Finding the Way in China

Critical issues for partnership and investment

Mark J Benedyk,  Head, La Jolla Incubator, The Pfizer Incubator, LLC, USA

Multinational pharmaceutical companies are rushing to China with an aim to access the low-cost scientific talent and also claim a stake in Asia's largest pharmaceutical market. But the Chinese business climate is far from what one normally encounters in the West.

In the news almost  constantly, the Chinese business climate seems to be changing daily. Overall international capital flows to Asia reached US$ 88 billion in 2006, compared to US$ 60 billion in 2005 and they are expected to have remained high in 2007, despite the recent turmoil in the banking and the capital markets.

Just as the US is seeing increasing globalisation in its business environment through cash infusions from sovereign funds and tremendous capital investment by overseas companies, China is itself seen by many in the business community as a greenfield opportunity to develop a business for billions of consumers. China represents by far the largest potential pharmaceutical consumer market in Asia, valued at US$ 23 billion in 2006.

Does the large scale perspective on doing business in China jibe with on-the-street experience of the average company? How does the average company make inroads into China?

As is often found in the pharmaceutical industry when dealing with other issues, when it comes to doing business in China, the devil is in the details. A top-down look on issues critical to developing opportunities for partnerships and investment in China in the pharmaceutical industry will be of great help.

Scale - There are many Chinas

Although approximately 20% of the global population is in China, to date, only 1.5% of the global pharmaceutical market is represented in the country. China itself is far from homogeneous in economic terms. Economists often talk about the "Three Chinas" that exist within China as a whole: the economically active South-West coastal region, the growing region slightly inland, and the most inland provinces that abut the Central Asian republics, Mongolia and India. In keeping with the sweeping changes that have taken place in China, those "Three Chinas" overlap with the other "Three Chinas" sometimes mentioned in recent years: privatised zones in the South-West coastal regions, the many State Owned Enterprises (SOEs) located slightly inland, and the extremely poor rural areas further inland.

Clearly, as one moves inland on a map of China, there is less economic development-for now.

Challenges

The competitive landscape presents a challenge to someone looking for pharmaceutical opportunities in China: There are over 3,000 drug companies in China and over 15,000 distributors as well. On top of this, China lacks the infrastructure necessary to distribute pharmaceuticals outside of large urban centre and the potential for counterfeiting is very high. After a series of highly publicised crimes of corruption and graft at the Chinese State Food and Drug Administration (SFDA) that were disclosed last year, the Chinese government has made drastic changes to processes and personnel there. It remains to be seen if those regulatory changes will be rigorously enforced such that they bear fruit in the near term for companies focussed on the Chinese pharmaceutical industry in the coming years.

Because of these questions about the regulatory environment and concerns about enforcement of intellectual property law, instead of focussing on the immediate potential for sales to the Chinese market, global companies are focussed on setting up research centres in China. Their intention being not only to capitalise on a low-cost technical workforce, but also, for the strategic reason, to establish a stake in the large and growing market that represents a tremendous revenue base for the pharmaceutical industry.

The need for commitment

Setting up alliances for research or manufacturing purposes can be bewildering given the vast landscape of options available to foreign companies in China. With a flood of potential business and investment partners aggressively seeking deals with US companies, a deep understanding of the business culture in China is essential for success. Key for any company is having someone committed to be on the site where a company decides to have a footprint. He or she should be bilingual, have a deep network in China among both business and government contacts, and should have clear goals in mind that focus solely on cultivating and managing relationships in China. Those responsibilities alone are more than a typical full-time job.

Pick the right structure - Incorporation in China

But how should that footprint look? China is a place where the government owns all intellectual properties of universities and research institutes and a vast amount of other assets that would normally be privatised in the West. Keeping this in mind, a key issue in determining how to incorporate in China involves a consideration of corporate goals in the region. Is the goal a permanent long-term presence in the market, or establish a plant for the low-cost manufacturing for a project with a limited timeline and budget?

The majority of press coverage in recent years has highlighted the latter, trumpeting the low cost of manufacturing in China across the board. Lax environmental regulations and poor oversight, however, show this to be a double-edged sword: the 'lead paint in toys' crisis and the surfeit of counterfeit pharmaceuticals coming out of China are examples of how the legal and regulatory systems in China are still playing catch up with the tremendous growth in the low-cost manufacturing sector that has occurred in the past few years.

With that in mind, the first thing to think about is the type and scope of business planned in China. Generally, there are three ways to proceed. They are:

Representative office

A subsidiary of a foreign company in China is called a representative office. This arrangement is best for a company needing a Chinese presence to facilitate business activities or research the developing Chinese market. However, this type of entity is limited in the extent of what type of business it can conduct. For instance, representative offices cannot legally conduct business transactions such as billing clients in China. This is an excellent arrangement for a company wanting to take a slow, measured approach to establishing a presence in China.

Joint venture

A joint venture is a type of business where a foreign firm enters into a legal arrangement to create a new entity with joint equity ownership with local Chinese partners. Given the shifting sands of the Chinese legal environment, this can be a risky route for a company to take. A joint venture structured one year, may be arbitrarily considered illegal by the government another year. Keep in mind, if your company is new to China, this path may be fraught with possible risks, given the evolving nature of the Chinese legal environment and a government that is only now just beginning to enforce intellectual property law provisions in a meaningful way.

