Mixed Fortunes

9 October 2008

New Chinese labour laws have altered working practices for businesses and employees alike. Ali Cain looks at the implications for companies looking east.

New labour laws introduced in China this year have fundamentally changed business practices in this rapidly developing superpower. At the same time, labour costs have skyrocketed, with labour shortages common in some areas, especially near the coast.

These developments have the potential to make China much less attractive to foreign businesses that want to use it as a source of cheap production. But at the same time, the Chinese domestic market is opening up to foreign companies, offering many a golden opportunity for growth.

"When the global market faces a negative situation, a big market [such as China] becomes attractive to foreign companies."

For those established businesses focusing their attentions on the export market, this means a fundamental change in business strategy. Potentially, businesses that do not understand this and fail to alter their strategy risk declining profits or worse. KK Chan, CEO of appliance manufacturer DeLonghi & Kenwood’s Chinese operations, says the labour market is a serious problem for foreign companies.

"Since China entered the World Trade Organisation, foreign firms have rushed into the market. All of a sudden there was a huge demand for university graduates and those with experience working with foreign companies," he says.

"Four or five years ago, I was paying a sales manager a monthly salary of CNY12,500. Today that figure is CNY27,500," he says (CNY12,500 is the equivalent of roughly £920, while CNY27,500 equals roughly £2,030).

Not only have base salaries increased, Chan says that under current Chinese labour market laws, employers are now required to offer attractive incentives to employees, or risk losing them to competitors.

"We now offer attractive bonuses, but it’s not only about paying better; it’s about making sure they are motivated to work with me and DeLonghi & Kenwood," Chan says.

Wayne Dai, chairman and CEO of computer chip company VeriSilicon Holdings and a winner of the 2007 Ernst & Young Entrepreneur of the Year award, says the labour market has changed. "You have to track hours and think about extra compensation, it makes things a lot more complicated," he says.

Aside from these new restrictions, Dr Kegang Wu, director and managing consultant of ChinaLink, which helps UK businesses enter the Chinese market, says labour is in short supply on the coastal seaboard. "If you want to set up a factory in Shanghai, be prepared to pay more for labour than in rural areas," he says.

Domestic market

The emerging Chinese middle class is developing a taste for western goods and services, creating an unprecedented opportunity for western firms to develop and sell products specifically for the Chinese domestic market.

Danny Po, a Hong Kong-based PricewaterhouseCoopers partner, says the most critical change in recent times has been the opening up of China’s domestic markets to foreign firms

"Foreign firms will now find the consumer domestic market very attractive," he says. "In the past, foreign firms have manufactured in China for export back to Europe or the US, but now this trend has changed. An increasing proportion of goods manufactured by foreign firms are being sold in the domestic market.

"When the global market faces a negative situation, a big market [such as China] becomes attractive to foreign companies. But this means they must change their strategy and adapt products and services to suit the local market," he says.

DeLonghi & Kenwood is one company that has chosen this strategy. "The most fascinating thing is that this huge market is getting more sophisticated by the day ... in the past consumers didn’t even know how to use the products we produce, now they want the luxuries of life," says Chan.

For instance, DeLonghi & Kenwood is now the number one manufacturer of coffee machines in China. Ten years ago, DeLonghi & Kenwood did not even offer this product category in the country, which is renowned for its affinity with tea. Chan says the Chinese consumer goods market is polarised between luxury items such as Kenwood's coffee machines and incredibly cheap, mass produced and marketed goods. "The majority of sales are either at the very cheap end or at the very high end," he says.

New legal structure

Businesses that want to make a go of it in China must of course work with local authorities and understand the intricacies of the Chinese political system. Wu says the Chinese Government is playing a significant role in working with foreign businesses. "They are often directly engaged with foreign firms. This is a different model to the western system. People have to understand that it's not government interference; it’s a free support service. Foreign firms can get free advice from the government and use them to help resolve issues."

Po says a mistake many foreign firms make is to assume power is controlled centrally in China. "Foreigners consider China to be a communist, centralised culture, but China is now decentralising. Policy making is centralised, but policy implementation is decentralised," he says.

For example, tax law is promulgated by the central government, but municipal and district governments can have different interpretations of tax laws and different tax practices. "It’s difficult to expect the same kind of treatment across China and Westerners need to be flexible and respect this situation," Po says.

"In the past, foreign firms have manufactured in China for export back to Europe or the US, but now this trend has changed."

For the last 20 years, the government has routinely offered tax holidays to foreign companies. "But now the government thinks investors are making a lot of money, so they should pay a reasonable rate of tax," says Po. "Incentives have been reduced so there is no tax holiday."

From this year, Po notes, companies that were on a 15% tax rate to encourage foreign firms to invest in coastal areas will have to pay 25% tax, a significant increase that will substantially add to the cost base for many companies.

There are exceptions, however. "High-tech investments still have the potential for tax privileges," says Wu. Special tax concessions are also available for agriculture and forestry investments, environmental technologies, businesses dedicated to the preservation of natural resources, high-tech pharmaceuticals and telecommunications.

Another key dynamic that is increasing business costs in China is the appreciation of the yen against many other currencies. Bloomberg figures show the yen has appreciated 16% over the last year. Cathy Du, chief accountant of China’s biggest technology company, Lenovo International, says the majority of foreign firms in China are exporters that rely on low manufacturing costs. "Many people in this position should consider hedging their currency exposures," she says.

Although new business conditions are a key consideration for foreign firms operating or thinking about operating in China, the other important factor is cultural understanding: without this, foreign firms might as well pack up and go home.

"There is a barrier that is not just lingual but cultural as well," says Po. "It’s possible to understand Mandarin, but not understand Chinese culture."

To get around this, Po advises foreign firms to respect the Chinese way of life and ways of doing business. "It’s important to have an experienced external adviser or a capable Chinese partner or business consultant to learn how to do business in China," he says.

There is no doubt sweeping changes to the Chinese business environment are keeping western businesses on their toes. Po’s final piece of advice for foreign companies considering doing business in China – or already doing business in China and struggling to adapt to the new business environment – is to be flexible.

"Foreign companies have to revisit their strategies and ask if higher manufacturing costs still make it worthwhile to operate in China and should the business be diversifying into the domestic market? Companies in this position need to urgently allocate senior staff to answering these questions," he says.