business in china: risks and opportunities (chatham house talk)

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Business in China: Risks & Opportunities Jeremy Gordon Author of “Risky Business in China” Chatham House 23 October, 2014 @RiskyBizChina #RiskyBizChina *Listen on PodBean * http://jeremygordon.podbean.com/e /business-in-china-risks-and-oppo rtunities-chatham-house-talk © Jeremy Gordon

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My talk on business risk in China at Chatham House on 23 October 2014. The audio can be heard as a podcast here: http://jeremygordon.podbean.com/e/business-in-china-risks-and-opportunities-chatham-house-talk

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Page 1: Business in China: Risks and Opportunities (Chatham House talk)

Business in China:

Risks & Opportunities

Jeremy GordonAuthor of “Risky Business in China”

Chatham House23 October, 2014

@RiskyBizChina #RiskyBizChina

*Listen on PodBean*http://jeremygordon.podbean.com/e/business-in-china-risks-and-opportunities-chatham-house-talk

© Jeremy Gordon

Page 2: Business in China: Risks and Opportunities (Chatham House talk)

“It’s getting harder for foreign companies to do business there... I really worry about China…I am not sure that in the end they want any of us to win, or any of us to be successful.” (Jeffrey Immelt, GE CEO, 2010).

“China is just too risky”. (Paul Bisaro, Actavis’ CEO, 2014).

“Current sentiment is that business risk is as high as it has ever been” (Risky Business in China)

Why is there so much negativity? What can businesses do about it? My view is that rapid and fundamental changes to China’s political, economic and social environment have changed the nature of opportunities and risks for international business in China.

There are certainly opportunities, especially in emerging sectors, services and around consumption and outbound investment.

But for many established players, it is the risks that grab the attention.

It is not all bad news – nothing in China is ever black and white – but the risks need to be managed.

Businesses need to understand and adapt to the new reality of doing business in China – grasp the opportunities, but avoid getting burnt!

#2. Jeremy Gordon 23/10/14.

Page 3: Business in China: Risks and Opportunities (Chatham House talk)

Good Dragon. Bad Dragon.

© Jeremy Gordon © Jeremy Gordon

#3. Jeremy Gordon 23/10/14.

Page 4: Business in China: Risks and Opportunities (Chatham House talk)

The dragon cliché is a well worn one! Blame Napoleon, not me: he said something like: “when the sleeping dragon awakes, it will shake the world”.

The dragon is certainly awake. And some parts of the corporate world are certainly shaking! But what does the dragon represent? What do we mean when we talk about China?

To western eyes the dragon is a dangerous threat. To Chinese eyes it is a positive power. We start from different perspectives and so, although we see the same thing, we can draw very different conclusions…

From one side China is one of the great cultures and the source of world-changing inventions. It is a positive power that has lifted hundreds of millions from poverty. It is also the driver of global economic growth.

From another it is an aggressive, strategic threat. A massive polluter, an infringer of intellectual property, and a state controlled by a mysterious Communist Party. Of course China can be both positive and negative. And it can have positive and negative implications that can change over time.

Look at the economic benefits for Australia of China buying its coal…and the potentially devastating impact new environmentally-friendly (but exporter-unfriendly) tariffs may have. Coincidentally helpful to local coal producers. And may be interesting leverage in the FTA that has been 10-years in the making.

#4. Jeremy Gordon 23/10/14.

Page 5: Business in China: Risks and Opportunities (Chatham House talk)

Welcome?

© Jeremy Gordon

#5. Jeremy Gordon 23/10/14.

Page 6: Business in China: Risks and Opportunities (Chatham House talk)

So China is complex. But is it welcoming? And on what terms? The picture is a light-hearted record of one of my visits to the Forbidden City in the mid 90s.

In the 1990s the open door policy was in full swing. China was welcoming to the manufacturing investment and industrial machinery my company was providing at the time. But it was less welcoming to the foreign pharmaceutical companies, banks, and insurers on whose behalf we were lobbying for market access.

Manufacturing businesses, while welcome, still had to export much of their production so that local competitors would be protected. This was of course long before China’s 2001 WTO accession.

But even now there are challenges over market access. Last year China was found to be in violation of WTO rules in relation to restrictions around rare earth exports (again on supposedly environmental grounds).

We were allowed through the door, but once inside we had to play by the local rules. What we were doing was still new. As were the rules. And it kept changing, so there was some flexibility in the system as different approaches were tested and as experiments in reform were tried out. Who you knew really mattered, as people made the rules, and those rules were often hard to find out about.

At times it might have seemed that Beijing was not looking (like the guard on the door). But perhaps they (and he) were just re-writing the rule book…which is now being generously applied!

China is welcoming to those it wants or needs to host, but the open door is also an exit, and anyone who breaks the rules or overstays their welcome might be pushed through it or, if they stay, made to pay – as GSK and others have found out to their cost.

