Dept of Real Estate and Construction Management Div of Building and Real Estate Economics
Master of Science Thesis no. 485
Foreign Direct Investment in the Chinese Real Estate Market - with focus on cross-cultural business
Author: Katarina Fu
Supervisor: Han-Suck Song Stockholm 2009
Master of Science thesis Title: Authors Department
Master Thesis number Supervisor Keywords
Direct investing in the Chinese Real Estate market - with focus on cross-cultural business Katarina Fu Department of Real Estate and Construction Management Division of Building and Real Estate Economics 485 Han-Suck Song Real Estate, China, FDI, investment approaches, JV, WFOE, cross-cultural business, Opinion 171, legal environment
Abstract China is a country in the middle of a transition from a less developed country into a strong and highly developed country. Business opportunities attract many real estate investors trying to get a piece of this giant cake. There are however some obstacles preventing investors to enter the Chinese real estate market. The business environment is confusing at first and might be very different to the Western way of doing business. The Chinese real estate market is controlled by the government through restrictions making it complicated for foreigners to invest. This combined with the cultural differences that exists makes it difficult to succeed without any sort of guidance. I have therefore through literature review and interviews with people in the Chinese real estate business and in connecting businesses compiled the most common issues that we can encounter in the real estate market. Governmental policies and restrictions are definitely aggravating factors for an investor, but the cultural differences make up important and real obstacles as well. Chinese parties strive for trust and long-term relationships with people they do business with. This is somewhat unlike the Western business style. Adaptability and being open minded to the Chinese culture and way of doing business is therefore important factors of success. Even though this thesis is focused on the real estate business I am sure the content of this thesis can be beneficial for whoever interested of working toward the Chinese market in other branches since it gives an indication of what we are up against.
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Acknowledgement First of all I would like to thank Ann‐Marie Johansson, Jonas Burstedt and Sebastian Hylving from Inter IKEA Centre Group who gave me the opportunity to make the most of my thesis. You gave me your trust to find my own focus within this difficult subject. In addition, you also arranged many of my interviews which have given me information that is difficult to find through literature studies. Secondly I would like to thank Michael Li from Vinge Advokatbyrå in Shanghai who spent much time explaining the complex legal environment regarding real estate in China. You helped me more than I ever could have expected. Thirdly I would like to thank Brian O’Connor, Colin Dowall and Henry Crabb from DTZ for arranging additional interviews that have been of importance in this thesis. Last but not least, thank you Han‐Suck Song for your ideas, encouragement, and interest in my thesis. You have given me inspiration and guidance when I needed it the most. Your opinions have through this thesis always been of great importance for me. Stockholm, 090617 Katarina Fu
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Table of Contents Master of Science thesis ................................................................................................................ 2 Abstract ................................................................................................................................................ 2 Acknowledgement ............................................................................................................................ 3 1. Introduction ......................................................................................................................................... 7 1.1 Background .................................................................................................................................... 7 1.2 Objectives ...................................................................................................................................... 8 1.3 Method and Problems ................................................................................................................... 9 1.4 Limitations ..................................................................................................................................... 9 1.5 Disposition ..................................................................................................................................... 9 2. Review of economic development in China ...................................................................................... 11 2.1 Briefing of the Chinese macro economy ..................................................................................... 11 2.2 Economic history post economic reform in 1978 ....................................................................... 12 2.2.1 The three stages of economic reform .................................................................................. 13 2.3 Review of Real Estate market in China ........................................................................................ 15 2.3.1 Rental levels ......................................................................................................................... 16 2.3.1 Approaches for investing in Properties in China .................................................................. 16 3. Literature review of international business expansion strategies .................................................... 17 3.1 Introduction ................................................................................................................................. 17 3.2 International business strategy ................................................................................................... 17 3.2.1 The diamond of national advantages ................................................................................... 18 3.2.2 Motivations and potential risks of international expansion ................................................ 19 3.2.3 Entry modes to international expansion: International strategic alliances and Wholly owned subsidiaries ........................................................................................................................ 21 3.2.4 Entry modes to international expansion: International Joint ventures ............................... 24 3.2.5 Entry modes to international expansion: Wholly owned subsidiaries ................................. 26 4. Entry modes in China ......................................................................................................................... 28 4.1 Why enter China .......................................................................................................................... 28 4.2 Entry modes ................................................................................................................................. 28 4.2.1 Wholly foreign‐owned Enterprise (WFOE) ........................................................................... 29 4.2.2 Equity joint venture (EJV) ..................................................................................................... 29 4.2.3 Cooperative joint venture (CJV) ........................................................................................... 29 4.2.4 Joint development venture (JDV) ......................................................................................... 30 4.2.5 The challenges with Joint venture ........................................................................................ 30
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5. Legal aspects of Real Estate .............................................................................................................. 32 5.1 Introduction ................................................................................................................................. 32 5.2 Legal environment ....................................................................................................................... 33 5.2.1 A different attitude to law .................................................................................................... 33 5.2.2 Keeping up‐to‐date ............................................................................................................... 34 5.3 Opinion 171 ................................................................................................................................. 34 5.3.1 FIE establishment ................................................................................................................. 35 5.3.2 FIE register ............................................................................................................................ 35 5.3.3 Registered Capital................................................................................................................. 36 5.3.4 Adjustments in Opinion 171 due to Opinion 50 ................................................................... 36 5.3.5 SLUC, Business License, Approval Certificate and additional procedures ........................... 37 5.4 Acquire land ............................................................................................................................. 37 5.4.1 Land administration department ......................................................................................... 37 5.4.2 Question marks .................................................................................................................... 38 5.5 Further regulations .................................................................................................................. 39 6. Cross‐cultural business in China ........................................................................................................ 40 6.1 Importance of culture and cross‐cultural business ..................................................................... 40 6.1.1 Defining culture .................................................................................................................... 40 6.1.2 Becoming cultural sensitive .................................................................................................. 41 6.2 Chinese Culture ........................................................................................................................... 42 6.2.1 Influences creating today’s culture ...................................................................................... 43 6.3 Chinese Business Culture............................................................................................................. 45 6.4 Some must‐know information during dinner and meetings ....................................................... 46 7. Experience and Opinions from people working in China .................................................................. 48 7.1 Introducing the interviewed ........................................................................................................ 48 7.2 West versus East .......................................................................................................................... 49 7.2.1 Western Style ....................................................................................................................... 49 7.2.2 Chinese Style ........................................................................................................................ 50 7.2.3 Short‐term or Long‐term ...................................................................................................... 51 7.3 Successful interaction and successful business ........................................................................... 52 7.3.1 Do your research .................................................................................................................. 52 7.3.2 Do it their way ...................................................................................................................... 53 7.3.3 Having an open and humble attitude ................................................................................... 54 7.3.4 Face ...................................................................................................................................... 54
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7.3.5 Guanxi ................................................................................................................................... 55 7.4 The Chinese Government – your partner in everything ............................................................. 56 7.4.1 The government’s role in China ........................................................................................... 56 7.4.2 A large real estate developer highly dependent and its land lease revenues ..................... 57 7.4.3 Corruption ............................................................................................................................ 57 8. Discussion .......................................................................................................................................... 59 8.1 Improved legal environment would attract additional investors ............................................... 59 8.2 Internationalisation towards globalisation ................................................................................. 60 8.3 Guanxi .......................................................................................................................................... 61 8.4 Never stop being adaptive .......................................................................................................... 62 8.5 The paradox of having both long‐term and short‐term perspective .......................................... 62 8.6 Not the whole picture ................................................................................................................. 62 References ............................................................................................................................................. 64
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1. Introduction 1.1 Background Foreign direct investment (FDI) in China has exhibited an increasing trend since 1978, when China introduced the economic reform1. FDI inflows have since then increased tremendously, and the number of international investors is growing. The Chinese real estate market is particularly interesting for many international investors. The property market is relatively young compared to the Western markets which give early investors many opportunities. On the other hand, the young and immature characters of this market make it quite risky to enter for many investors. Yet another important factor that can explain why the Chinese property attracts foreign investors is the changing legislation concerning FDI’s and in particular real estate ownership laws.2 Land in China is based on collective ownership with the state controlling the development. These circumstances, together with poor protection of private real estate rights, have contributed to why foreign investors have played a small active role in China’s real estate market. However, the real estate conditions are now under the process of changing which is increasing the attractiveness of real estate investments in China.3 Sound investment decisions are based on an understanding of the relevant market and the market’s code of conduct. Although China is a prospering country with many investment opportunities, it also contains obstacles preventing foreign investors to enter the market. The business environment is controlled by the government through restrictions which makes the environment complicated and aggravating. This combined with the cultural differences that exist makes it difficult to succeed without any sort of guidance. There are numerous of guide books describing the situation in China and many of these books emphasize the cultural differences and governmental ruling. Culture and governmental ruling differ quite a lot from the western style we are used to. 1
www.fdi.gov.cn 2009-05-17 www.burges-salmon.com 2009-03-23 3 www.burges-salmon.com 2009-03-23 2
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Additional knowledge regarding Chinese culture, history, etiquette, geography, etc. is therefore just as important as hard facts (Ambler and Witzel, 2003). But the unwritten rules are not always so easy to get a grip of. Having good relationships (in Chinese called guanxi) with business partners, but especially with government staff and other politicians at different levels, is important when doing business. Good guanxi with the government officials and business partners can be of much help by e.g. diminishing upcoming obstacles and introducing real estate investors to the right people, but also to facilitate information sharing. Guanxi can however be somewhat difficult to establish, especially if the business men from western countries withhold poor understanding of the Chinese culture and way of doing business. The downside of doing business in a country that is heavily based on relationships is corruption. The Chinese government is trying to eliminate corruption, particularly in its own organisation with help of anti‐corruption regulations. However, the problems do still exist and one can read about local or district mayors being prosecuted by the central government for corruption every other day in the newspapers (China Daily, 2009; Shanghai Daily, 2009). China is also the land of paradoxes. The consequence of not being able to read between the lines, analyse situations correctly and understand the meaning of ‘face’ can have devastating consequences. Investing in China can therefore be very time consuming, expensive and confusing.
1.2 Objectives The purpose of this thesis is to present and discuss factors that that might enable foreigners to make well founded strategic decisions regarding FDI in China. With purpose of providing further understanding of doing business in China, hard facts such as investment approaches, law and regulations will be discussed side by side with factors that are more difficult to grasp such as culture and the importance of guanxi. The focus of this thesis will be directed on the importance of understanding Chinese business culture and the importance of guanxi in order to undertake successful real estate investments.
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1.3 Method and Problems I will perform a general literature review with focus on international strategies and management as well as cross‐cultural business in China. Due to rapid changes in China, interviews with investors and property consultants active in the Chinese property market will also be conducted complimentary to the literature review with purpose of making this thesis more up‐to‐date.
1.4 Limitations The performed interviews were mostly focused on the individual impression and experience without any profound analytical discussions. The questions were not sent in advance to the interviewees, which can have affected the level of depth in the answers given. In addition, the interviewees are all working within different branches of real estate and connecting businesses, which also affect their varying experiences. Some work more with the government on a day‐to‐day basis whilst others work more with partners and clients. Also, due to the importance of personal relationships the wider network one person has will affect whether he or she perceives the business environment as difficult or easy. No discussions have been made regarding the interviewee’s network or relations in relevant business sectors.
