehensive laws for foreign trading companies. The reduction on import tariff has

attracted many foreign investors to come and choose exporting as a form of entry mode

in China. However, this is not permanent. Host country may vary its import tariff

according any events that may affect its national security and economy. Import tariff is an

excellent tool for the Chinese government to manage and control the import and export

system in China.

Currency exchange rate is another important factor that foreign investors need to

be considered when choose exporting or importing as an entry mode in China. The laws

and regulations governing foreign exchange control in China were initially promulgated

on January 26th, 1996, and China’s most basic law on foreign exchange control is the

‘Regulations of the people’s republic of China on foreign exchange control’. Foreign

companies prefer low currency exchange risks countries rather than high exchange rate

risks and China has been adopting fix exchange rate system for many years. Therefore it

is fairly reliable for foreign companies to choosing exporting or importing as a manner

for international businesses. However, because of the tremendous development of the

Chinese economy, the Chinese currency Yuan has been fluctuated recently against US

dollars which affect the decision makings for foreign investors. It is comparatively

unpredictable on the Chinese Yuan under this condition therefore foreign investors need

to think carefully during this particular period.

China has tested its decentralizing foreign trading system and has wanted to

integrate itself into the world trading system. In November 1991, China joined the Asian

pacific economic cooperation (APEC) group, which encourages and promotes free trade

and cooperation in economic, trade, investment, and technology issues in Asia. Ten years

later, in 2001, China became the leader of APEC, and Shanghai hosted the annual APEC

leaders meeting.

In 1999, Premier Zhu Rongji visits the United States and signed a bilateral

Agricultural Cooperation Agreement. This resulted in the removing of the Chinese

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restriction on the import of beef, poultry, grain, and citrus. Following in November 1999,

a historic bilateral market-access agreement between China and the US has been reached,

which lead to the entering of China into the world trade organization (WTO). The major

part of the liberalization agreement is to lower tariff and eliminate the market impediment

in China after joining the WTO. For example, the Chinese will be able to import, export,

and trade their product with the foreigner without the involvement of a government. In

2004, a tariff rates on the US agricultural export decrease from 31% to 14% and from

25% to 9% on the industrial product segment by 2005. Moreover, the agreement also

gives the opportunities for the US service provider such as banking, telecommunications,

and insurance. After China signing the bilateral WTO agreement with the EU and some

others trading partner in 2000, China also consider the issue of the multilateral WTO

accession. In order to increase the export, china has introduced the policies such as the

development of foreign-invested factories. These also pull together the imported

component into consumer goods for export. After 15 years of negotiations, china has

become a member of the world trade organization on 11 December 2001. This can be

called as the longest negotiation period of GATT records.

China has adopted the so-called ‘export promotion development strategy’ which

was proven to be a remarkable success in the Asian NIEs. Together with export

promotion policy, china has implemented economic reforms and open door policies and

made efforts to promote trade by concluding several bilateral trade arrangements and

adopted unilateral actions. There has been substantial progress in reducing tariff barriers

in the 1990s: the average un-weighted tariff rate on imports declined from 43.9% in 1992

to 23.6% in1996 and to 17.6% in 1997. China has also formulated and implemented a

series of preferential policies to encourage international trade. Duty exemptions for

intermediate products used in the production of exports have been particularly important

in boosting china’s foreign trade.

It is obvious that China’s regulations and policies on foreign exporting to China

are toward internalization and there are fewer differences between exporting to China and

exporting to other countries. After China jointed with WTO, Foreign investors adopting

exporting may not suffer huge negative effects from the Chinese laws and regulations and

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the Chinese laws act as a tool to protect the foreign investor’s rights. However, the

reduction of import tariff results severe competitions against international investors, and

as time passed, the opportunities for adopting exporting as an entry mode in China is very

little. There will be less and less foreign investors can choose exporting as an entry mode

to China with the increasing difficulties from global competitions.

4.3 Licensing and franchising

Licensing and franchising are the two types of entry modes that typically with

high risk and unreliability in the Chinese market. However, since China opened its door

and joined WTO, the Chinese regulations and laws are fairly comprehensive for licensing

and franchising. For example, the Shanghai economic commission issued a notice to

implement the administrative measures on commercial franchising operations in

Shanghai with respect to foreign invested franchising operations. Foreign invested

enterprises that intend to engage in franchising operations must first obtain relevant

licenses for commercial enterprises accordance with the administrative measures on

foreign investment in commercial sector. The notice also underscores the disclosure

obligations imposed by the measures, which requires those who have engaged in

franchising operations before December 31st, 2004 to report the status of their franchising

operations to the competent authority before May 30th, 2005 for record fill purpose. This

announcement has confirmed that Chinese laws and regulations on licensing and

franchising entry modes are moving toward with respect to globalization and

internationalization. The Chinese laws aiming to protect foreign company’s trade mark,

brand name, and other rights. It can be declared that foreign investors adopting licensing

and franchising in China will protected under the inclusive laws made by the Chinese

government.