Wholly foreign owned enterprises (WFOEs)

WFOEs are 100% foreign owned companies. For many biotech companies and smaller pharmaceutical companies, this is an increasingly common route taken towards establishing a presence in China. It allows a company to establish a presence in China with minimal capital requirements. In addition, it offers a company significantly more control over decision making than a representative office or a joint venture.

Key cultural issues - A western perspective

To be successful in doing business in China, it is critical to understand cultural influences which drive alliances and partnerships. The concept of Guanxi (connections or relationships) is central to all business alliances in China, from start to finish. For instance, a purely formal business arrangement starting with a phone call and ending with signed contracts would be seen as grossly inadequate by a Chinese partner. The proper cultivation of a relationship with a Chinese partner both socially and from a business perspective influences the success or failure of the partnership and will dictate the tenor of the interaction going forward. Spending time in the town where potential partners reside and leveraging common contacts to network with Chinese companies do play an important role in the success of a business in China.

The process of developing the relationship is almost as important as the closing of an executed agreement itself which should be accompanied by a signing ceremony that celebrates the new partnership. But companies need to keep in mind that the final executed agreement is just a starting point for a partnership. There will be constant communication back and forth once an alliance is put into place. Hence, from a management perspective, it is critical to have someone in charge of interfacing with that partner or partners.

Given the need for frequent and accessible contact to do business in China, again, it is important to have personnel who are bilingual, bicultural and who can improve the interaction between both parties. It is difficult to imagine how a successful Chinese partnership can be established remotely, without the rich interaction that face-to-face meetings and conversations bring to a business alliance.

Driving collaboration

A few simple drivers will help immensely in developing business and investment partnerships in China. First of all, the need for a long-term interaction is key. It is self-defeating to focus on a goal of doing business in China without dedicating the time and resources required to doing it right. If a company merely wants to appoint an agent to act on its behalf in China, it shouldn't expect a huge return on its investment. On the other hand, if there is a strong commitment to developing business in China and that is reflected in a clear dedication of senior management and resources to the job, the rewards can be handsome, indeed.

Understand China: Local relationships = Local knowledge

As mentioned at the beginning of this article, there are "many Chinas". The SFDA regulatory offices in Beijing are half a continent away from the pharmaceutical R&D centre in Pudong, Shanghai, and the cultures and languages in both locations are equally distant from each other. Knowing the local power structure and the local way of doing business is the key to success in China. The freewheeling aspect to all of life in Shanghai is in stark contrast to the straitlaced atmosphere of Beijing, where the seat of government power lies. For all intents and purposes, they might as well be two different countries, deserving of two different offices, one for each city.

Understanding the power of the government

The concept of a central government is often very foreign to Westerners. All university intellectual property is the property of the government, and until recently, the militzry was the largest corporate shareholder in China. The Chinese regulatory authorities oversee a vast landscape of approval applications that boggle the mind. Every aspect of business is government regulated as well, to an extent not always apparent to Western eyes.

If companies do not have a good relationship with government officials in the region where they do business, getting business done gets quite difficult. It is that simple. Forging relationships with potential partners who themselves have good relationships with government representatives and due diligence on potential partners is a must.

Everything cuts both ways

As a foreign entity in China (read non-Chinese), a foreign company is a ready target for exploitation by unscrupulous businesses that see it as a walking bank account. The companies are also seen as an invaluable asset by the sophisticated Chinese business owners looking for long-term partners. Companies should not jump to conclusions about potential partners until their due diligence is not complete.

Similarly, a Chinese businessman or businesswoman acting alone is one of literally tens of millions of small business owners. A Chinese business owner who has a highly visible alliance with a Western partner, though, is something entirely different. Your affiliation has value in itself. If partner is chosen wisely, foreign companies can benefit tremendously through their affiliation.

Guanxi is more powerful than a formal contract

In a country where the concept of a uniform rule of law is relatively recent, relationships and face count for everything. In many ways, they are more powerful forces than the contract law that governs business transactions in the West. Companies need to keep this in mind when dealing with local business owners. Each is part of a local network of people that do business together. If the company can help the social standing of its Chinese partner in that network, it will be a valuable ally and help get value in return for the relationship.

Negotiation never ends

Negotiations never end in a fast-moving environment like the Chinese economy, and partnerships may evolve very quickly as the business environment evolves. Chinese partners are not only allied with foreign companies, but with a host of other Chinese companies in a vast network of players about whom foreign companies may know very little or nothing at all. If the relationship is not going in the direction they want, speaking up is the best choice. Companies should remember that the contract is just a starting point for their interaction with Chinese investors or business partners, and that said, a contract is always a two-way agreement. Keeping an open mind, and being open to possibilities for change when doing business in China, benefits everyone.

Be open to change, but not too open

Where does this leave the newly arrived foreign businessman or businesswoman, just getting off the plane in China? China is changing, and nothing breeds business opportunity like a crisis of change. Contrary to popular belief in the West, however, the Chinese word for crisis (weiji), is not composed of the characters for "danger" and "opportunity". To achieve success, a company should do its homework, just as it would anywhere else. Often the chaos and excitement of a rapidly changing environment like China can be alluring to opportunistic companies, but as always the standard business rules apply here. Partnerships are about mutual self-interest, and there is a lot of that in China, at the moment. Companies should be vigilant about due diligence and above all, persistent, as the Chinese business environment is very new as well as fluid. If they run into a roadblock, they should be persistent and adaptable and remember the Chinese proverb, "Where there's a will, there's a way."

Author Bio

Mark J Benedyk
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