1.5 Disposition This thesis is organized as follows: In chapter 2, I present a review of the Chinese economy. The three stages of development that has led china to become the rather developed country we observe today are explained along with the status of the real estate market. In chapter 3, I discuss the legal aspects in China with focus on the establishment of foreign enterprise and land acquisitions. Opinion 171 is the foundation of China’s real estate regulations and is also discussed in chapter 3. Chapter 4 explains the theory behind expanding business and what sort of investment approaches we can use when entering a new market. Moreover, I will also discuss the level of risk and control that the different approaches contain and what benefits the approaches has. In chapter 5, I specify the most typical entry modes in China and the challenges for Joint ventures specifically. Chapter 6 and 7 go hand in hand and discuss the cross‐cultural business. Chapter 6 however, is more focused on the influences of Chinese culture and 9
business culture whilst chapter 7 is highly based on interviews with people working in or in related markets to real estate. Common pitfalls and other good‐to‐know information are explained in these two chapters. Chapter 8 concludes this thesis with a discussion.
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2. Review of economic development in China 2.1 Briefing of the Chinese macro economy China has in an astonishing pace grown and become more and more important to the world economy. China is now in the beginning of the 21st century playing a large role in the world energy and commodity market. The growth began a few decades ago and is in many ways very similar to the growth of US, UK, and continental Europe a century ago. The main difference is however the massive population in China. As a result of the large need of energy, China was in 2007 the world’s largest emitter of carbon‐dioxide and is becoming more of a global player in search of mineral and oil outside of its own borders. Their largest challenge in the future will be to maintain the economic growth at the same time as reducing the global footprint as much as possible. (Handelsbanken, 2009) China had in the year of 2007 a population of 1.321 billion 4, a population growth of 4.25% compared to year 2000. China is currently the world’s most populated country closely followed by India5. The level of child birth in China has been quite stabile with approximately 12 newborns per 1000 inhabitants every year since 2003. In 2006 one third of the population (33.66%) was in the age range 0‐24. The age range 25‐44 was also one third (33.31%) of the population. The remaining third of population is mainly consisted of people in between 45‐64 (23.83%), and one tenth of the total population (9.20%) is older than 65 years6. In the upcoming 10 years, KPMG Property and Infrastructure (2007) estimate that about 400 million people from the country side will move to the cities. In addition, the United Nations estimates that China will by year 2015 have over 60 cities with a population exceeding one million. GDP was in 2007 USD3,400,351 giving a GDP growth rate at 11.4% per annum calculated with constant prices of 1990. GDP per capita has grown at a high pace reaching USD2604.2 at 2007, a major increase compared to 2000 when the GDP per
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www.stats.gov.cn 2009-05-07 www.infoplease.com 2009-05-07 6 www.stats.gov.cn 2009-05-07 5
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capital was USD956.07. Furthermore, the registered unemployment of labour force was in year 2008 4.0%, giving it a growth of 0.9 percentage points in comparison to 20008. The growth has indeed been very impressive. However, it seems like the golden age is about to end. A report from Handelsbanken (2009) is showing that the demand of exporting goods is dropping. The private real estate investment is also approaching a point of saturation. Nevertheless, the Chinese government is decreasing the domestic falls by creating fiscal stimulus packages. In November 2008 the government announced a package of RMB4 trillion and their goal is to continue providing stimulus until their ambition, avoiding mass unemployment, has been completed. (Handelsbanken, 2009) The battle for investment capital between cities all over the country is hard. Second and third tier cities are offering unique niches to attract capital and investors have therefore many more investment options now than in previous years. Consumer patterns, taste and preferences are also different in the regions which can help narrowing down where we would like to invest initially. 9
2.2 Economic history post economic reform in 1978 China has in the past been isolated from the world and the world’s economy. The breaking point of change, however, started in the end of 1978 when the Chinese government decided to open its economy for foreign investors. The economy opening in 1978, the so‐called “open‐door policy”, was the starting point of China’s economic reform (Alon, 2003). The economic reform has gradually improved the Chinese people’s living conditions and reduced the population living in poverty from 53% in 1978 to 8% in 200110. In addition, the country’s average growth rate have after the starting point of the economic reform been around 9%. No other countries have, historically, managed to achieve such high growth rate (Ek, 2007).
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data.un.org 2009-05-07 www.stats.gov.cn 2009-05-07 9 dcb-ev.org 2009-06-14 10 www.econ.worldbank.org 2009-01-02 8
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2.2.1 The three stages of economic reform The economic reform can be described in three stages. The first stage was the experimental stage (1979‐1986), where the central government created four economic zones on the east coast. The local government had in the economic zones the authority to approve foreign investments without involvement of the central government. Firms could also receive beneficial tax policies in the established economic zones. This made it easier for foreign investors to operate in China, particularly in the economic zones. The investment incentives were surely a step towards the right direction but nonetheless, the legal environment was still weak when it came to protecting firm’s intellectual properties. This created a large uncertainty among foreign investors. Investors were during the experimental stage often frustrated over the governmental bureaucracy which could end up being very time‐consuming. High costs, limited access of the domestic market, etc. was also obstacles making it more challenging for foreign firms to succeed and take market shares, compared to domestic firms. The second stage, the growth stage (1987‐1991), started after the government’s second modification in 1986. The modification led to an improved Foreign Direct Investment (FDI) environment. Two profound improvements due to the modification was (1) the introduction of the new investment approach; Wholly foreign‐owned enterprise and (2) a promulgation which encouraged further foreign investments; The promulgation of the Provision of the State Council of the People’s Republic of China for the Encouragement of Foreign Investment, also called as the 22 articles. These improvements lead to preferential treatment and operational freedom for foreign invested enterprises (FIE). In addition to these two improvements, the government also created further incentives to increase the attraction of investing in China. Some of the incentives were reduced land use fees, exemptions on foreign exchange transactions, decentralized decision making regarding joint venture‐ approvals, preferential bank loans, and access to raw material, etc. The adoption of Cooperative Joint Venture Law in 1988 and the amendments to the Joint Venture Law in 1990 also contributed to a further rapid growth of FDI. The third and last stage (1992‐ 2000), which is the boom stage, was a period of time when the investment environment became friendlier due to additional improved FDI policies. FDI grew larger and many joint venture‐approvals could be made on a local governmental level and therefore reducing some bureaucratic stages in the process. (Alon, 2003) 13
FDI can bring several positive effects with it ‘…such as increased capital accumulation, transfer of advanced technology, skilled labour and superior managerial knowledge. These factors can help to stimulate the industries and in the long run, generate productivity growth in the economy.’ (Ek, 2007, p 3) Alon’s three describing stages are illustrated in exhibit 2.1, a statistical diagram of FDI in China. The diagram shows the amount of realized FDI in China from 1980‐2007. We can see that the amount of investments in the experimental stage, just after the open‐door‐ policy in 1978, was very limited. Even if some increasing investment amount, between 1987 and 1991, can be seen in the growth stage, the third stage starting from 1992, which is the booming stage, definitely created the needed incentives to successfully attract FDI. Exhibit 2.1 Amount of realized FDI in China post‐economic reform 80 70 60 50 40 30 20 10 0
Source: Ministry of Commerce The People’s Republic of China (2005, 2008); National Bureau of Statistics of China (2004); UNCTAD (2005), Also referred in Krug and Hendrischke (2007)
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2.3 Review of Real Estate market in China The Chinese real estate market has yet not experienced a full life cycle. There are therefore not much historical data that can be use as references when predicting the future. The economic reform in 1978 was the starting point for major changes in the real estate market and the market is now becoming more and more accessible for private property developments, especially in areas that need to attract more capital and work opportunities. Nevertheless, the transformation is an ongoing process and as a result of the transformation the market is becoming more refined. The majority of all investments are made on the east coast. First tier cities such as Beijing, Shanghai, Shenzhen, and Guangzhou has attracted majority of all investment capital and are already highly developed economically. It is therefore becoming difficult to find land of high quality in first tier cities due to the shortage of space and high prices11. Smaller cities are however very keen on attracting more investors and battle for investment capital. They offer unique niches and are apprehended as more forthcoming.12 Investment focus has therefore altered to second and third tier cities13. Foreign direct investment in the real estate market has with large margins been dominated by Asian companies, often owned by Chinese overseas. These companies come from Hong Kong, Taiwan and South East Asia. Multinational companies from Australia which already have business in Asia and have the financial capacity are also very active in the Chinese real estate market. In addition, the investment trend has also attracted some Japanese real estate companies to enter the Chinese market (Soon, 2007).
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dcb-ev.org 2009-06-14 dcb-ev.org 2009-06-14 13 www.dtz.com 2009-06-14 12
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2.3.1 Rental levels 2008 rental levels for some first and second tier cities can be found in exhibit 2.2. The rental levels give an indication of what rental levels we in general can expect on the Chinese market.
Exhibit 2.2 Rental levels in prime locations 1
2008 rental levels in prime locations per meter and month (RMB) 2
Beijing
Shanghai
2
Guangzhou
3
1
Excluding service charge and management fees
2
First tier city
3
4
Office
Retail
Industrial
206
527‐1420
53
270
1130‐1067
44
107
248‐2035
29
4
Second tier city
4
Average rental level
Source: Asia Marketview Q3 2008, CBRE
According to CBRE office rental growth has under year 2008 reached its peak in all reference cities seen in exhibit 2.2. The rental levels are now anticipated to decline. Retail and industrial rental levels are however still anticipated to have further growth with Shanghai taking the lead of having most potential to increase their levels.
2.3.1 Approaches for investing in Properties in China There are two general direct investment approaches; the first and less complex approach is to acquire real estate and make profit on the generated rental income (property management). Effort can also be put on refining real estate to increase rental income. The second approach is construction projects where land is acquired and buildings are constructed with purpose to make profit on either leasehold and/or through sale. (Deloitte, China Real Estate investment handbook). The latter approach includes a more complicated investment process with many regulations. It also includes a range of uncertainties hence regional interpretations regarding development regulations may vary.
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3. Literature review of international business expansion strategies 3.1 Introduction In this literature review I focus on the following two areas in the field of international business expansion strategies and FDI’s; (1) the more traditional economic and business strategy approach to international business (chapter 3.2), and (2) the role and importance of different business cultures in international business and FDI's (section 2.3).
3.2 International business strategy There are different entry modes for a firm to approach. The type of entry mode that is the most suitable depends on several factors. The fundamental factors are however what extent of investment and risk one are willing to take contra the degree of ownership and control that is required and expected when entering the market. The different investment approaches and its relationship to risk and control are illustrated in exhibit 3.2. The more control a company have over their business also implies that they need to undertake a higher level of risk. Exporting involve the lowest level of risk and investment as well as the lowest degree of ownership in control whereas Wholly owned subsidiaries involve a high level of risk and investment with full degree of ownership and control (Dess et al., 2006). Between Exporting and Wholly owned subsidiaries are the strategic alliances which involve higher level of control than Exporting and lower level of risk than Wholly owned subsidiaries.