Because licensing and franchising involve smaller amount of foreign capital

inflow to China compared to other FDI forms, the Chinese government pays less

attention on licensing and franchising than FDI. In addition, it is more risky for foreign

43

investors adopting licensing or franchising than FDI. However, Licensing and franchising

help to explore intangible core competencies such as patents, inventions, formulas,

processes, designs, copyrights, and trademark, and help to overcome tariff and non tariff

trade barriers. Foreign investors implementing licensing or franchising as a type of entry

mode may provide good technology and management transfer from outside China to local

Chinese companies. Licensing and franchising both inject many positive variables to

China such as technologies, business know-how, management systems, etc. those

variables assist China to develop its economy efficiently and quickly. As a result, China

has published various laws to support and protect Licensing and franchising as entry

modes in China. However, the cultural variables make licensing and franchising in China

untrustworthy and unreliable.

Foreign licensing and franchising are encountered by the domestic infringement

of intellectual property rights. According to United State customer’s service, China

ranked first in seized counterfeits in 2002. Chinese domestic companies have the superb

skill of copying brand name products, and some fake products are even better than the

proper one with the cheaper price. This is the nightmare for private companies, especially

foreign international companies. For example, top class brand name company, Louis

Vuitton chose franchising as an entry mode and opened a new branch in china selling

expensive hand bags. A few months later, the local private companies have imitated

Louis Vuitton products and selling the counterfeits all over China. The local private

companies selected similar materials and was selling the same hand bag at a price 20

times cheaper than Louis Vuitton’s hand bags. People find Luis Vuitton hand bags every

in the city, even low income female farmers were carrying duplicated Luis Vuitton hand

bags. Nowadays, if someone holding an original Luis Vuitton hand bag on the street in

china, the Chinese will think it is the fake one and cost only about 10 pound. Similarly,

watch industry and DVD industry also suffered from the counterfeits in China. China has

the largest number of fake watches and seized huge number duplicated watches all over

the world, especially in Asia such as Thailand, Malaysia and Singapore. Then the

counterfeits are redistributed and sold from those countries to Europe and America

through various channels such as E-bay, etc. More over, the most shocking event for

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counterfeits in China is happened in the DVD industry. There are fake CDs and DVDs

for movies and software everywhere in China and the Chinese seems get used to it and

don’t consider it as an illegal thing. Even now, people still can find fake CDs and DVDs

outside their houses. As a result, foreign investors adopting licensing and franchising are

affected by the infringement of intellectual property rights and the time for Chinese to

duplicate the original products is very short, sometimes takes only a few days after a new

product is launched on the market.

Licensing products are facing obstacles from the Chinese government. New

foreign properties may find it not easy to enter the Chinese market and in touch with the

local customers, as the Chinese government released certain restrictions on broadcasting

foreign TV programs and foreign participation in publishing to protect the national

security. However, due to the Chinese special policies, adopting Hong Kong’s media as a

channel to promote their products to local customers is a lot easier and faster. Foreign

licensors can also use channels such as internet and short messages system to build

recognition of new properties.

4.4 FDI- Joint Venture

Since china launched the economic reforms and called for foreign capital

participation in its economy in 1979, China has received a large part of foreign direct

investment inflows. China has been the second largest FDI inflow recipient after United

States and the largest host country amount developing countries. For twenty years from

1979 to 1999, the total foreign direct investment inflow in China has reached 306 billion

US dollars which is equal to 10% of the world total FDI flows.

The Chinese FDI trends can be distinguished according to the changes in the

regulations and laws in China. From 1979 to 1983, the Chinese government established

four Special economic zones in Guangdong and Fujian provinces and offered special

incentive polices for foreign companies who invest in those areas. This resulted limited

45

amount of FDI capital inflows and the main FDI inflow are located at those four special

zones. The total inflow of FDI during this five year was only 1.8 billion US dollars and

approximately 360 million US dollars annually. Since 1984, Hainan Island and other

fourteen coastal cities across ten provinces were continuously opened which further more

stimulated the FDI inflow in China. From 1984 to 1988, the total FDI inflow reached

10.3 billion US dollars. However, the remarkable upward trend of FDI inflow was

impacted and started to decline due to the Tiananmen incidents. Until 1992, after Den

Xiaoping circulated China’s southern coastal areas and special economic zones, the

China’s policies on opening its door to the world and applying economic reform were

pushed forward evidently. Since then, China adopted a new approach, which turned away

from special regimes toward more nation-wide implementation of open policies for FDI.

The Chinese government has issued many new policies, regulations and laws to

encourage and support FDI. The result of this were remarkable, the total FDI inflow in

1998 reached 45.4 billion US dollars.

China has some unique policies that other countries dot not or can not have.