#6. Jeremy Gordon 23/10/14.

Page 7: Business in China: Risks and Opportunities (Chatham House talk)

Then… © Jeremy Gordon

#7. Jeremy Gordon 23/10/14.

Page 8: Business in China: Risks and Opportunities (Chatham House talk)

So how did we get to this point. A quick look into the past might help provide some context.

This is one view of China that was taken in 1991 in Dali, Yunnan. It could have been 1881! At that time “foreign devils” like me were a rare sight.

Dali was a 15-hour bus ride from Kunming. It is now a 40 minute flight from Kunming’s Arup-designed international airport to Dali airport.

In a short space of time China has moved from rural agriculture, to urban industry and services. From basic roads and slow buses, to modern airports and high-speed rail.

International businesses have played a role in planning and designing the infrastructure that drives modern China, but while they would like to see more access, local interests maintain a local advantage.

#8. Jeremy Gordon 23/10/14.

Page 9: Business in China: Risks and Opportunities (Chatham House talk)

…Now

© Jeremy Gordon

#9. Jeremy Gordon 23/10/14.

Page 10: Business in China: Risks and Opportunities (Chatham House talk)

Now things are very different – this picture was taken in Dazu, near Chongqing in 2012. The young girls ran across the car park with smart phones and shouted “hello” in English. They are confident, educated, connected, tech-savvy consumers with aspirations to “the Chinese dream”.

They live in Chongqing, on some measures the biggest city in the world, with 30 million people, around 3,000 new urban residents a day, and with massive development plans, including the Liangjiang New Area. (Ref. Bo Xi Lai and Neil Hayward).

The progress has been palpable. But on the flip side China is still challenged by many issues, including wealth disparity, environmental degradation, an ageing population, rising health costs and slowing growth.

The many parallel and challenging transitions have included China’s move:

• From a closed to open economy – though it could open further

• From state to private enterprise – though the state still has a key role

• From production to consumption – as costs have risen along with incomes

• From rapid to slower growth – the new normal, with new challenges

• From exports and investment to domestic consumption

• From anything-goes to anti-corruption

Where it will go next, and how, is a key question.

#10. Jeremy Gordon 23/10/14.

Page 11: Business in China: Risks and Opportunities (Chatham House talk)

One Dream?

© Jeremy Gordon

#11. Jeremy Gordon 23/10/14.

Page 12: Business in China: Risks and Opportunities (Chatham House talk)

All that change and development presented itself at the Beijing Olympics in 2008 – China’s grand coming-out party!

I was in Beijing before the Olympics for an event with a big foreign bank, including, ironically, a private dinner in the Forbidden City.

I noted the “One World One Dream” slogan, also ironically beside the defences of the Great Wall.

It made me think of Jim Mann’s Beijing Jeep – about the troubled beginnings of one of the first JVs in China – which talked about sharing the same bed but different dreams. Something that become a cliché on a par with Napoleon’s!

On one level perhaps there is “one dream” – the same one held by Olympic athletes, Chinese and foreign firms – to win!

The question is whether there is a level playing field on which to compete, and whether the rules are the same for all the competitors…

#12. Jeremy Gordon 23/10/14.

Page 13: Business in China: Risks and Opportunities (Chatham House talk)

Changing Risk & Opportunity

©iStock.com, georgeclerk 

#13. Jeremy Gordon 23/10/14.

Page 14: Business in China: Risks and Opportunities (Chatham House talk)

Earlier I noted Jeffrey Immelt’s words about China not wanting foreign firms to win. That was in 2010. But the environment for foreign firms had already started to change.

I remember blogging in 2006 about a comment from the head of the NBS, Li Deshui, who warned of the impact of “malicious acquisitions” by foreign firms. There were (and still are) also accusations of foreign firms evading taxes and of mistreating Chinese consumers.

Immelt’s words also followed big problems for Rio Tinto in 2009, which woke many people up to the risks of the market, not just of being penalised for breaking the law, but of the difficulty in getting access to arrested employees (even foreign ones), and for the longer-term business implications.

GSK’s problems in 2013 should perhaps not have been such a shock – as the sector is well known for being corrupt, and as the anti-corruption campaign and reform of the healthcare sector made it an obvious target. But many were surprised that senior and well-connected foreign executives were arrested. There was also a complicated back story, but it brought due diligence and business risk into sharp focus.

Another risk reminder was Caterpillar’s $500m 2013 investment write-down following an accounting fraud in China. Accounting fraud and due diligence failure is not new in China. And it is an open secret that many Chinese firms keep more than one set of books.

And the risks are real. Not only commercial ones – also political. SOEs have been guided away from big foreign IT and consulting firms; there have been accusations of hacking and IP theft, and a raft of AML actions against foreign firms (which have accounted for 80% of recent fines).