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Exhibit 3.2 The relationship between risk and control for six different investment approaches14
Source: Adopted from Dess et al. (2006)
3.2.1 The diamond of national advantages A firm that want to succeed internationally must create additional value to the firm and achieve competitive advantage. It is also necessary to avoid pitfalls that exist on the global market. Having profound market knowledge is fundamental for a company’s performance. Market knowledge can be divided into (1) objective knowledge and (2) experimental knowledge. ‘Objective knowledge is relatively easy to acquire and should not be of crucial importance for the relative performance of firms within a market…experimental market‐specific knowledge is knowledge about the specific market and its characteristics: business climate, culture, structure of the market system and knowledge about individual customers…it cannot be acquired as easily as objective knowledge, and it concerns the characteristics of the specific foreign market’ (Carlsson et al., 2004, p 23). There is also a theory which Michael Porter of Harvard University created. It is called ‘the diamond of national advantages’ which can be implemented on an international level. The diamond consist of four determining attributes that take part in weather a firm is successful or not. These four attributes are (Dess et al., 2006):
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The definition of Strategic Alliances is not clearly settled. Therefore some forms of Strategic Alliance, like Joint Venture, are inconsistently categorized and treated separately.
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Factor conditions – In classical economics the building blocks creating usable consumer goods and services are land, labour and capital. Porter explains however, that there are also more factors taking part in the development. Investing in industry‐ knowledge and talent, recruiting skilled human‐resources as well as having good supporting infrastructure such as transportations and communications systems and banking systems are also important factors. Demand conditions – Firms that have demanding consumers regarding goods and service will give the industry the incentive and pressure of constantly improving their goods and services, satisfying the demand on the market. In addition, if firms have the ability to produce more innovative products they can push themselves to higher standards and therefore become market leading. Related and supporting industries – Related industries can offer similar opportunities and create the opportunity to enter new markets which can create a more competitive market for existing firms through efforts such as cost control, product innovation, and novel approaches to distribution. Firm strategy, structure and rivalry – Rivalry is particularly intense in nations that have conditions of strong consumer demand, strong supplier base, and high entrant from related industries. Domestic rivalry thus provides strong incentive to look at markets in other countries. Furthermore, firms that have experienced intense domestic competition are more likely to have strategies and structure that allow them to successfully compete in world markets.
3.2.2 Motivations and potential risks of international expansion International expansion, which is a type of investment, is in general related with risks. In order for investors to be willing to make risk‐investments there need to be motivating value‐adding factors that compensate the risk. The motivating value‐added factors for international expansion are (Dess et al., 2006):
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•
Increased size of potential markets
•
Spread fixed costs, such as research and development costs, to several countries and markets (economies of scale)
•
Extended lifecycle of products hence different countries and markets are in different stages of maturity
•
Optimised physical location for every activity in its value chain
If we believe the motivations are strong enough for expansion the first thing we need to do is to determine which countries that is most suitable for international expansion. The process of international expansion is described with help of the Uppsala Model by Johanson and Vahlne (Dunning and Lundan, 2008). According to the Uppsala model, firms will take small expansion steps (Rolander and Zhang, 2008) to countries that are geographically and culturally close to ours and then gradually expanding to countries further away. The model predicts "increasing resource commitment to foreign markets over time as a result of organizational learning and the accumulation of experience. It also predicted that firms would diversify their investments into countries with higher level of ‘psychic distance´” (Dunning and Lundan, 2008, p 91). The psychic distance is defined as the factors preventing the flow of information on the market e.g. language and cultural differences, industrial development, education (Rolander and Zhang, 2008). There are as mentioned also risks involved with international expansion. Political and economic risks such as social unrest, military turmoil, demonstrations, violent conflicts and terrorism can pose serious uncertainties and threats during an expansion. Additional possible risk is currency fluctuations which can pose substantial risks and need to be monitored if the firm is operating in several countries. The fluctuations in exchange rates between own currency and host currency can, even if a small fluctuation, have a large effect on the revenue. Further risks in international expansion are also management risks where culture, customs, language, income levels, customer preferences, distribution systems etc. need to be taken into consideration in the decision making of international expansion. (Dess et al. 2006) The Economics Intelligence Units (EIU) is a leading research and advisory firm which analyses countries, industries, and managements. EIU presents country risk scores and 20
credit rrisk rating o on a yearly y basis. Thee risk ratinggs are based on risk‐faactor scorees which sums up to a totall score. A lo ow score in ndicates thaat the risk‐factors aree low which h in turn ountry ratiing. In exhibit 3.3 are the EIU’s ccountry risk k scores an nd credit creates a higher co risk rattings for 20 008 in a num merous of countries aall over thee world. Sw weden, for in nstance, receiveed a score o of 9 and a rrating of 10 0. Rate 10 iss the best p possible ratting which implies that theere is a low w credit rissk in the country. China receiveed a score at about 30 and a 3 rating o of 7, meaning there arre more creedit risks that need to o be taken into consid deration when in nvesting in n China. Exhibit 3 3.3 Economiccs Intelligencce Units (EIU)) ‘Country Rissk Rating’ Score 70 60
Co ountry Risk Raating Rating 10 9 8
50 40
7 6 5
30 20
4
Rating Score
3 2
10 0
1 0
Source: w www.eiu.com m 2009‐01‐20 0
es to intern national expansion: Internatio onal strate egic alliances 3.2.3 Entry mode and Wh holly owne ed subsidiiaries To deciide in whicch way we should perrsue our bu usiness wee need to w walk througgh three manageerial stagess and deteermine whiich manageerial style is the mosst suitable for our operatiion. The th hree managgerial stagees is illustrraded as a chart in exxhibit 3.4. In I stage one thee firm need d to make th he strategicc decision on whether to pursuee a (1) coop perative interfirrm relation nship (straategic allian nce) or (2 2) rely on market trransactionss or (3)
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conduct mergers and acquisitions (M&A) for expansion of the business. The primary risks of pursuing market transactions in stage one is the difficulties of competing against competitives on our own. Competing on a new market against local firms without local market knowledge create a disadvantage and increases the level of risk. M&A include high transaction costs and large sum of financial capital in an early stage which makes it a high risk investment. An additional risk for M&A is also the high content of ‘noise’ on the market for buying and selling companies. Noise diminishes the correct information making it harder to distinguish which the true attractive deals are (Peng, 2005). A strategic alliance may therefore ‘be a flexible intermediate solution to solve strategic growth problems.’ (Peng, 2005, p 266). When the decision of undertaking a strategic alliance have been made, the second stage is to determine whether the firm should be equity‐based or contract‐based. There are four driving forces guiding us to the most suitable strategic alliance. The first driving force is the uncertainties between the emerging firms regarding the shared resources and capabilites. The perferrable solution to solve this issue it to establish an equity‐ based alliance. The second driving force is the firms need of control. Control and monitoring possibilities are in equity‐based alliances larger than in contract‐based alliances. Third driving force is the real options that can be seen as the contract‐based alliance which in the future could become an equity‐based alliance. The last and fourth driving force are the institutional constraints. In some countries the government put restrictions on what type of entry modes that are are allowed. Government in emerging markets are for instance, generally more encouraging of equity‐based alliances, especially joint ventures, so that domestic firms can get access and learn more from the foreign firms. (Peng, 2005).
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Exhibit 3.4 Three stages managerial chart of forming strategic alliances
Source: Adopted from Tallman and Shenkar (1994), also referred in Peng (2005)
In the process of deciding the most suitable strategic alliance Peng (2005) has listed the long‐term and short‐term commitment of the different types of strategic alliances. Peng’s (2005) define the strategic alliances’ sub groups as following: ‘Contractual alliances include co marketing, research and development (R&D) contracts, turnkey projects, strategic suppliers, strategic distributors and licensing/franchising. They entail a relatively low level of commitment and are often limited in scope and duration. Equity‐ based alliances call for a higher level of commitment. Examples include strategic investment (one partner invests in another as a strategic investor) and cross‐ shareholding (both partners invest in each other)’ (Peng, 2005, p 255). See exhibit 3.5. Exhibit 3.5 The variety of strategic alliances
Source: Peng (2005)
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Strategic alliances have a significantly higher risk of failure in comparison to single firms. One of the fundamental differences is cooperation between several partners creating a larger uncertainty. Both relational and performance risks are needed to take into consideration and prevented if possible. (Das and Teng, 2001) In this thesis, I focus on joint ventures. For more information regarding the other alliance types, see Peng (2005).
3.2.4 Entry modes to international expansion: International Joint ventures A joint venture involves creating a third‐party legal entity (Dess et al., 2006), where the parent firms ‘combine a portion of their resources to form a separate jointly owned organization.’ (Inkpen and Li, 1999). There are many reasons why firms come together and create a third entity. Two of the main reasons are the can gain exposure to new sources of knowledge and technologies (Dess et al., 2006) from the joint‐firm and to create an international value‐added network (Dunning and Lundan, 2008). By having further knowledge, technology, and a wider network, firms can benefit from each other to develop and improve their core competences. It will by having core competence lead to better competitive advantages on the market. It can therefore be beneficial to enter partnership with host country firm through, for instance, a joint venture to obtain market shares. Moreover, host country firm can in a partnership provide with very useful information about local market, competitive conditions, legal matters, and cultural nuances (Dess et al., 2006). However, beside the alliance risk itself, other risks such as loss of technology and market share, and damaged trademark reputation is needed to be taken in consideration. Strategic alliances, and joint ventures in particular, have in recent years become increasingly popular modes for firms to enter and success in foreign markets (Dess et al., 2006). However, ‘many joint ventures fail to achieve their potential and joint venture failure rates remain high, frustrating the efforts of many firms to capitalize on alliance strategies’ (Inkpen and Li, 1999, p 33). Although the potential benefits are many, managers must be aware of the risks associated with strategic alliances and joint ventures and know how they can be minimized (Dess et al., 2006). In addition, managers
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must also determine what level of risk tolerance they are prepared for before establishing a joint venture (Inkpen and Li, 1999). Dess et al. (2006) establishes four factors needed to create a successful joint venture. First factor to create a successful joint venture is to create a clearly defined strategy which also must be supported by the joint parties. Second success factor is that there must be a clear understanding of what capabilities and resources the organization upholds. Third success factor is that there must be genuine trust between the partners. Trust is vital and without it one party may take advantage of the other by e.g. withholding its fair share of resources and gaining access to privileged information. Last and fourth factor, cultural issues that can potentially lead to conflicts and dysfunctional behaviours need to be addressed. It is however also important to recognise the differences at the same time so that the joint venture can develop the element of a ‘common culture’. Having a common culture in the joint venture is essential for the partnership. In addition to these four factors, a joint venture is highly dependent on what the involved parties are expected to do and what they really do in order to work together successfully. The first joint venture negotiations are only the first step in a “multiple‐step relationship” (Inkpen and Li, 1999, p. 33). By having careful planning in an early stage can reveal whether a joint venture is the best approach or not for international expansion (Inkpen and Li, 1999). Exhibit 3.6 shows some of the most important planning issues for joint ventures.
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Exhibit 3.6 Planning issues for joint ventures Joint Venture Planning Issue
Implication
The objetive of successful negotiations:
Successful joint venture cannot be one‐sided. Mutual
mutual value creation
value creation and co‐destiny should be the objective of all joint venture partners.