Those kinds of policies were created under the communism theory of the republic of

china. For instance, in china, the land is belonging to the country, to the people, not to

any single person himself. This is very different compared to capitalistic countries.

Companies need to define the nature of the land with the local government before

implement on businesses. In other words, the government has to lend the land to private

companies and consider the types of the business and necessary period of time for

lending the land. Sometimes the lending is free of charge, but sometimes, it costs huge

amount of money. For example, if a foreign company is willing to build a hotel in a rural

area, the land for building the hotel has to be agreed by the government for lending to the

company. If the government is enthusiastic on the development of that area and interested

in building a new hotel, then it may be easily agreed with free of charge, on the other

hand, the government may collect some fees for the lending of the land proportional to

the period of time the company is willing to borrow. In addition, if the nature of the land

is for farming and not for building a hotel, then it has to be changed by the government

before the land is lent to the private company. Unfortunately it may take years for only

46

changing the nature of the land. The result is, that private company eventually running

out of funds as they couldn’t get started for the construction of the hotel. Running

business in China is more complicated than developed countries.

Since china opened its door to the world, more and more multinational enterprises

paid massive attentions on Chinese market as the Chinese government provided

numerous attractive policies and regulations for joint venture companies. For example,

foreign direct investing private companies have the advantages of paying no car tax fees.

Chinese government also provides special economic zones for private companies. In

those zones, private companies enjoyed extra offers than other companies such as less tax

rate or low tariff, better government support, and etc. In the past 20 years, China has

mainly opened its economic market alone the coast line on the east. However, a few years

ago, China paid large attention on the west which further enlarges the opportunities for

private companies, especially multinational enterprises. The reason for China to provide

thus advantages for private companies is obvious, in return, china will create more

employment opportunities and the Chinese will learn capital, technology, and

management know how from other countries. This type of development strategy is very

popular in developing countries, especially in East Asia. For instance, Thailand has

created BOI zones for industrious enterprises with free tax for five years. FDI may results

some negative impacts on developing countries, such as dependency and instability,

china has adopted certain special policies that not only attract FDI, but also control the

inflow of FDI to avoid those negative impacts. Joint venture became the most influential

form of entry mode for foreign investors in China and China has paid its most attention

on protecting and attracting more and more foreign joint venture firms into the Chinese

market. The Chinese realized the benefits of having joint venture enterprises as it benefits

both the country and the people in the country. Therefore Joint venture entry mode enjoys

plentiful supporting policies from the Chinese government. However, recently China

pays more attention to foreign wholly owned enterprises and the number of Joint venture

in China is decreasing. This is because of the globalization and Chinese government

opened most of its industries to foreign investors and they are willing to take full control

and become the owner of thus businesses. In return, huge amount of capitals and assets

47

are installed to the Chinese market. The trend of Chinese laws will be moving towards

foreign wholly owned enterprises positively. However, certain industries such as Banking

and media businesses are still protected and restricted by the Chinese government in

China. Foreign investors don’t have the opportunities for adopt foreign wholly owned as

an entry mode and only choose joint venture as an entry mode for foreign direct

investment in those industries.

The Tiananmen protest in late 1989 has stalled foreign investment in China. As a

result, the Chinese government then introduced numerous laws and regulations regarding

to encourage and attract foreign investors to invest in high priority sectors and regions.

An example for this is the encouraged industry catalogue which sets out the degree of

foreign involvement allowed in various industries sectors.

During 1993, Chinese total output was accelerated due to the fast economic

development and the foreign investment capital inflow to China was elevated. The

Chinese economic further expansion was pushed by the government’s introduction of

Special Economic Zones that provide special policies and conditions for foreign investors.

At that time, there are more than 2000 Special economic zones in China. Beijing, the

capital of China was approved by the Chinese government for additional long term

reforms in order to meet the international standardization and to participate more on

market oriented institutions, moreover, to gain total control from the central government.

The Chinese government published a policy named ‘socialist market economy’, in this

statement, the public owned enterprises or state enterprises would continue take control

for the main industries in China. Therefore foreign wholly owned enterprises were not

allowed in those industries. The fast growing economy has pushed China with high

growth rate with lower inflation rate. However, the Asian financial crisis occurred in

1998 and influenced the economic development in Asia, including China. The economy

in China was slowed in the late 1990s. After the Asian financial crisis, Chinese

economy’s growth has then accelerated again early in the new century, reaching 9.1% in

2003, 9.5% in 2004 and 9.8% in 2005.

