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We have dealt with hundreds of clients over the past decade within our operations in China and, overwhelmingly, those company clients that have failed have fell into the below categories.

To note, the vast majority of the clients that have retained us from the beginning of their entry and have heeded our advice have succeeded (some, however, have not – China is loaded with risks).

Some we have, in recent years, advised, strongly, to look to greener pastures with lower labor costs, thus, foregoing our services of winding-up a company in China because of low margins caused by increased labor costs (most have not listened).

The clients that have listened have used our Southeast Asian/South Asia market entry services. Our favorite destination, for most low-skill manufacturing, these days, is Bangladesh and Cambodia. We are finding most low-margin and low value-added businesses should consider, first, Bangladesh and Cambodia and forgo China and other markets with drastically increasing labor, tax and compliance requirements. The Chinese government is even advising this.

However, China is becoming the must-be investment destination for those in consumer products, industries that can capitalize on the growing Chinese middle class, tech and medical equipment manufacturing companies and manufacturing that requires skilled labor at labor costs that are much lower than OECD economies (Korea beware).

We have had a few clients, over the years, squeezed out because of reduced margins or a failure to be able to capture on the Chinese middle class (normally poor market research), but few that had the typical shareholder dispute and government compliance issues that are increasingly the bread-and-butter of our China law firm. Regrettably, many of these bread-and-butter clients, previously, have hired legal and business professionals that were nothing but hacks or utilized counsel with no experience in China (flying out a couple of times a year and no office in China is a clear sign of a hack)

Here is our list. If you have any to add, drop me a comment and I will likely add your comment to the list:

  • Wrong joint venture partner. We find many people have done little to no due diligence on the partner and finds, quickly, that the partner is a shark. A shark with friends in the government and teeth that love to bite.
  • No or poorly drafted shareholder agreements. Must be drafted by an experienced international attorney doing business in China. A guy from the West coast U.S. that flies in for a few cases a year is not adequate. Some of these guys are great marketers: beware and screen counsel.
  • No feasibility study. Legal, Technical and Cost. Again, not from a guy sitting on a sofa in NY. We refer to the best for technical and cost work. However, the best is not cheap and the process won’t simply take a couple of weeks. Good guys in this business are systematic. Systematic guys need time. Trust us, we have never seen an opportunity simply disappear.
  • Flagrant violations of Chinese law. If you are in the local newspaper, call your lawyer quickly. Know the law and follow the law to the tee. Compliance doesn’t, simply, mean hiring a Chinese compliance officer that graduated from law school last year. It, also, doesn’t mean hiring a lawyer sitting on a sofa in NY.
  • Stepping on the wrong guys toes. Easily avoided. Stay low and dry. The head of our China Practice Team was a U.S. Marine officer and he has learned to always keep his head down and his socks dry.
  • No Friends in China. Read: “How to Make Friends and Influence People” by Dale Carnegie and make a lot of Chinese friends and hire people that have a lot of friends in China.
  • No IP Protection Strategy. I wrote so much about this on this blog that I am not going to bore you.
  • No Internal Processes to Check Quality of Products. If you are producing junk – its your own fault. Build a system and no junk will be produced. If you can’t build a system, we know a Swiss guy that builds systems that will drive you nuts, but will, without a doubt, end in a quality product. Unless you sell junk (scrap metal, trash incineration etc.), then, keep up the good work.
  • No Understanding of Chinese Consumer Behavior. We use the best company in market research in Asia (and these guys are quite small). All clients that we have referred have been satisfied, because they are not simply performing surveys, but understand how to read consumers. Simply, Idea Analytics is the best, since they use the best algoritism (weed out the clutter) and have experience with reading Asian consumers.
  • Hiring the Wrong Senior Employees. Executive recruiters operating based on contingency, only, will normally feed you anything and often the anything is crap. If you have crap working for you, you will produce crap. Some of the international head hunters operating in China are no better. We have referred to two recruiters in China and had minimal issues with them (communication is not great though), but this is because if they won’t feed us crap, since we will feed them nil in the future and give them an ear full.

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China is and will continue to be one of the most attractive markets for consumer goods. With a population of more than one and a half billion people and a middle class of more than 300 million, that is projected to grow to at least 700 million in the next 20 years. Based upon our experience in China and having been a part of the tremendous growth, we have seen that this emerging middle class, which is already larger than the U.S. population, is spending money like crazy and is not saving like previous generations.

Given that China is one of the only places in the world that has had double digit growth in GDP (except for this year which is still 8%), it has a burgeoning and spend crazy middle class, a developing legal system and excellent infrastructure, everyone should want to bring their products and services into this market. It’s not that easy. For many products, and services there are taxes. China does not have a national sales tax on retail items like other countries and so it imposes import duties, value added taxes and consumption taxes which the importer, wholesaler or retailer must add to the price the consumer pays. It’s all hidden, but, believe me they can be quite steep. For example, the total duty on imported wine, which is the only wine worth drinking in China, is between 41 and 50% which can make many products cost prohibitive when compared to quality – the value is just not there.

And people think China is cheap! I would offer that in the major cities in China, cost of living is higher than most cities in the U.S. and Europe and inflation has not stopped in the 10 years that we have been advising clients in China. China aint cheap anymore, but, the domestic market where they don’t mind paying higher prices on quality items (that aren’t fake) is enormous and growing.

So, until the central government decides to either scrap it’s antiquated and cumbersome Value Added Tax “V.A.T.” system, which we don’t see that happening for a long time as too many people would lose a lot of money ,or they lower the import duties and consumption taxes on imported products – there might be other way to bring in imported products that are in high demand in China.