Initial partner relationships and knowledge
Firms should enter negotiations with knowledge about their potential partner, including the firm's joint venture objectives, the firm's strengths and weaknesses, and the firm's reputation and experience with joint ventures.
Perspective toward risk
Joint ventures involve various types of competitive and financial risks. The sources of risk should be identified and tolerance to the risks determined.
Negotiable and non negoiable
Before joint venture negotiations begin, firms should clearly decide on issues that are negotioable and issues that are non‐negotiable.
The importance of individuals
The strength of alliance relationships is largely a function of the relationships between individual managers. The individuals who will be involved in joint venture negotiations and management should be chosen carefully and as early as possible.
Joint venture governance and trust
Since joint venture governance structures will evolve over time as the venture strategy emerges and pertner trust develops, firms should be prepared for these changes when initial contracts are negotiated. Too stron an initial focus on formal controls can lead to problems, such as poor managerial selection and excesive monitoring costs.
National cultural issues
If the proposed joint ventures is internationa, the individuals slated to negotiate and manage the joint venture should have a solid cross‐cultural knowledge base.
The importance of flexibility and review
Joint ventures agreement should be as flexible as possible to allow for uncomplicated changes in veture scope. Flexibility and review should also be built into the negotiation.
Source: Adopted from Inkpen and Li (1999)
3.2.5 Entry modes to international expansion: Wholly owned subsidiaries This entry mode gives the highest level of control over our international operations and can also generate the highest returns. Nevertheless, a wholly owned subsidiary involves 26
the highest level of risk since the firm is the single owner with 100% of the total shares. By owning all shares the firm become the sole risk bearer of the investment. There are by two means a firm can establish a wholly owned subsidiary: A. Acquire an existing company in the country we want to expand to or B. Develop a totally new operation (Greenfield venture) Wholly owned subsidiaries are the most expensive and risky of the previously discussed entry modes. Because of the risks and high costs wholly owned subsidiaries is most appropriate when a firm already has the required knowledge and capability. If the firm possesses the necessary knowledge and capability it can leverage rather easily through multiple locations in many countries. By establishing in multiple locations in many countries firms spread the risk to many markets and submarkets as well as spreading the costs. Risks can also be further reduced by hiring local talent, people who are working in the relevant market with relevant knowledge. In difference to strategic alliances, the wholly owned subsidiaries entire risk is assumed on the parent company. (Dess et al., 2006)
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4. Entry modes in China 4.1 Why enter China The general consensus regarding FDI’s is that it contributes to a growing economy in the host country. Among many factors that have positive effects on the economy the two main factors in China, from a Chinese perspective, has been (1) transferring information and knowledge from foreign firms to domestic firms and (2) bringing capital in to the country (Ek, 2007). The term ‘foreign direct investment’ is a broad term and includes “Sino‐foreign joint ventures, joint exploitation and exclusively foreign‐owned
enterprises (also called wholly foreign owned enterprise or Wholly owned subsidiaries), foreign‐funded share‐holding companies and joint development”.15 There are from a foreign perspective also many factors why companies are particularly attracted to do business in China. Some of these factors are (Handelsbanken, 2009): •
Cheap land and blue‐collar workers16
•
Low taxes for high‐technology companies
•
Well developed infrastructure versus other emerging markets
•
Underdeveloped judicial system; problems of copying (infringement)
•
Tight supply of qualified white collars17 fluent in English
•
Ownership restrictions in strategically vital sectors
4.2 Entry modes It is to operate in China first needed to create an onshore vehicle e.g. Foreign Invested Enterprise (FIE). The Chinese government has opened up the possibility for starting up different type of investment entities with different owner‐structure for undertaking FDI in China (Li M., Vinge Advokatbyrå). What sorts of owner structure one may choose depends on the investment approach. The level of risk and control are the two main factors that determine how the owner‐structure will look like and is therefore also the
15
www.fdi.gov.cn A blue-collar worker is form the working class and is typically performing manual labor with hourly wage. 17 A white-collar worker is an educated worker and is typically performing office, admin, and sales coordinated tasks, etc. 16
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determining factors of what sort of entry mode that will be used. We will discuss the different entry modes that are most common in China in this chapter. 4.2.1 Wholly foreignowned Enterprise (WFOE) The WFOE is the same as wholly owned subsidiaries that is described in chapter 3.2.5 and is named ‘exclusively foreign owned enterprise’ by Handelsbanken. WFOE is in China a relatively new entry mode. Joint ventures with domestic firms was until late 1990’s required for all foreign firms that had interest in investing in China. When WFOE was allowed the foreign firm received full control and ownership of the firm without involvement of domestic partners. WFOE has become a more common entry mode for investors. The increasing popularity is mainly due to the establishment of further WFOE implementation regulations which created a more clear business environment. In year 2000, WFOE accounted for approximately 51% of all FDI (Alon, 2003) and WFOE entities are commonly used when acquiring real estate from Chinese developers (Deloitte, 2008).
4.2.2 Equity joint venture (EJV) EJV is one of the most popular entities used in China and has by the end of year 2000 accounted for about 60% of all foreign invested enterprises. It is a long‐term alliance (Dunning and Lundan, 2008) and the EJV parties share profit and losses based on the individual contribution of registered capital (Alon, 2003; Deloitte, 2008; Michael Li, Vinge Advokatfirma). Registered capital is the amount of equity that the foreign enterprise brings overseas into China. Further discussions regarding registered capital can be found in chapter 5.3.3.
4.2.3 Cooperative joint venture (CJV) CJV was the single most important entry mode in China until the early 1990’s. Each party is responsible for their separate legal entity and will therefore only bear their own separate liabilities (Alon, 2003). On the contrary to EJV, CJV’s profit and assets does not need to be shared in the same proportion as the investment. Contract agreements are the base of how investment and profit are shared between the parties (Deloitte, 2008; 29
Michael Li, Vinge Advokatfirma). The advantage with CJV is its flexibility, in terms of its quick establishment and resolving of firm, and informal approach.
4.2.4 Joint development venture (JDV) This is, historically seen, a quite small share of all FDI in China. JDV’s are most common in large‐scale development projects within e.g. exploration of minerals and petroleum. It is more of a cooperative agreement between foreign and domestic partners. (Alon, 2003)
4.2.5 The challenges with Joint venture The Chinese government has until the late 1990’s required joint venture ownership for all equity based investments. For some restricted sectors, such as banking, it was not until China joined the WTO that they were lifted from the joint venture requirements (Dunning and Lundan, 2008). The benefits from a joint venture ‘is highly dependent on what each partner is committed to do and actually does over an extended period of time… many firms view joint ventures as intentionally temporary and recognize that their venture will not last indefinitely’ (Inkpen and Li, 1999, pp 33‐35). Chinese however, have a long‐time perspective when doing business (Lewis, 1997) and their joint ventures can sometimes last for generations (Ambler and Witzel, 2003). From a Chinese perspective, a joint venture can be a way to receive more technology knowledge as well as investment capital. Western perspective would be having the opportunity to learn more about China (Ambler and Witzel, 2003). If both parties of the joint venture can agree on the managerial aspects shown in Exhibit 4.1 they increase the likeliness of having a successful joint venture (Dunning and Lundan, 2008). However, according to Ambler and Witzel (2003) many western joint ventures in China fail within the first year. The reason for failure is primarily due to lack of trust and incorrect expectations. The western short‐term and Chinese long‐term perspective in doing business might just be one of the incorrect expectations creating joint venture failure. Divorcing your joint venture partner can be a painful process. Even though the Chinese government has implemented the ‘Contract law’ with purpose to protect all parties’ legal rights it does not always work so in practice. The judicial system is 30
understaffed with a high number of judicial staff having no education in the subject, including the judges. It is therefore seen as ineffective according to Elgsæther (2004).
Exhibit 4.1 Questions Joint venture parties need to be in complete accord about When are Joint Ventures Likely to Succeed? 1. the objectives of the JV 2. the amount and type of resources, capabilities and market access which each partner should commit to the venture 3. the inventive structures and enforcement mechanism underpinning the creation and deployment of such resources and capabilities 4. the way in which the venture is organized and managerial responsibility is divided 5. the distribution of benefits of the venture 6. the form and direction of the venture's growth and/or its pattern of diversification
Source: Adopted from Dunning and Lundan (2008)
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5. Legal aspects of Real Estate 5.1 Introduction Here I present the legal aspects specifically directed to the foreign investor’s situation within the real estate sector. I focus on opinion 171 which is the foundation of the Chinese government’s real estate regulations. I also present some additional legal details regarding enterprises owned by foreign investors which can be necessary to be aware of before direct investing in real estate. As mentioned in the beginning of this thesis, I have conducted a number of interviews with people working on the Chinese market. Most of the information I have received from the interview is presented in chapter 7. However, I have with some of the interviewees discussed the Chinese legislations. This information is due to this thesis’ disposition more suited to be presented in this chapter. Following are the interviewees: Niklas Ericson
Deputy General Manager at Svenska Handelsbanken, located Svenska Handelsbanken’s Shanghai branch.
Peter Groenholt‐Pedersen
Manager at Valuation and Advisory Services, located at DTZ’s Shanghai office.
Michael Li
Associate, located at Advokatfirman Vinge’s
Shanghai office in China.
Theodore Justin Novak
Associate Director at Investment Department,
located at DTZ’s Shanghai office.
Simon Y K Shiu
Senior Project Manager within the department of
Building consultancy, located at DTZ’s Beijing
office.
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Tony Tang
Land Acquisition Manager at Property Department, located at IKEA’s Shanghai office.
Li Xia
Support Manager at Property Department, located
at IKEA’s Shanghai office.
5.2 Legal environment Historically, Chinese real estate law has been marked with uncertainty as to the protection of private real property rights. As foreign investment continues to flow into the Chinese real estate market, the Chinese government has made significant strides toward embracing the concept of private ownership rights. The movement toward greater private ownership rights culminated on October 1, 2007, when the 2007 Property Law became effective. This new law provides more expansive property rights to private owners and demonstrates China’s commitment to boosting economic and social development by creating a climate of greater certainty18. Even though the government has indeed shown their commitment to improve the legal environment Li M. emphasizes that the real estate legislations are yet not complete since the laws and regulations are relatively new, starting from the economic reform 30 years ago. Much is adopted from other countries and is still not completely tested in China with Chinese circumstances. The legislations are therefore not always as efficient as one would like them to be. 5.2.1 A different attitude to law ‘There are sharply differing attitudes to law, particularly to its aims and purposes, in China than in the west. In the latter (for better or for worse), we tend to see the law as the essential set of rules of conduct governing our society, and also as our primary form of redress when things go wrong. Quite different traditions exist in China; here the “rules of conduct” are the ethics and standards of behaviour required in a Confucian society. Social pressure rather than legal instruments are used to ensure compliance’ (Ambler and Witzel, 2003, p 80) Ambler and Witzel continues ‘this does not mean that there are no laws in China; but the laws are used in different ways...many of the issues 18
www.burges-salmon.com 2008-11-25
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which westerners tend to think of as legal issues are better conceptualised in China as relationship issues. ’Ambler and Witzel experience is confirmed by people working in China. Shiu explains that, as an example, if a firm break a contract by not fulfilling their part of the agreement he would rather discuss the contract terms and figure out a solution instead of confronting with legal consequences. Li M. recommends directly speaking to the manager if a dispute occurs and letting lawyers mediate to find a solution instead of having the court settle the dispute. He explains that the parties attitudes can change depending on circumstances in the business process and people in China are in general mentally prepared that ‘difficulties will come’. Worth pointing out is perhaps that when discussing cooperation difficulties with the interviewed, none of them mentioned the court as a solution to their problems.