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Opening up to the world remains vital to China's development. Foreign-invested

enterprises create about 45% of China's exports, and China continues to attract large

investment inflows. Foreign exchange reserves exceeded 800 billion US dollar in 2005,

more than doubled from 2003. China then became the world's biggest holder of reserves

in 2006. However, there remain several barriers to free trade including administrative

enforcement and non-tariff measures. The local content requirement and the export

proportion requirement may inversely act to promote FDI. The import substitution policy

may function to promote FDI in the short term but further competition, which can be

created from the increase in import, may positively act to promote new additive

investment in current investors for introducing high-technology production. Also,

Chinese further acceptance of multilateral investment arrangement is necessary to

promote FDI into China. For example, china still does not allow wholly foreign-owned

companies to trade in many areas even though it has started to liberalize it. China’s entry

into the WTO will be conductive to the settlement of the problems. If foreign invested

companies are permitted to establish their own retail trade that would help them to

expand the scope of their investment and increase their market portion.

Up to now, the Chinese government has created world standardized laws and

regulations to support Joint venture in China and in order to attract more and more

foreign investors to China, the Chinese government has released abundant policies to

provide advantages for foreign direct investment. Even through China put high attention

in attracting foreign wholly owned enterprises to China. The main and major industries in

China are still under controlled by the Chinese government, and the unique situation in

China makes it hard to changes. Therefore foreign wholly owned companies still facing

many obstacles compared to Joint venture. Foreign Joint venture is the most appropriate

entry mode for foreign investors that willing to choose foreign direct investment in China.

However, as China moves toward globalization, foreign wholly owned companies may

surpass Joint venture and become the core entry mode for FDI in China.

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Chapter 5

Case Study of KFC in China

5.1 Introduction

A case study on KFC is investigated during the writing of this dissertation.

Kentucky Fried Chicken (KFC) is one of the most well known fast food chains in the

world started in the early 1930's by Kernel Sanders in the Southern USA as a small

franchise operation. Colonel Sanders has become a well known personality throughout

thousands of KFC restaurants World wide. Quality, service and cleanliness (QSC)

represents the most critical success factors to KFC's global success.

Throughout its 35-year history, the company has gone through several stages and

has answered to a legion of corporate parents from Heublein to R.J. Reynolds. The most

significant stage was when the enterprise was sold to the American giant, Hubelin

International in 1974. Rapid growth throughout the use of franchising together with

increased competition from primarily MacDonald's reduced the consistency of the

standard of both food and service on the individual franchise level leading to massive

decreases in profitability. Together with low Research and Development funding from

Hubelin, the division found it difficult to match the expansion plans of its main

competitors. KFC responded to these problems by improving staff training; employ a

new manager- Michael Miles capable of managing an effective turnaround strategy. The

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QSC motto was emphasized on a global level together with slogans such as "We do

Chicken Right". In 1982, Hubelin International was acquired by R.J. Reynolds and

Richard Mayer succeeded Miles.

5.2 INTERNATIONALIZATION OF KFC

Opposite to Hubelin International, R.J. Reynolds was willing to fund KFC's

overseas expansion plans. In order to reduce risk, KFC encouraged franchising in

complicated markets. This reduced financial risk, but also increased problems of

operational control, as local franchisees often were more interested in maximizing profits

in the short term rather than to adhere to corporate standards and strategic plans. To find

the balance between corporate control and cultural sensitivity has been the main point of

concern at KFC.

5.3 CHOOSING THE CHINESE MARKET

The China expansion plans first came-up in the early 1980's after several

successful expansions in the South East Asian (SEA) region including Japan. Tony Wang

who was born in China, educated in Taiwan and in the USA, and now living in Singapore

was appointed manager for KFC's SEA region. He was given the autonomous

responsibility to further investigate the feasibility to further expanding KFC's operations

in Asia to the world's most populous nation and the largest market for consumer goods-

China. On the other side of the scale, expanding into China would certainly be KFC's

most risky international business strategy so far. Moreover, a "go-ahead" signal would

make KFC the first western fast-food chain in China.

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5.4 RECOMMENDATIONS

An expansion into China is recommended. The potential size and growth of the

market in association with improving political stability makes the Chinese market very

attractive. As KFC has been able to successfully expand into the Pacific Basin, and its

popularity in the region (large portion of the population is Chinese), the people in China

will most certainly find KFC's products attractive. In addition, the ready access of quality

poultry in the major metropolitan areas and host government emphasis on modernization

of this industry can ensure a reliable supply of supplies. Opposite to this, potential

competitors such as MacDonald's face major barriers to enter the market due to poor beef

supply. Moreover, the Chinese government has opened-up access to its markets.

5.5 MARKET ENTRY OPTIONS

There are three market entry strategies that can be employed by KFC: Franchising and

Licensing, Wholly owned subsidiary and Joint venture.

First, KFC's traditional franchising strategy, which is emphasizing standardization

and reducing financial risk, on the expense of cultural sensitivity and control. Due to

China's strict foreign investment laws such a strategy is not feasible. In addition, KFC

will be pioneering in the fast-food field and thus needs to be highly sensitive to cultural

demands. In the past, KFC encountered problems with aligning corporate planning with

franchisee's short-term focus on profitability.