In an era of slower growth, rising costs and greater competition, these things can have a big impact. And can lead to cut corners and more risk taking as supply chain “efficiencies” are found and as desperate people fight for contracts in underhand ways.

#14. Jeremy Gordon 23/10/14.

Page 15: Business in China: Risks and Opportunities (Chatham House talk)

Changing Strategy

©iStock.com, trait2lumiere 

#15. Jeremy Gordon 23/10/14.

Page 16: Business in China: Risks and Opportunities (Chatham House talk)

The changing business environment is not just a theory. My own business used to be 100% focused on market entry strategy. From the early 2000s there was more demand for risk management, but now I am involved in 3 businesses, focused on risk management, Chinese outbound investment and the Chinese consumer.

The opportunities are clear from China’s scale alone. The risks are not unique to China (which is on a par with the BRICS in risk surveys). But they are amplified by China’s scale and by the concentration of industry clusters, infrastructure and knowhow. The risk is even greater where China is a market as well as a source of production. I unintentionally wrote bit of a PESTLE Analysis as I listed areas of change, including:

• Political –Xi Jinping’s anti-corruption campaign / international assertiveness on territorial issues • Economic – bigger and slower as the new normal / rebalancing / ODI / decisive role of the market • Social – urbanisation / the Chinese dream / protests / ageing population• Technological – indigenous innovation / R&D spending / innovation • Legal – 4th plenum focus on rule of law / more judicial independence, but still a political rule of law • Environmental – the future is hazy, and presents risks across all the above

Strategic responses are required – better risk management may be a start, but more likely fundamental strategic changes are needed. Change is coming from every angle. International businesses need to pause for thought, and consider what strategic direction to take. Some have already done so:

• Tesco – from developing own retail business to taking a minority 20% stake in a JV • 3M – A strong localisation programme. “In China for China” & “Playing as a local”. • Weetabix – got acquired by the Chinese firm Bright Foods. So it can enter China

with the benefits of local ownership, knowledge and connections.

Companies that take an overly aggressive and arrogant approach, may find it is not just Weetabix that China can eat for breakfast!

#16. Jeremy Gordon 23/10/14.

Page 17: Business in China: Risks and Opportunities (Chatham House talk)

Testing Times

#17. Jeremy Gordon 23/10/14.

Page 18: Business in China: Risks and Opportunities (Chatham House talk)

Times are testing.

The trouble is that too many of us have fixed perspectives and we tend to see things in black and white, clichéd snapshots, just like in the example of the Chinese dragon.

Try this quick test, which popped up in my social media stream the other day (along with many other HK related posts!)…

Can you see the pattern?!

The answer depends on the ability to change position. Instead of looking from the outside in, we need to look from the other side before it makes sense…numbers of the car parking spaces – just upside down.

Many of the things foreign firms worry about when looking in make perfect sense to Chinese looking out.

Many of our assumptions – for example about the rule of law, contracts, audited accounts and codes of conduct - cant simply be transplanted and expected to flourish.

We need to adapt out thinking and be ready to move when that car starts driving towards us!

#18. Jeremy Gordon 23/10/14.

Page 19: Business in China: Risks and Opportunities (Chatham House talk)

The New Reality

© Jeremy Gordon

#19. Jeremy Gordon 23/10/14.

Page 20: Business in China: Risks and Opportunities (Chatham House talk)

Some things, like the Great Wall, never seem to change, but beyond the obvious landmarks the change is everywhere. We are facing:

• Rising costs, squeezed margins and cut corners that result in bribery scandals, toxic supply chains & product recalls

• Slowing growth to under 7.5%, with harder-to-reach targets • Increased competition, especially from Chinese firms (the top challenge reported

by USCBC), and pressure for unfair advantage• Increased scrutiny from regulators and the media, especially in relation to foreign

firms (and corrupt officials)

In response we need:

• Genuine engagement at multiple levels, and more understanding of the challenges faced by both sides (not just opportunities!)

• A strategic review with risk as a core component• A move beyond compliance box ticking, with balanced corporate values that align

with individual rewards• Vocal localisation for the long term and for the local good

International businesses need to align with policy and to understand that while the door may still be open, the defensive wall is still there!

For many businesses the issue is now not how they should judge the Chinese dragon…but whether the dragon will judge them to be good or bad for China!

#20. Jeremy Gordon 23/10/14.

Page 21: Business in China: Risks and Opportunities (Chatham House talk)

• Twitter: @RiskyBizChina • LinkedIn Group: Risky Business in China

• LinkedIn: https://www.linkedin.com/in/jgordon • Email: [email protected]

Order “Risky Business in China”http://www.amazon.com/Risky-Business-China-Diligence-Consultants/dp/1137433213

@RiskyBizChina #RiskyBizChina

#21. Jeremy Gordon 23/10/14.