5.2.2 Keeping uptodate Legal environment can change from year to year (Ambler and Witzel, 2003) and because the property market in China has grown at a high pace in the past few years the importance of constant updating ourselves in the subject is important. Up‐dates can easiest be found on Ministry of Commerce’s (MOC) webpage. Novak points out that legal up‐dates are not announced by MOC which puts the responsibility of keeping up‐to‐date on the people in the business by regularly checking the MOC website. In 2006 authorities from different regions declared opinions regarding how this fast growing development could be regulated with purpose to create a more stable and healthy market development (Jian Zhu Fang [2006] No.171, further on called Opinion 171). What they concluded can be found in the following chapter 5.3.
5.3 Opinion 171
Opinion 171 is the foundation of China’s real estate regulations and became effective in beginning of 2007 and has thereafter been clarified and adjusted through Shang Zi Han [2007] No. 50. Opinion 171 and 50 regulates the process of entering the Chinese market, initial investment capital and the in‐ and outflow of investment capital. The reason for why establishing these regulations are many. The first reason is that it creates greater
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private ownership rights making the real estate legal environment more certain19. Second reason is that it decreases foreign real estate speculation and cools down the increased real estate prices through the introducing of a relatively large amount of own investment capital before entering the Chinese market.
5.3.1 FIE establishment To be able to operate with commercial purposes one must first apply to establish a foreign‐invested enterprise (FIE) in China at the Ministry of Commerce (MOC) or MOC’s local branch. MOC’s mission is, amongst many other responsibilities, to formulate and draft laws regarding development strategies, guidelines and policies of domestic and foreign trade and international economic cooperation. MOC also give general guidance regarding foreign investments that are nationwide and supervise enforcement of laws, regulations, contracts and statutes regarding foreign‐invested enterprises.20
5.3.2 FIE register When the FIE application has been approved the enterprise has to be registered at the State Administration for Industry and Commerce (SAIC) or SAIC’s local branch. Besides registering enterprises SAIC also register and protect trademarks. SAIC regulate and maintain market order through ‘administrative enforcement, drafting relative laws and rules and make regulations and policies’ with the mission to create a ‘regulated and harmonized market environment of fairness, justice and faithfulness…maintaining market order and protecting the legitimate rights and interests of businesses and consumers’.21 It is important to emphasize that an enterprise can only commence within the by SAIC approved business sector and no other sectors. (Op. 171)
19
www.burges-salmon.com 2008-11-25 english.mofcom.gov.cn 2008-11-11, 2009-03-12 21 www.saic.gov.cn 2008-11-11 20
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5.3.3 Registered Capital When investing in China a certain amount of registered capital is needed. The amount of registered capital is based on the size of total investment (table 5.1). Registered capital is a percentage of total investment given that the minimum level for every investment range is fulfilled. The difference between total investment and registered capital is the amount of capital that is allowed to borrow from foreign lenders. (Li M., Vinge Advokatbyrå; Ericson, Handelsbanken) Approval of capital registration is made by MOC and the reason why capital must be registered is to secure the capacity of a company and limit the shareholder’s personal liability. In China, under Chinese jurisdiction the shareholder of a limited liability company (llc) can only be responsible for maximum the amount that has been contributed in the registered capital. (Li M., Vinge Advokatbyrå).
Table 5.1 The minimum amount of registered capital in relation to total investment capital Total Investment (“TI”) Registered Capital ≤ USD 3m ≥ 70% of TI USD 3m – 10m ≥ 50% of TI & minimum of USD 2.1m USD 10m – 30m ≥ 40% of TI & minimum of USD 4m ≥ USD 30m ≥ 33% of TI & minimum of USD 12m
Source: (Li M., Vinge Advokatbyrå; Ericson, Handelsbanken)
If there is need for reducing or increasing registered capital the registered capital must be re‐approved by local authorities and all other certificates must also be updated at the above mentioned departments respectively. (Li M., Vinge Advokatbyrå)
5.3.4 Adjustments in Opinion 171 due to Opinion 50 When the FIE is (1) established and (2) registered, a FIE Approval Certificate and a temporary Business License and a will be issued by MOC and SAIC respectively. These documents will be valid during the period of one year. It is according to Opinion 171 not until these two documents are received that an enterprise can start bid on land and/or sign leasehold. An adjustment through Opinion 50 has however changed and simplified the process order for enterprises. It is now allowed to bid on land before setting up a FIE. By changing the order, enterprises can significantly reduce the risk of missing out 36
on investment opportunities due to governmental bureaucracy. Land ownership or preliminary grant/purchase agreements is now, after the establishment of Opinion 50, needed before establishing a FIE. It was practically impossible before Opinion 50 to bid on land since the process of starting a FIE took too long. (Li M., Vinge Advokatbyrå)
5.3.5 SLUC, Business License, Approval Certificate and additional procedures When full grant fee has been paid the enterprise need to apply for a State‐owned Land Use Certificate (SLUC) at the land administration department. When receiving the SLUC a formal and long‐term Business License and FIE Approval Certificate will be issued within the approved business sectors for the enterprise. Without the Business License and the FIE Approval Certificate the enterprise may not deal or develop properties. 5.4 Acquire land Land in China is exclusively owned by the government. All exploited land is therefore founded with a land lease agreement, also called ground fee (Li M., Vinge Advokatbyrå). The land lease agreement gives the acquirer the user rights of the land for a period of time. It is however a wasting asset since there is nothing that can be kept or sold when the lease expires. To acquire user right of the land an open land bidding process is needed where the highest bidder wins. I will in this chapter discuss the most common issues real estate developers encounter when acquiring land.
5.4.1 Land administration department The local governments are on a strained budget with land use fees being an important source of revenue (Ding, 2005). The local government can therefore, through land administration department, have specific requirements on the land use and what sort of bidders they want to attract to maximize their revenue. By having a dialogue with the local government about our intentions the possibility for us to adapt to their requirements opens up. In reverse, by showing our sincerity and willingness to adapt they can, in some cases, also be flexible and willing to compromise (Li X., Tang, IKEA). It is however good to do some research before taking initial contact with government (land administration department) about a specific site. Ding recommends checking the site first and then making a marketing analysis over the area. If the site is satisfactory 37
and the market analysis shows business potential it is appropriate to provide a draft to the local land administration department explaining our intentions with the available site. The land administration department might have suggestions of its own as to what they prefer to have built on the site. The government knows that they are in a good position when it comes to land negotiations but are, according to Groenholt‐Pedersen, still not unreasonable. If their vision does not fit our vision we need to explain to them why our vision is the better choice. By creating a well founded draft including information about the potential tax revenues and increase of local employment our negotiation position is strengthened since providing positive micro and macro economical effects are desirable from the government’s perspective (Li X., IKEA). If the government prefers a certain firm’s concept the government can give ‘special treatment’ by setting up specific requirements in the bidding process. The specific requirements will screen out bidders that do not have the same capacity and profile as the favoured firm. It is however still an open bidding for those who fulfil the requirements (Li X., Tang, IKEA). To speed the development forward, local government can put up deadlines which property developers must keep up with. In some cases the time limit can be very tight. Shiu who works with building consultancy explains that if we are confident with our project and the project is working well with the regulations we could ask permission to start constructing before we have received the right approvals, discussed in chapter 3.3. He stresses that if we fulfil the requirement, there should not be any problems but we have to insure that we do the work well. Li X. is also familiar with this procedures and explain a risk with it; if something were to happen during the construction, for instance someone getting seriously injured, the project can be put at risk since the needed approvals have not yet been received. Even though the firm has received permission to start without approvals, the government will not back you up if problems occur. This can ruin the project and diminish the reputation of the firm.
5.4.2 Question marks As mentioned before, ownership of land is kept by the government. Land acquisition can only be made through leasehold agreements. The leasehold agreement gives us the right to use the land during a specific period of time. This sort of wasting asset brings a large 38
uncertainty as to how long we can benefit from our investment. We will definitely be the underdog during negotiations for renewed leasehold since large amount of initial investment is already made. The question is will the government take advantage of the situation? The risk exists but is probably very small since the consequences would be devastating for future investments (Novak, DTZ). The answer will however be revealed in the upcoming decade since that is when the first land lease agreements will expire.
5.5 Further regulations The enterprise is not allowed to take domestic or offshore loan if any of the following conditions are not fulfilled; (1) the registered capital must be fully paid in, (2) the SLUC must have been obtained and (3) at least 35% of the total investment must be paid in. Furthermore, a fixed rate of return is not allowed to be guaranteed in either contract, articles of association, equity transfer agreement or other document (Li M., Vinge Advokatbyrå). The leasing regulation increases the risk for developers since the development and construction must be initiated before letting out any space. The developer will therefore need to invest a large amount of capital before knowing if their building will be fully occupied. (Li X., IKEA) Further procedures that need to be carried out due to regulations are: •
Name pre‐approval registration
•
Make a company stamp
•
Apply for an Organization code certificate
•
Tax registration
•
Register to take money off shore
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6. Cross-cultural business in China 6.1 Importance of culture and crosscultural business The importance of having knowledge regarding culture is put on the test when business is done with people from a different cultural background. It is important to assure that all people involved in our business are on the same page with the same goal and pulling towards the same direction. The Chinese culture differs quite a lot from the western culture. Knowledge regarding history, etiquette, geography, etc. is just as important as hard facts (Ambler and Witzel, 2003). But the important unwritten rules are unfortunately not always so easy to get a grip of. These subjects are what we will be discussing in this chapter.
6.1.1 Defining culture ‘As generally understood, the culture of a society comprises the shared values, understandings, assumptions and goals that are learned from earlier generations, imposed by present members of a society and passed on to succeeding generations. This shared outlook results, in large part, in common attitudes, codes of conduct, and expectations that subconsciously guide and control certain norms of behaviour.’ (Deresky, 2006, p 83) Deresky sums the definition of culture well and we see that culture is something very complex. A numerous of factors play part in the definition of culture and these factors are not always easy to grasp. Many of the factors are subjective and therefore diffuse. To fully learn and understand a culture, very different to our own, might not be an easy task since culture is as Deresky mentioned learned from earlier generations and imposed by present members. There is therefore a lot to take in and learn if starting from a later stage in life. ‘As the globalization of business brings executives more frequently together, there is a growing realization that if we examine concepts and values, we can take almost nothing for granted. The word ‘contract’ translates easily from language to language, but notionally it has many interpretations. To a Swiss, German, Scandinavian, American or 40
British person it is something that has been signed in order to be adhered to. Signatures give it a sense of finality. But Japanese regard a contract as a starting document to be rewritten and modified as circumstances require. A South American sees it as an ideal which is unlikely to be achieved, but which is signed to avoid argument.’ (Lewis, 1997, p 11) The more deviating a culture is from our own the less we can take what we believe as normal (and abnormal) for granted. The business environment differs quite a lot in comparison to the conditions in the home country (Carlsson et al., 2004). Common sense and judgment based on experience differs in many countries and cultural clashes can very easily occur. An example of this is a frequently used word within business all over the world: contract. What a contract is can vary very much depending on what country you are in (Lewis, 1997). A contract are in some countries seen as the ideal agreement, something that is not possible to fulfil, whilst some other countries, especially western countries, are very focused on fulfilling the contractual terms. If none of the parties are aware of the different existing interpretations and, in addition to this, also have poor communication, many things can take a bad turn. The consequences can, particularly in a late stage, be devastating. The interpretation of silence is also a cultural clash depending on where we are. Silence is in many western countries seen as something negative during negotiations. It is however in some eastern countries seen differently. Silence can in east be interpreted as if one is listening and learning. The choice of being silent can also be equally important as to what is chosen to be said (Lewis, 1997).