A wholly owned subsidiary represents the second option. Such a strategy relies

upon total control over competitive advantages and ensures complete operational and

strategic control. It also involves high investment expenses with no financial risk sharing.

With high levels of resource commitment and little country-level flexibility and

responsiveness, this option is not recommended.

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5.6 RECOMMENDED ENTRY MODE: JOINT VENTURE

When KFC first went into the Japanese market in the early 1970's, the company

chose to form a joint venture with a large scale poultry producer with excess capacity.

This 50/50 joint venture served the two partners very well, as KFC was able to ensure a

stable supply of quality supplies to its operations, and the local corporation was able

increase efficiencies in production by selling its excess supply. Furthermore, KFC was

able to utilize existing distribution networks serviced by the partner and at the same time,

adhere to exiting rules and regulations imposed by the Japanese government on foreign

direct investment.

Despite of the many differences between the Chinese and the Japanese market, a

similar joint venture agreement is highly recommended in China. The essence of a joint

venture is the synergy effect of two different entities merging. Such an international

business strategy will attempt to; solve many logistic problems such as access to good

quality chicken and other supplies, solve many logistic problems such as access to good

quality chicken and other supplies, ease the access to the Chinese market, share risk with

a local entity, and finally serve as a sign of commitment to the host government

increasing goodwill. In addition, due to the complexity of many barriers to entry into

China, a potential partner with sufficient contacts/networks with government agency

officials may smooth the process of setting-up operations in the nation.

The potential joint-venture partner should be large, well established, provide

excellent distribution channels and have personal network access to government officials.

It should also have modern equipment and a good management record. It is

recommended that a partner is found by backwards integration. In other words, a good

domestic poultry supplier should be discovered. In order to ensure total commitment and

balance of power between the two partners, a 55/45 joint venture, with KFC as the

dominant partner should be set-up.

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By building on each partner's core competencies, knowledge, and efficiencies, a

mutually beneficial synergy effect could be achieved as a result of joint venture activities.

For instance, the local partner can learn from KFC how to produce a better product at a

lower cost and further expand on its new competitive positioning. KFC, on the other hand,

can maintain quality supply which is detrimental to its success.

A joint venture will also significantly ease the entry to the virgin Chinese market.

A new entrant would find it very difficulty to form local and personal networks between

businesses and government agencies, which are crucial to success and provide access to

the local market and domestic suppliers. In addition, local business customs and laws can

be quicker understood and established ways to cut bureaucratic red-tape can be further

utilized. Also, the local knowledge of culture, language and geography is beneficial for

any foreign entrant into a relatively unknown market.

In order to cope with the significant political risk of investing in China, a local

joint venture partner will share this risk. There is always a risk of domestication measures

imposed by the host government, often leading to major financial losses for the foreign

investor. By having a 55/45 joint venture agreement, this risk is potential eliminated,

since only 55 percent of operations are domesticated. If such an unfavorable situation

would arise, KFC has clearly less to loose in such an agreement. In addition, by being the

dominant partner, KFC will be able to ensure cost, quality and strategic control measures.

The Chinese government may very well find KFC beneficial to the nation, as it is

the pioneering western fast-food outlet. Training the joint venture partner, personnel and

other institutions in the value chain can reduce learning and experience curves. KFC's

operations may also inspire local competitors to increase service and quality of food. It

can also help to create a competitive fast-food industry in China as new competitors

respond to KFC's ideas. Moreover, a joint venture agreement commonly produces

goodwill and commitment between the host government and the foreign investor. In such

a relationship, the foreign investor is not seen as trying to take advantage of the nation for

profit purposes, but rather show willingness to share. Maintaining good relations with the

54

host government is a critical success factor as government policy impacts intensely upon

business activities.

5.7 RECOMMENDED LOCATION

Even if KFC had developed "excellent contacts" with the government of Tianjin,

further expansion should not be made here. The poor supply of good quality poultry and

the geographic location does not attract too many westerners that are able to bring-in

foreign currency, which is crucially needed to ensure profitability.

Instead, the Chinese capital city, Beijing is recommended as the preferred location

for KFC's entry into the Chinese market. Beijing is the center for most political activity

and provides the necessary access to government agencies and business regulatory bodies.

Furthermore, it has a large population of nearly 9 million inhabitants. The numerous

universities located in the city further educates people that may make them more open to

foreign ideas perhaps including western fast-food. More importantly, plenty of western

tourists are attracted to Beijing's many tourist attractions, increasing the potential for

generating foreign currency sales. Also, suppliers of poultry are available. Beijing can

serve as the initial platform of KFC's operations and later expand into other potential

areas such as Shanghai and Guangzhou.