China and Hong Kong operate under a one country two systems arrangement that has been in place since the turnover in 1999. Despite obvious cultural differences and the fact that there is a border crossing, most of us who do business in South China consider the two as one. In fact, there is a treaty between Hong Kong and China which many people don’t know about that allows for Hong Kong companies and professionals to operate in China and also a few other things such as the duty free import of Hong Kong made products. Below is a summary of the CEPA rules pertaining to importation of Hong Kong products which could provide a solution to the high import duties in China.

In order to enjoy zero tariffs under the Closer Economic Partnership Agreement (CEPA), goods exported from Hong Kong to Mainland China must fulfill the rules of origin and show evidence of being “made in Hong Kong.”

The execution of the rules of origin is detailed in the “Customs Provisions of the People’s Republic of China on Executing the Rules of Origin for Trade in Goods under the Mainland/Hong Kong Closer Economic Partnership Arrangement (haiguanshuling No.106, hereinafter refers as ‘Provisions’),” which was promulgated in December 2003 and came in effect from January 1, 2004. Under the Provisions, “Hong Kong” as the origin of goods shall be determined according to the following principles:

1. Goods entirely obtained in Hong Kong 2.Goods “substantially manufactured” in Hong Kong if not entirely obtained in Hong Kong Goods entirely obtained in Hong Kong According to the Provisions, goods entirely obtained in Hong Kong include:

  • Minerals exploited or extracted in Hong Kong
  • Plants or related products collected in Hong Kong
  • Animals born and raised up in Hong Kong and their related products
  • Animals hunted in Hong Kong
  • Fish and other sea products caught by ships with Hong Kong licenses and regional flags and their related products
  • Waste disposal for recycling from and collected in Hong Kong
  • Waste and scrap for recycling resulting from manufacturing in Hong Kong
  • Products made out of waste disposal or waste and scrap mentioned above Substantial processing, transformation, or manufacturing The criteria of determining whether the products are “substantially manufactured, transformed, or processed” in Hong Kong should include the following:

Manufacturing or processing operations. The goods should be endowed with essential characteristics after principal manufacturing or processing operations in Hong Kong.

Change of tariff number. Change of tariff number refers to a change of the four-digit tariff numbers and taxation categories after the manufacturing or processing operation of non-Hong Kong materials in Hong Kong. Moreover, no further manufacturing or processing should happen outside Hong Kong.

  • Ad valorem percentage. Ad valorem percentage is the ratio between the total value of raw materials, components, labor and product development that are fully acquired in Hong Kong, and the FOB value of the finished product for export.
    Ad valorem percentage = (Value of raw materials + value of components + labor costs + product development costs) ÷ (FOB value of finished product for export) Products with an ad valorem percentage equal to or greater than 30 percent, and with the last manufacturing or processing procedures completed in Hong Kong, shall be regarded as “substantial processing.” The following stipulations apply:
  • Calculation of the above “ad valorem percentage” should be consistent with generally accepted accounting standards and with the “Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994.”
  • “Product development” refers to product development conducted in Hong Kong for the purposes of producing or processing the exporting goods. Incurred expenses for development shall be related to the exporting goods, including the costs for self-developing of the producers and processors, as well as the costs for the developing of consigned natural or legal person. The expenses also includes fees for purchasing designs, patents, patented technologies, trademarks or copyrights processed by a natural or legal person in Hong Kong. The concerned value should be clearly identifiable under generally accepted accounting standards and the provisions of “Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994.”
  • If raw materials or components originating from Mainland China are used and they constitute part of the export products in Hong Kong, when calculating the ad valorem percentage of the export product, the raw materials or components from Mainland China should be deemed to be originating from Hong Kong. The ad valorem percentage of the export product should be greater than or equal to 30 percent, and greater than or equal to 15 percent excluding the price of the raw materials or components from mainland. Other criteria The “other criteria” refer to other criteria agreed by authorities of both Mainland China and Hong Kong in determining the origin of the products, besides the three above-mentioned criteria.

Mixed criteria. The “mixed criteria” means that two or more of the above-mentioned criteria are used in determining the origin of the products.

Manufacturing or processing for the purpose of transporting or storing the goods, facilitating the packaging of the goods, or better packaging and displaying the goods is not considered as “substantial processing, transformation, or manufacturing.”

Simple diluting, blending, packaging, bottling, desiccation, assembling, sorting or decorating will not be regarded as “substantial processing, transformation, or manufacturing.”

Package, packaging materials, containers and accessories, spare parts, tools and explanatory materials accompanying the goods should be ignored in determining the origin of the goods.

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China recently made sweeping changes to its Consumer Protection law. The changes mark the first time that the law was modified in two decades – brought on by what the Chinese government calls “changes in the makeup and challenges of the consumer sector.”

According to an article by Reuters, the new laws “increase consumer powers, add rules for the booming internet shopping sector and stiffen punishments for businesses that mislead shoppers.”

The true purpose of the revisions, according to the article, is so that China can further move its economy away from one that is built on investment-driven growth, and transform it into one that’s led by domestic consumption.

Consumption contributed to just 45% of China’s economy during the beginning of 2013, which is down from about 60% during the same period last year. The Chinese government hopes that these new law is going to allow consumers to purchase Chinese products with increased confidence.

The new revisions will also strengthen the role of the China Consumers’ Association, which sometimes acts as a representative for plaintiffs in class action suits brought against retailers.

To read more, you can read the article from Reuters here: China Overhauls Consumer Protection Laws

Check out some related articles by IPG Legal here:

  • Import Duties & Taxes in China: The Wine Example
  • How to Succeed in Business in China
  • Another Reason for Establishing a Company in Hong Kong for Entering the Chinese Market
  • China May be Deep into a Bubble According to the Financial Times