6.1.2 Becoming cultural sensitive The meaning of being cultural sensitive is that we are conscious, caring, and understanding of other cultures perspectives. Having understanding of other cultures perspectives gives us a greater opportunity to create effective interaction and cross‐ cultural relationships. To work in an effective cross‐cultural relationship we must first become aware of our own culture. If we can become aware of our own culture we increase our chance to avoid cultural mistakes. Cultural mistakes can for instance be our expectations of how other people will behave. The different importance of the content of 41
a contract, mentioned in previous section, is for instance something that is beneficial for us to be aware of without dismissing other, for us, deviating methods and interpretations. It is however important not to generalise culture. Potential subcultures due to factors such as ethnic groups, geographic, etc. may exist (Deresky, 2006) and be of more importance. According to Deresky (2006), management studies and company reports show that lack of cultural sensitivity cost companies business both opportunities and money. What also is interesting is that Pothukuchi et al. (2003), also referred in Dunning and Lundan (2008), through an Indian survey of 127 joint ventures discovered that the likelihood of having a negative effect on joint venture was higher due to corporate cultural differences than to national differences. This verifies the importance of creating a ‘common culture’ in a joint venture which we discussed in chapter 4.2.4, without excluding the importance of national cultural differences.
6.2 Chinese Culture As mentioned in Chapter 6.1.2 we must first of all understand our own culture before understanding others. It is as we try to comprehend other cultures also important to avoid generalization of culture hence various subcultures may occur. The Chinese culture is in many ways very different to western culture. The Chinese culture is documented several thousand years back and the Chinese people are very proud over their cultural and historical legacy. The culture makes them feel superior in the area of moral and spiritual values which they expect foreigners to respect (Lewis, 1997, Ambler and Witzel, 2003). Lewis (1997) describes the Chinese values with adjectives in exhibit 6.1.
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Exhibit 6.1 Adjectives describing some of the essentials in Chinese values
Chinese Values Modesty Courtesy Generosity Sincerity Loyalty Adaptability Tolerance Pride Gratitude for favours Respect for elderly and hierarchy Source: Lewis (1997)
6.2.1 Influences creating today’s culture The Chinese culture is influenced by many believes such as Confucianism, Taoism, Yin and Yang, Buddhism, etc. (Lewis, 1997). The influences are however not so connected with religious feelings, but more seen as philosophies creating the foundation for Chinese values and behaviour (Fang, 2006). The most important influence for the Chinese values which also serves as the foundation for Chinese society is Confucianism (Ambler and Witzel, 2003). Many of the Confucian teachings can be seen in Chinese behaviour. Confucianism teaches for instance the importance of relationships and group‐belonging which consequently diminishes the individual focus. Group thinking permeates the whole society putting the group’s need in first place. According to Confucianism there must be unequal relationships between people enable to maintain a stable society. The unequal relationships are implemented by having a superior authority who cannot be questioned. However, in reverse the superior has mandatory obligations, e.g. protect those who submit to his or her superiority. See exhibit 6.2. The effect of the unequal relationships is collectivism where people have many roles in the society and the people are more a member of a group rather than an individual (Lewis, 1997). The family is extremely important (Deresky, 2006) whereas the family, just as in the society, has a greater value as a whole than the 43
sum of the individ duals (Alon n, 2003). Other fundaamentals in n Confucian nism are caalmness, avoidin ng extremees, indulgeence and maintaining m g everybody’s face by behavin ng in a virtuou us matter through t moderation in all way ys (Lewis, 1997). 1 ‘Facce’ will be further discusssed in chaptter 7.3.4. Exhibit 6 6.2 The uneq qual relationsships which m maintain stability
Source: L Lewis (1997)
d yang is a a strong vieew of life and a a way y of thinkin ng. Exhibit 6.3 illustraates the Yin and symboll for yin and d yang wheere both of f the colourrs are depen ndent on eaach other. T There is also a d dot of black k in the wh hite area an nd vice verrsa symbollizing that nothing is definite (Fang, 2 2006). Thee meaning of nothing being definite is thatt whateverr that goes on now will nott last foreveer. Situatio ons will chaange, for beetter and for worse.
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Exhibit 6 6.3 The symb bol of yin and d yang
6.3 Chinese Bussiness Cullture ‘Eastern n organizaational form ms and management styles are substantivvely differeent from the scieentific, orgganization traditionallly adopted d in the west, w which h characterristically involvees diffused d network structuress and rolees with fleexible goalls and quaalitative judgmeent. Aesth hetic Chineese manaagement styles s are heavily dependent upon relation nships and d informallity, with “fuzzy” acccountabilitty and au uthority baased on trust…F Fuzzy think king stresses that structure is teemporary and the prrocess of ch hange is immineent…As a reesult, nothiing is black k and whitee, as everytthing is in aa constant process of chan nging from o one shade of grey to aanother.’ (A Alon, 2003, p. 9) d th he reality which weesterners face when n doing bu usiness in n China. Alon describe Informaality togetther with gray‐shade g ed factors like diffussed networrk structurres and qualitattive judgment make tthe businesss environm ment comp plicated and hard to ggrasp. It is especcially hard to grasp iff you are u used to a w western more straightt‐forward b business style. M Moreover, th he essence of businesss in China is personall relationsh hips, guanxxi, which increases the level of difficculties one can experrience. Nev vertheless, a two‐gen neration study of Chinese o managers made by Ralston et R al., describ a ed by Dereesky (2006 6), show differen nces betw ween generrations. Th he new generation g is using a more western w manageement style compareed to previous generaations. Th he changingg manageriial style will deffinitely create an easiier environ nment for w westerners to work in n. But even n though the man nagerial sttyle is chan nging, the y young geneeration of m managers iss at the sam me time also holding on to their Conffucian valuees (Deresky y, 2006, p. 111).
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6.4 Some mustknow information during dinner and meetings The Chinese are a welcoming and generous people (Lewis 1997). It is therefore important to avoid offending them. Their manors are however somewhat different compared to the western and it is not always easy to know what appropriate behaviour is. Food in China is very versatile and is a central part in the Chinese life and having dinner together is therefore the norm. During dinner, the appropriate behaviour is to try all the delicacies that are served by the host without leaving any dish empty. Leaving a dish empty imply that the host did not order enough food whilst the same manner in west would indicate that the food did not taste good. Table manners are in China otherwise quite free and the dinner is usually ended by the host standing up. Do not insist on paying the bill before the host has the chance to do so since it can be interpreted as insulting and loosing face. (Lewis, 1997) During meetings, the Chinese declares their departure early whilst westerners often declare their departure just before they are leaving. Chinese courtesy involve a prolonged farewell by following their guest to the street or accompanying a part of their guest’s way. Furthermore, Chinese courtesy also involves humility with under‐ statements in their reply, not mentioning their own impressive business or academic qualifications etc. (Lewis, 1997). In Exhibit 6.4 are some additional brief must‐knows.
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Exhibit 6.4 Additional must‐knows in the Chinese culture Additional Must‐know's ‐ Chinese prefer meetings to be formal, although dress is usually comfortable. ‐ Seating will be according to hierarchy and business cards are exchanged. ‐ The senior man must be shown great respect and attention at all times, even though he takes little part. ‐ The real decisions will be made outside the meeting, which is principally for information gathering. ‐ The pace will be slow and repetitious. The time frame is too long for westerners who may see the slow‐down techniques as bargaining ploys. ‐ Politeness is observed at all times. Confrontation and loss of face must be avoided. ‐ Chinese rarely say ‘no’ – only hint at difficulties. ‐ Decisions have a long‐term orientation. Negotiations in China are important social occasions during which one fosters relationships and decides if the people on the other side of the table are suitable partners in the long run. ‐ They consider you technically competent, otherwise inexperienced in business relations. ‐ They negotiate step by step in an unhurried manner. They prefer to open proceedings with a discussion of general principles of mutual interest. That is probably enough for the first day. They dislike US eagerness to sign a contract. ‐ They are thrifty, cautious and patient. You will have to match their patience and stamina, otherwise deals and opportunities will be lost. ‐ They combine flexibility with firmness and expect both these qualities in you.
Source: Lewis (1997)
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7. Experience and Opinions from people working in China 7.1 Introducing the interviewed To support this discussion I add the answers from the interviews I made during my visit in China and Denmark in 2009. The interviewed are all working in the Chinese property market or in connecting business. Following are the interviewed: Shaun Brodie
Associate Director at Research Department, located at DTZ’s Shanghai office.
Hui Ding
Managing Director located at Inter IKEA Centre
Group’s Shanghai office.
Colin Dowall
Director at Property management,
located at DTZ’s Shanghai office. Sebastian Hylving
Deputy Managing Director in China, former Group
Development Manager in Denmark, located at the
Inter IKEA Centre Group’s Shanghai office.
Michael Li
Associate, located at Advokatfirman Vinge’s
Shanghai office in China.
Xia Li
Support Manager at Property Department, located
at IKEA’s Shanghai office.
Theodore Justin Novak
Associate Director at Investment Department,
located at DTZ’s Shanghai office.
Simon Y K Shiu
Senior Project Manager within the department of
Building consultancy, located at DTZ’s Beijing
office.
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7.2 West versus East The consensus from the interviewees is that network structures based on guanxi is the single most important tool in doing business. We can by having well established guanxi, especially with the Chinese government, make time efficient decisions with smooth processes. It might sound strange for us and the unique business relationship with the Chinese government will be further explained in chapter 7.4. When we are aware of how we are perceived as well as how we perceive the Chinese our focus can be directed on creating efficient cooperation as well as successful negotiations. Due to the importance of being cultural sensitive, see chapter 6.1.2, I compiled the differences between Chinese business approach and western business approach based on the people’s experience I conducted interviews with.
7.2.1 Western Style The general character of westerners’ approach and business style according to the interviewees is that we are strong minded and have a professional working style. Shiu exemplifies this by saying that one can be sure of that ‘A is A, and B is B’ and nothing else if the words come from a westerner. Shiu also adds that westerners are more careful and analyses projects before initiating them, making the investment decisions better founded. Westerners are also keen to do things correct by complying each law. Furthermore, westerners in general require a clear time frame for projects where the process steps are clear and set up accordingly to the time frame. Something that can bother the Chinese particularly is the western attitude regarding time. Westerners are time efficient and want to go straight to the point in meetings room whilst the Chinese, with their relationship focused approach, want to speak about many other things before discussing business. Westerners are by the Chinese sometimes seen as naïve in some extent and slow on reacting and making quick decisions. Shiu believes the reason why westerners are slow on making decision is because the decision making are not always made locally, but are needed to be anchored and approved in the home country first.