One or two initial outlets should be set up in order to get a "taste" of how KFC

will be perceived in the Chinese Capital. Both dine-in and take-out facilities, much in line

with most of KFC's international operations ought to be offered in large, clean and well

serviced company owned outlets to cater for the customers with above average disposable

incomes. In order to ensure the right cultural fit of the business, restaurants must be

highly functional and effective in order to serve large numbers of customers due to the

cheer size of the population. Special menu-substitutions may also have to be facilitated,

such as substituting rice for French-fries.

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5.8 CENTRAL CONTROL VERSUS LOCAL RESPONSIVENESS

In a foreign market with high political risk and low cultural knowledge, a high

degree of cultural sensitivity is crucial. Centralized control cannot be maintained since it

is impossible to effectively manage an overseas operation from the headquarters without

the information and knowledge needed to make sound strategic decisions.

China operations surely need to be able to quickly respond to political and/or

market changes. The joint venture will facilitate some of this responsiveness, but a KFC

or a R.J. Reynolds head office in the region with a high level of autonomy is needed.

Perhaps, such a regional office could be set-up in Hong Kong to oversee overall

corporate objectives of further expanding R.J. Reynolds products and KFC into the

Chinese market.

5.9 CONCLUSION

The Chinese market represents a great opportunity for KFC, but also significant

risk. KFC should begin operations in Beijing and later expand into other metropolitan

areas. By finding an appropriate domestic business partner via backwards integration, it is

possible to further build on opportunities and significantly reduce risk throughout

financial sharing, cultural sensitivity, and favorably treatment from the host government.

Choosing the right form of entry mode is the most crucial part for KFC to enter the

Chinese market. KFC needs to consider on cultural, political, and environmental

perspectives with respect to the Chinese local market conditions before making the

decision.

From the case study, it can be concluded that Joint venture is the most suitable

form of entry mode for KFC to invest in the Chinese market. Joint venture with Chinese

partner helps KFC to solve many logistic problems and create good relationships or

56

Guanxi with local government and people. In addition, provide positive benefits to the

country, simultaneously obtaining enormous profits from the Chinese market.

57

Chapter 6

INTERVIEW OF A FOREIGN INVESTOR IN

CHINA

6.1 Introduction

An interview was done with Mr. Cai Rongzhuang, chairman of Lvbang

international company Co., LTD, who is an oversea Chinese lived in Thailand for more

than 20 years. In 1997, Mr. Cai Rongzhuang after success in his business in Thailand

came up with a thought to invest in China. After 2 years, in 1999, Mr. Cai Rongzhuang

decided to go back to his homeland and invested in Daxing town, Beijing for some

agricultural businesses. He invested 10 million Yuan in Daxing for a green food project.

The concept for this project is to set up a chain system between local farmers and Lvbang

international company to produce and sale high quality vegetables and fruits in Chinese

supermarkets and convenient shops. Because he is an oversea Chinese, he knows the

Chinese culture and market conditions very well. When asking on the types of entry

mode he decided to select for entering the Chinese market, the answer is clear and

straight forward: FDI. The details of the interview are shown below:

6.2 Interview

Question (By me): Why do you choose China as the place to invest?

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Answer (By Mr. Cai Rongzhuang): I am a Chinese and I would like to donate my

personal experience and finance to help my hometown- Daxing. I would like to help the

local farmers to produce cheaper and better quality products and services and gain more

profits. In addition, to provide employment and improve local citizen’s standard of living.

I have signed hundreds of contracts with more than 200 farmers in Daxing to collect,

clean and pack their vegetables and fruits by using high tech machineries. In addition,

several groups of skilled agricultural technicians were send to every farmer to help and

teach them on planting, fertilizing, protecting insects, and harvesting with technology and

experience to generate better quality vegetables and fruits with minimum lost. All the

vegetables and fruits will then be sent to the selecting section, cleaning section,

sterilization section, packing section, and distribution section. At last, the products will be

distributed to every supermarkets and convenient shops in Daxing, Hebei, and Beijing.

Moreover, I have constructed two green food restaurants in Daxing. The meaning of

green food restaurant is that all the food in the menu is made from vegetables and fruits.

There are more than 60 types of dishes made from only vegetables and the concept for

the restaurant is to let people know that we can cook vegetables in many ways that are

delicious, beautiful, and good for health. I also built a large exhibition hall in Daxing and

planned to set up various types of exhibitions and shows relating to green food to provide

a media for Daxing people to communicate and discuss with each other in order to help to

improve the quality, standard and costs of the products and services.

Question: What type of entry mode did you choose when invest in Daxing?

Answer: I know the Chinese market and culture quit well. Therefore I decided to choose

foreign direct investment. After visiting Daxing many times, I have found an experienced

partner who has the ability and capability to help me for the achievement. I chose equity

joint venture, and I am holding 51% shares. Exporting is simply an international trade,

not really an investment. I am not interested in this type of entry mode because exporting

can not enter the Chinese market essentially. The input and output for exporting are low

and considering the Chinese market, with the current speed of economic development,

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exporting can not lasting for a long time due to the high competitions and rapid changing

of customers tastes resulted from globalization. I also don’t like licensing and franchising.