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7.2.2 Chinese Style The general character of Chinese approach and business style is seen as more complex than the western since the Chinese are not always very outspoken. It is therefore a risk that the parties misunderstand each other. As mentioned in chapter 6.2.1, the Chinese have many different roles in the society and this can also be seen in business. Furthermore, doing business in China is basically about personal relationships, guanxi. However, Shiu do see a small decline of the importance of needing good guanxi but still emphasizes the importance of guanxi. Guanxi is still the ‘1st, 2nd, and 3rd most important’ when it comes to doing business in China according to Shiu. In addition to the Chinese behaviour, Dowall experience that how parties potentially can benefit on each other is the foundation for how the Chinese will treat us. So if they believe you can do some good for them, they will be more open and helpful than if they did not see how it will benefit themselves. Furthermore, creating mutual trust is important and decisions are therefore made (partly) based on how they feel your mutual relationship is rather than relying on contractual agreements. It can, because of the importance of good relationship and trust, be seen as offensive if too many questions are asked hence this is an indication of our lack of trust according to Li M. Meetings are preferable held face to face. Video or phone conferences are not very appreciated. The reason for preferring to meet face to face instead of through telephone or video conferences might be because the great importance having a personal relationship with those they do business with. Taking the time for personal meetings is also an indication of our sincerity. In the meeting room all parties must maintain face and avoid offending other parties, thus the ‘spirit’ of the meeting must be kept positive. A consequence of maintaining a positive spirit during meetings is that it diminishes the possibility of being completely upfront and open. ‘No’ is not a word that is said directly, even though that is what they mean. According to Fang (2006), there are 16 different ways a Chinese person can say ‘no’ and one of these 16 ways are ‘yes’. Suggestions for other possibilities, keeping the positivity flowing, will instead be brought out indicating dissatisfaction. By not being completely upfront and open during meetings, due to maintaining face, Dowall says the real discussions are therefore made behind ones back. 50
Li M. believes the avoiding of saying ‘no’ upfront is a way to avoid hurting feelings. In addition to these communication differences, Dowall explains that nothing that is being said can be taken for granted. ‘No never mean no, and yes never mean yes’ and this is needed to have in mind at all times. A way to avoid misunderstandings is to repeatedly ask questions in different ways to be sure that all parties involved are on the same page, which paradoxical can be seen as offensive since asking too many questions is an indication of lack of trust. The negotiation process before making any decision can take very long time, Dowall says ‘it is sometimes necessary to give a lot for free before a contract is signed’ and it can in extreme cases take a year or more before a contract is signed. Additionally, in contrast to western way of doing business the real negotiations start after signing the contract. Brodie have experienced similar cases as Dowall. Brodie however add that when the discussions are made the deal itself can go very quickly, as well as upcoming deals. Shiu believes that the Chinese have more of a ‘can do’ attitude, meaning that they are more positive and confident that they will succeed. Shiu explained that he, as a real estate consultant within building consultancy, experiences where clients have due to their optimism pushed and insisted on unreasonable requests. On the other hand, Shiu also explains that obstacles and difficulties in projects are always expected to occur no matter how much we try to plan in advance. Because of this attitude, the Chinese do not feel that they need to plan everything in detail since the circumstances will change in the future anyway. 7.2.3 Shortterm or Longterm From a business perspective the Chinese are more short‐termed compared to west, which can seem contradictable to their long‐term perspective on (business) relation‐ ship. In comparison to how westerners do business in China, Shiu has observed that the Chinese do not always have equally well developed business strategies. In addition, their attitude towards business is not always very strict and their attitude will lead to a busi‐ ness with short‐term perspective. However, despite the deep cultural traditions, Chinese people are very adaptable and receptive of other influences. Perhaps more receptive
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now than before due to globalisation. The adaptation to globalisation can in a changing phase transform short‐termed perspective into long‐term perspective.
7.3 Successful interaction and successful business This chapter is also based on the interviews made in China and Denmark which we mentioned in chapter 7.1.
7.3.1 Do your research There is a list of challenges with doing business in China that everyone faces. In order to run our business smoothly and efficient we need to overcome the challenges. Understanding the culture is one of the main challenges. Dowall explains that there are big differences in traditions and history and it is therefore more of a challenge for a westerner. He therefore believes it is important for us to do our research in the initiation phase and learn about the culture, tradition, and history so that interaction with the Chinese will work more smoothly. Furthermore, Brodie says it is important to do due diligence on the investment. By doing due diligence we regard the legal, financial, and market aspects, as well as the accuracy of the sellers information before making the investment decision. In addition, it is good to have in mind that it is more complicated and time consuming to do business in China if we are unfamiliar and inexperienced with the Chinese market. Brodie continues; having a good lawyer specified in the field can be of much help in the process and classic pitfalls can be avoided. But perhaps the most important of all things, be sure to check everything twice and confirm information that has been brought to you, if possible, with several different sources. The accuracy of information can never be taken for granted. Doing research on people you intend to do business with is also a good idea. It is in general beneficial to know the background of the person you are dealing with. Novak recommend picking the right partner by looking at his track record and see if he or she has the capability to perform what is required. Novak also emphasizes the importance of having an honest relationship. It is, as mentioned before, time consuming to do business. 52
7.3.2 Do it their way Trust is vital (Lewis, 1997) and we have to show the Chinese that we have a long‐term perspective regarding our business relationship. Li M. recommend not trying to have high ambitions to make everything perfect at once, even though detailed planning is good. The reason for why Li M. recommend less focus on details in the beginning of a business relationship is because Li have experienced Chinese parties sometimes be‐ coming disturbed by the westerners ‘obsession’ of detailed contracts. The Chinese party has interpreted the focus in details as a sign of lack of trust. He therefore suggests that details or sensitive matters are discussed further in the relationship instead, hence these matters can be easier to solve when both parties have a good relationship. The Chinese market is complex in many different ways. Novak stresses the importance of getting accustomed and localized, instead of trying to change the way business is made. He believes the local way of doing business is the most successful. In addition, as the market is still immature with many loosely defined and alternating gray areas we need to be flexible in both our approach as well as in our thinking. Brodie adds that when we become more familiar with the system and more experienced we will know what we can expect and work will become easier. The Chinese negotiation style can vary depending on who they are negotiating with and how well someone can maintain face largely affects the whole negotiation (Lewis, 1997). Hylving stresses the importance of not putting too much pressure on negotiations by asking direct and straight forward questions. By being too straight forward can put pressure on the Chinese party to give an answer even though they do not really have one. Traditional courtesy, as the reluctance of saying ‘no’ mentioned earlier, might be the reason for it. To reduce pressure we need to adjust to the situation. Hylving therefore try to phrase open and discussable questions, for instance by rephrasing direct questions to open questions e.g. ‘could you tell us about…’ or ‘perhaps we could…’. Hylving believes the rephrasing reduces pressure so that the counterparty feel that they can speak more freely, creating a mutual discussion on the same level rather than something more similar to a questioning. Dowall adds; do never show uncertainties during a meeting, it is better to analyze and discuss what they have said and what they
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might have meant after the meeting. The real discussions are, after all, made outside of the meeting room behind your back. 7.3.3 Having an open and humble attitude Brodie believes it is important to be patient, read facial expressions, and recognise what the Chinese party is saying during negotiations and cooperation. He further on adds that it is important to be very precise and clear with what we want and it must be put with a soft, logical, and encouraging approach to reduce the chance of misunderstandings. Moreover, Brodie reminds that we must always have in mind what we can do for them, not only what they can do for us. It is important to create a relationship where both parties give and receive. Many interviewees’ stresses the importance of having fun with the Chinese party. Dinner invitations, going to events, or the national classic; singing karaoke together, are some appreciated activities. We can through these activities see a more relaxed and casual side of each other which can influence our mutual business in a positive way. Gift giving is also an option, either as a way to market your own brand or just to show appreciation and respect. The social activities are a way to strengthen guanxi as well as creating a deeper understanding of the Chinese people and their culture.
7.3.4 Face Chinese can be quite sensitive in terms of how they are being held by others in the light in which they appear. Making them lose face ought therefore to be avoided hence this can have severe consequences e.g. ceased co‐operation, even though it was not intentional. Politeness can however diminish the risk of losing face for both parties and what might be beneficial is to give face, meaning you enhance someone else’s reputation or prestige (Ambler and Witzell, 2003). Face is however also a way to kill emotions. By showing face true emotions is hidden, weather it is positive or negative emotions. In addition, by showing face the communication can become more indirect and suggestive. Due to the indirect and suggestive way of communicating face is ‘…a major reason behind misunderstandings in cross‐cultural business negotiations in China’ (Faure and Fang, 2008, p 198). The self‐restrained attitude is however in the process of changing and becoming more and more individualistic. Nowadays people in the daily life want to 54
be seen and no longer be one amongst many others. As a result, self‐effacement is no longer being seen as a quality (Faure and Fang, 2008). Face is also connected to guanxi (relationships) since it is likely that we establish good relationships with those who give face. (Ambler and Witzell, 2003)
7.3.5 Guanxi As mentioned earlier, guanxi is the Chinese word for personal relationships and is something very important and frequently used in China. In difference to the western business practice, which is built up on contract law, the Chinese is built up on guanxi (Weber and Witzel, 2003). A sociologic study by Li L. (2006) shows the importance of guanxi knowledge. Li L. explain in his study that guanxi is cultural tradition and a very powerful device that can transform weak ties into strong ties. Guanxi can mediate formal rules with external institutes with possibility of smoothing the processes. Guanxi can also function as a device to allocate investment capital. It has through a historical perspective been a social force that has been driving the Chinese real estate development forward (Li L., 2006). There is however some indications that the importance of guanxi is diminishing in China with a business style resembling the western, less focused with no need of personal network. Nevertheless, it is still an important part of business (Shiu, DTZ), especially in small‐ and medium‐sized companies (Fang et al., 2008). Guanxi is also something that constantly needs to be maintained even if business is not made at the current moment. By maintaining our guanxi we make sure that our counterpart remembers us in future businesses (Li M., Vinge Advokatbyrå). Maintaining and improving guanxi can consist of something very simple such as sending a card or a movie ticket (Li M., Vinge Advokatbyrå) but can also involve dinner invitations, party arrangements, karaoke etc (Novak, DTZ). Face and guanxi are in reality interacted as Ambler and Witzell (2003) mention. Knowledge regarding both subjects is therefore essential to make the social interaction function as best we possibly can. What we in chapter 7 are discussing is overall very 55
important in the social interaction. But only with time and experience can we develop an instinctive feel of where the fine line goes.
7.4 The Chinese Government – your partner in everything The Chinese economy has since the start of Mao’s time until around 1980 been a centralised planned economy (Ji M., 2008). The starting point of adopting a more market‐oriented economy came in 1978 when the economic reform took place. The development towards a market economy is gradually developing even though the grip around the economy today still is very tight. The government has through the economic reform created the needed environments to maximize China’s domestic and global economic interests and is therefore a large player in the Chinese economy and the real estate market. (Ambler and Witzel, 2003).
7.4.1 The government’s role in China Ambler and Witzel (2003) explain that the state’s view point regarding the economical development in China; ‘is seen as being at the service of the state, and the state does not hesitate to intervene when it thinks the economy is going in undesirable directions. This applies to local as well as central government…the rules will change any time they think it suits them’ (Ambler and Witzel, 2003, p 80‐83). An example of this is also described by Ambler and Witzel (2003); ‘Government in China has considerable powers. It can deny approval for proposed projects, and it can withdraw licenses from existing ones. On a single day in 1996, the government of one eastern city withdrew licenses for over a hundred joint ventures, for reason ranging from disputes between partners to lack of profitability...it follows that if you have good relationships with the relevant branches of government, you are more likely to get what you need, be it permission to build, develop, sell goods, set up a factory, form a joint venture or whatever. Good relation with government can make the wheel of bureaucracy turn faster, even allowing you to “jump the queue” and get approval more quickly than you might expect’ (Ambler and Witzel, 2003, p 84).
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7.4.2 A large real estate developer highly dependent and its land lease revenues Within the real estate business, the government is seen as the biggest real estate developer (Li X., IKEA) and people in the real estate business that we have interviewed verify the importance of having good relations with government, especially the local government In order to have a good relationship with the local government we need to understand their situation. In 1993 the central government adopted a tax restructuring which resulted that the responsibility for urban and public services was shifted from the central government to local governments. ‘The restructuring improved the central government’s fiscal conditions. However, the revenue share for local governments was not increased at a level commensurate with their increase in responsibility. Consequently, many local governments face increasing budgetary deficits…more than one‐third of county level governments have serious budget problems…[and] one of the means by which government increase revenues is through public land leasing.’ (Ding, 2005, p 5‐6). In addition to the land leasing fee, the government also collect taxes associated with the acquisition, such as farmland occupation tax, land management fee, vegetation development funds, public service project development fees, LUR fees for newly added construction land and agricultural tax. These taxes and fees can account up to 45‐55% of the total costs (Ding, 2005). Knowing that the local government is highly dependent on the finances which land leasing generate we understand their situation better. 7.4.3 Corruption The definition of corruption is not always clear in China. While some do not see gift giving and using your personal relationships to do business as corruption, others find it corrupt that one need any type of relationship in order to receive good service. A clear case of corruption is however bribery. ‘Bribery is expensive, tends rapidly to get more so, damages reputations, and leads to pseudo‐guanxi with the wrong people’ (Ambler and Witzel, 2003 p 106). Articles about corruption where people working for the government has accepted bribes can be found in the newspapers everyday in China (China Daily, 2009; Shanghai Daily, 2009; Novak, DTZ) even though they are risking a lifetime imprisonment or in severe cases even capital punishment (China Daily, 2009; Shanghai Daily, 2009; Ambler and Witzel, 2003). 57
Li X. at IKEA in Shanghai explains that if you start bribing someone then you need to bribe the next person in line as well and in the end, you do not know when or how to stop. It becomes a vicious cycle. IKEA has for instance created corruption policies so that it can be avoided. There is however no unclarity that bribery is wrong and corrupt. It is the gray zone that is more difficult to judge and perhaps the real problem in the business. Weber and Witzel (2003) call this ‘greasy payments’ which they divide into two categories, (1) tips and service payments, and (2) extortion. ‘Tips and service payments where the amounts are minor compared to possible costs, and extortion. It has long been the custom, for example, to leave 100 Yuan notes in envelopes under the plates of senior people invited for lunch and a business presentation. The money is ostensibly to pay for travel expenses…the practice is being replaces by small gifts like ties and pens…is not going to make much difference to anyone…Extortion, where quite a large sum is involved before something happens, is another matter.’ (Weber and Witzel, 2003, p 107). Transparency International is an organization against corruption which publishes a corruption table on a yearly basis. The table consists of 180 countries in 2008 where the higher ranking a country has the less the country is perceived as corrupt. Table 7.1 shows an abbreviated version of Transparency International’s table from 2008 where China is ranked as number 72.
Table 7.1 Corruption table for 2008 Ranking 1
Country New Zealand
Ranking 72 80
Country China
1
Sweden
Brazil
4
Singapore
80
Thailand
9
Canada
85
India
14
Germany
109
Argentina
16
United Kingdom
115
Egypt
18
Japan
121
Viet Nam
18
USA
147
Bangladesh
23
France
147
Russia
35
United Arab Emirates
178
Myanmar
40
South Korea
180
Somalia
Source: www.transparency.org 2009‐03‐17
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8. Discussion The essential with this thesis is describing the factors that are most important to consider for international real estate investors when they draw up plans to enter the Chinese real estate market. In order to be successful the investors have to understand the complicated investment environment. Being familiar with the market’s code of conduct as well as the cultural differences is crucial to succeed. The business environment is confusing hence the governmental restrictions are complicated and often changed. This combined with cultural differences makes it difficult to succeed without any sort of guidance. I have therefore in this thesis focused on following areas: •
The legal aspects of real estate with focus on Opinion 171
•
Entry modes in China and the level of exposure to risk and control with focus on Joint Venture
•
Cross‐cultural business and an overview of the Chinese culture
•
Interviews with business people in China
8.1 Improved legal environment would attract additional investors Historically, Chinese real estate law has been marked with uncertainty as to the protection of private real property rights. As foreign investment continues to flow into the Chinese real estate market, the Chinese government has made significant strides toward embracing the concept of private ownership rights. Although the business environment is complicated and restricted, China’s commitment to boost the economic and social development by creating a climate of greater certainty demonstrates their willingness to attracting foreign investors. However, China obviously needs to catch up with the legislations regarding real estate in order to reach a stable and predictable legal environment similar to many western countries. By eliminating the now aggravating and confusing factors the environment could become less risky and China would therefore not only attract high risk investors but also low risk investors. This could diversify and give stability to the market growth and development. And with more investors comes additional investment capital since the increased protection and reduced risk for the 59
invested capital. Legislations and regulations will however change as soon as the government sees that the development is going towards a direction that is unsuitable to the government’s development plats. It is during those times extremely important to keep up with the changes and adjust to the situation.
8.2 Internationalisation towards globalisation As the world is becoming more and more internationalized with waves of cultural clashes it will also lead to globalization where different cultures stand side by side in harmony. People’s preferences will in the future become more and more homogenous. China and its people are experts in adaptation and I their balance between west and east we be found in due time. Their culture is highly valued and people are therefore very keen on preserving it. Nevertheless, the new generation of managers and workers with academic education is more influenced by western management and style. These managers are more accepting to western ways and have more or less some experience of it. It is however still important to respect and understand that there are major differences between east and west. Since the Chinese people are a more group‐oriented people the biggest mistake we can make is to presume that our way of doing business is the best and most efficient way. Westerners have a more individual‐oriented way of working and forcing our working methods onto them can give devastating results. We must consider and respect Chinese fundamental values of group belonging and work with that as a starting point. The importance of having good and positive relationships, guanxi, with the people involved, with all decisions being well anchored, is extremely important in the Chinese business sphere. As many of the interviewee’s pointed out, we need to get accustomed to the Chinese manners and do it their way. It will be more time consuming and perhaps inefficient (or just different?) in some perspectives but in the end, it is their country we want to do business in so it is most likely that they know best how business is made there. Having that said, it is my strongest believes that we, in a longer perspective, should embrace the Chinese customs which we think are good and at the same time preserve the best of our own customs. Thus, this will be true globalization where cultures are balanced and accepted worldwide.
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8.3 Guanxi Face and guanxi is strongly linked together. Face is however something we can choose to give without depending on external factors. What type of guanxi we foster is only partly depended on our selves. The other part of what guanxi we have is relying on what others think and are prepared to do for us. I therefore want to stress the importance of subject. Li Linyan’s (2006) sociological study regarding the real estate market as a guanxi intensive market also proves the importance of needing knowledge about this subject, especially in this business branch. Using guanxi when doing ordinary business is no different to the countries in west. We all prefer to do business with someone we know or that has been given positive recommendations. A good cooperation in an earlier project increased the chance of future successful projects. That is one of the ways we protect our business and investments. The guanxi‐based business is in China definitely more infiltrated in every link in life, both private and professional, compared to the west. Guanxi is also a very powerful and effective leverage tool that can produce fast result, decisions and also investment capital through informal corridors. Parameters which are not fulfilled in the formal equation can through guanxi still be possible to conduct. These positive effects of guanxi are something I definitely believe is worth maintaining. However, it becomes questionable, in not wrong, if we need guanxi when dealing with government and other governmental institutes such as banks in order to get the required service within a reasonable period of time. One would want the government and related institutes to be unbiased and serve all matters and people with the same level of service and standard. But perhaps what is most important of all, serving the country and its people with their best interest at heart. Unfortunately corruption does exist. The definition of what corruption is varies between the people I have interviewed. Some pointed out that it is probably more common within domestic companies. I have not performed any interviews with domestic companies so the statement remains undefended. It is however a reminder of China still having some fundamental improvements that are needed to be made within the subject guanxi.
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8.4 Never stop being adaptive The Chinese atmosphere is undoubtedly giving signals of ‘Everything is possible’. And in some ways it is true. Nothing in China is really fixed, game rules change all the time and it is important to maintain flexible and adaptive.
8.5 The paradox of having both longterm and shortterm perspective I would like to bring up the relations whom Chinese people have regarding long‐term perspective and short‐term perspective. I have in this thesis written about how the Chinese want to have long‐term relationships with the people they do business with but at the same time, they do not plan their business with a long‐term perspective. It might seem contradictive at first. However, due to the situation in China where the development is changing really fast. The government does everything it can to avoid the Chinese economy to get overheated. They regulate those branches that are in a high risk of becoming overheated, such as the real estate market, and the regulations can be set all of a sudden. I therefore do not believe there are a lot for room left for long‐term planning since you cannot be sure of what will happen in the next two‐three years. It is easier to ride on the current wave and be ready to jump on to the next one when you see it coming.
8.6 Not the whole picture The perhaps most interesting part of this thesis is the cross‐cultural business sections. Never before has China and its real estate market been as attractive as it has been this last decade and never before has so many westerners been doing business in China. My sections about cross‐cultural business is partly based on literature reviews and partly based on interviews. The interviews are exclusively performed at international companies and in majority with westerners working in China. My thesis is regarding the cross‐cultural sections are therefore most definitely influenced by their subjective views. If I were to have performed interviews with domestic people, working at domestic companies, I might have gotten another perspective on business in China. This will be left undiscovered for now. Knowledge regarding cross‐cultural business is subjective where situations must be adjusted from person to person. The basics are
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nevertheless always the same in my opinion. Where ever in the world we are located, be respectful, open, humble, alert and a very good listener. I was told a proverb when I was in China performing the interviews which I think is the perfect ending of this thesis. It reflects the Chinese mentality where people constantly, in both business and in everyday life, see the opportunities even though the environment is unstructured, undeveloped, and uncertain. Proverb: Qing shui mei yü – There are no fish in clean water.
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