Because I feel that there is less responsibility for me to choose licensing and franchising

as the types of entry modes and it is harder for control and manages the company. Joint

venture is the most suitable form of entry mode for Lvbang I think. Chinese culture is

quit unique compared to other countries and only local companies understand their

customers well. With the help of local partner, Lvbang can enter the Chinese market

speedily through good Guanxi with the locals. By building on each partner's core

competencies, knowledge, and efficiencies, a mutually beneficial synergy effect could be

achieved as a result of joint venture activities. For instance, the local partner can learn

from Lvbang how to adopt the chain system and high standard management skills, further

expand on its new competitive positioning. Lvbang, on the other hand, can learn and

know the local customers, suppliers, and government officials to help it for further

development.

Question: what are the obstacles you have faced? How did you overcome those

obstacles?

Answer: Well, doing business in China is not that easy as I thought. The most severe

obstacle I faced when registering Lvbang in China is communicating with the

government. The power of government is superb for company, especially foreign

invested company in China. A good Guanxi with local government officials can bring

enormous benefits to the company; on the other hand, a bad Guanxi will drive the

company to death. For example, when Lvbang ask the government to change to property

of the land for construction of exhibition hall, it was told by the government officials that

it may take one year to do so. But the local partner has very good Guanxi with the local

government officials, therefore it takes only two months to change the property of the

land and the construction was implemented right afterward. The Chinese culture is also

important. Without knowing the customers tastes can result negative effects to the

company. When Lvbang first named its products in English, it was not very welcomed

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and accepted, after receiving advices from the local partner, Lvbang changed its product

name in Chinese, and soon caught the attention of the local customers. In brief, there are

3 things that foreign investors need to understand and solve before making

implementation: Cultural, Governmental, and environmental factors in China.

Question: what will you expect the future of Lvbang?

Answer: I think the future of Lvbang is bright with perspective. Even through the

Chinese economy is growing dramatically, the cheap labor costs and sufficient labor

sources provide core advantages companies run their businesses in the Chinese market;

the quality and standardization of products and services in China are still poorer than

other developed countries, and foreign companies can produce competitively lower prices

of products and services with a better efficiency and quality. There are still many things

can be improved and enhanced in the Chinese market. Foreign investing companies may

bring new technology and management systems to help China to expand toward

developed countries.

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Chapter 7

Conclusion

7.1 Chinese market environment

In 1978, with the open door policy, China began a deep economic reform which is

call as Jingji gaige in Chinese, which brought about modernization and growth: fast

development, together with structural changes and lifestyle improvements have made the

country one of the main players in East Asia.

Since the opening up, china applying foreign capital has resulted positive

feedbacks which drives it towards globalization and internalization. There are basically

three stages for china to absorb foreign capitals. The first stage occurred from 1979 to

1991, since the reform of the Chinese government. The government mainly relies on

foreign loaning and foreign investments have only occupied a small part of the total

foreign capitals. In this stage, the total foreign capital entered China was nearly 80 billion

US dollars, 52 billion from foreign loaning and 28 billion are from foreign investments.

The second stage was from 1992 to 1997, in this stage, the situation has turned over,

foreign investment became to main part of total foreign capital and foreign loaning

became a subsidiary part. Foreign direct investments started to exist in the Chinese

market and the Chinese market became more attractive for foreign investors. In 1992, the

FDI projects in China exceeded 58 billion US dollars. The third stage began after 1998;

foreign investors realized the importance and draw high attention on the high potential

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Chinese market. Large scale of foreign capital from foreign companies has injected into

all types of markets.

China has the largest population in the world, more than 1.4 billion. The market in

China is enormous and extraordinary. It is necessary for foreign investors to identify the

market and divide this huge market in to segmentations. Samsung’s sale manager in

Beijing stated that “marketing in China is like dealing with all Europe”. ‘The Chinese

market can be segmented in many ways depending on what criteria are used, such as

geographic, demographic and social cultural’. Geographic means to divide the market by

areas, such as east, central and west regions which is also adopted by the Chinese

government; demographic segmentation is to divide the Chinese market according to the

demographic factors such as age, gender, race and education level; further more, the

social cultural segmentation involves social class, religion and life style choices. Foreign

investors need to choose the right and suitable entry modes for different kinds of

companies at different circumstances. One of the strengths of the Chinese business model

is the business market is large and transparent. The number of population is each segment

is more than the whole population of some countries. For example, the number of

children in china is more than the population of Thai citizens in Thailand. The huge

number of population in China becomes the biggest advantage for attracting foreign

private business enterprises. The meaning of transparent can be defined by the easy

understanding of the Chinese market after segmentation.

Entering Chinese market is complicated and challenging. Foreign companies need

to carefully investigate the Chinese culture, government regulations, policies, laws, and

Chinese market environment. It is easier for companies that enter Chinese market to

follow the examples of both local and foreign companies that have already achieved

success there.

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7.2 Comparing different forms of entry modes in China

Exporting is the simplest form of trade that allows foreign companies to enter

Chinese market. Since exporting does not require the goods to be produced in the target

country, no investment in foreign production facilities is required, which reduces risk if

the project fails. In addition, exporting is usually seen as a low key method of entering a

foreign market as it avoids the often substantial cost of establishing manufacturing

operations in the host country such as, factories, machineries and employees. However,

since China opened its door to the world, the reduction of import tariff results severe

competitions against international investors and as time passed on, the opportunities for

adopting exporting as an entry mode in China is very little. There will be less and less

foreign investors can choose exporting as an entry mode to China with the increasing

difficulties from global competitions. In addition, foreign companies adopting exporting

as an entry mode in China face severe obstacles against counterfeits in China. Another

disadvantage for foreign exporting of particular types of products to China is the poor

after sale service.

Licensing and Franchising are the two convenient forms of entry mode that

foreign investors can choose to enter the Chinese market. Recently the Chinese

regulations and policies against Licensing and franchising are getting more

comprehensive and inclusive. Foreign companies will receive total protections from the

government which ensure stability and reduce the risks. However, comparing to FDI-

Joint venture, licensing and franchising are still lack of control and management.

Licensing and franchising are often chosen by foreign investors when a multinational

company has strong core competencies in technology and design, or intellectual property

rights are well protected in a host country, or tariff and non tariff trade barriers are high in

a host country, or political risks are too high to invest indirectly in a host country. There

are many negative effects for Licensing and franchising such as Dianqiao in cultural

aspect and media restrictions in political aspect.

64

Joint venture is the most popular form of entry mode presently. Even through

there are many disadvantages to foreign Joint venture, such as high risk compared to

other modes of entering foreign markets, require higher amounts of resources and

commitment as appose to other modes. Joint venture has abundant advantages: the first

being that the company has direct ownership (unlike licensing) which provides a high

degree of control in the operations and the ability to better know the consumers and

competitive environment. Secondly, since china opened its door to the world, more and

more multinational enterprises paid massive attentions on Chinese market as the Chinese

government provided numerous attractive policies and regulations for private companies.

In the cultural aspect, Joint venture provides plentiful employment and higher wedges

and salaries to local labors. Technology and information transfer also benefits China

significantly. Comparing Joint venture with other forms of entry modes in the cultural

aspects, it requires the highest level of Guanxi and negotiation with the local peoples.

However, Joint venture enjoys the advantages in the competitive production factors and

the cheap and plentiful labor forces and resources. In addition, there are less influences

on cultural dangerous such as ‘Duanqiao’ or Counterfeits for Joint venture compared with

exporting, licensing, and franchising. Joint venture also benefits from the Chinese

government support in various aspects, such as special car tax rate, special economic

zones, etc. more over, Joint venture has many advantages for investors; it spreads the

costs and risks to two parties and improves access to financial resources. Joint venture

has the ability for companies to access to new technologies and customers, access to

innovative managerial practices easily and quickly. The adoption of joint venture as an

entry mode may lead to economic of scale and advantages of size. In addition, joint

venture can influences the structural evolution of the industry, pre-empting competition,

create of stronger competitive units, Speed up to meet the market demand, and improved

agility.

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7.3 Best choice- Joint venture

As stated above in section 7.2, Joint venture is the most suitable form of entry

mode to entry the Chinese market in the current economy condition. There are abundant

advantages for Joint venture both culturally and politically compared to exporting,

licensing and franchising.

So far, the Chinese government has created world standardized laws and

regulations to support Joint venture in China and in order to attract more and more

foreign investors to China, the Chinese government has released abundant policies to

provide advantages for foreign direct investment. Even through China put high attention

in attracting foreign wholly owned enterprises to China due to the globalization, and

Chinese government opened most of its industries to foreign investors and they are

willing to take full control and become the owner of thus businesses. In return, huge

amount of capitals and assets are installed to the Chinese market. The trend of Chinese

laws will be moving towards foreign wholly owned enterprises positively. However, the

main and major industries such as Banking and media businesses are still protected and

restricted by the Chinese government in China, and the unique situation in China makes it

hard to changes. Therefore foreign wholly owned companies still facing many obstacles

compared to Joint venture. Foreign Joint venture is the most appropriate entry mode for

foreign investors that willing to choose foreign direct investment in China. However, as

China moves toward globalization, foreign wholly owned companies may surpass Joint

venture and become the core entry mode for FDI in China.

As China moves toward internationalization and globalization, FDI will be come

the most supported and encouraged form of entry mode in China from the aspect of the

Chinese government. Moreover, foreign investors adopting FDI in China will receive

more and more benefits for themselves.

66

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