Market Entry Structures for China and India

February 25, 2011 Posted by China Briefing Reading Time: 7 minutes

A golden age for foreign investors beckons

Op-Ed Commentary: Chris Devonshire-Ellis

Feb. 25 – One of the aspects of the Global Financial Crisis and the resulting shift of financial resources has been of course the sudden re-appraisal of China. Now being seen as potentially catching up with the United States, it has recently overcome the Japanese economy to become the world’s second largest. However, amongst all the bellicose rhetoric about what this means, only a fraction of the true implications have really come across. The (not so harsh) reality is that China is poised to finally become the massive consumer market the world can sell too.

In my recent article about the Japanese and Chinese economies, I pointed out the differences in supermarket and department store sales volumes between Japan and China. To reiterate, Japan achieved a total of US$153 billion in supermarket sales in 2009 against China’s US$39 billion, with Japan also ahead in department store sales at US$78.6 billion against China’s US$37.9 billion. Japan has achieved those sales volumes in a per capita consumer market one-tenth the size of China’s. Those are impressive figures from the Japanese perspective, but what it indicates from the Chinese perspective is just how much growth potential there is in China. While it could be argued that Japan’s supermarket and department store infrastructure is close to saturation, that is definitely not the case in China. The clear message is that China has massive potential for sales of foreign goods.

The point is also hammered home in auto imports. Despite China investing heavily in its own auto industry, sales of imported vehicles have nearly doubled in the past 12 months. The value of those imports is just under a million units at some 813,600 and again belies a trend – China’s domestic markets are indeed opening up.

Although the China market has effectively been open for business for the last 25 years, the main drivers in opening up China to foreign investment have come from two sources – the entrepreneurs, willing and able to rough the China market conditions, and flexible enough to adapt, and the MNCs, with huge corporate pockets able to take the occasional hit and retain the ability to throw money at problems. The middle market – U.S. and European businesses geared to selling products and services onto their own domestic markets – has yet to be fully pried open. It is these businesses that will both feel the need to expand as attitudes change, and the dual realities of the dangers of over-reliance on traditional markets, coupled with a dawning that China represents a potentially lucrative additional sales target that will drive such businesses forward.

The same is true of India. For long a moribund, lethargic economy, its near bankruptcy – in ways similar to China in the late 1970s – has caused an on-going revolution in the country’s economic restructuring. Far gone are the days of state crisis and emergency, and ushered into their place is a booming economy that holds similar promise to China, but some years still behind. While infrastructure used to be seen as the bane of India, those decrepit buildings, roads, airports and port facilities are now the new opportunity. India has earmarked US$700 billion to spend on infrastructure development over the next five years, much of that will come from the private sector. The Indian government will offer partnerships and provide finance for foreign investors to assist with the national reconstruction that is taking place. All those architects, contractors, sub-contractors, engineers and suppliers that built Chinese infrastructure such as Pudong International Airport, the Guangshen Highway and Dalian’s port among many other projects should be applying for their India visas and getting out to the new land of redevelopment.

Like China, India also has a massive domestic market, and they too are in the mood for buying. Rolls-Royce have just announced plans to double their dealership network, while the country is now the second-most attractive destination for manufacturing competitiveness.

Clearly, both American, European and all other international manufacturers have significant opportunities to invest in China and India as these markets continue to develop and open up. A golden age of global investment is about to take place.

However, I also recognize that for many businesses yet to take steps overseas, China and India can seem exotic, possibly confusing, and for certain a long way away. That perception has the unfortunate side effect of magnifying risk. While due diligence and the hiring of experienced counsel should always take place, for the new to Asia investor, here is a quick snap shot of the types of investment structures that should be considered as an initial market entry.

China

Representative office
Representative offices (ROs) are cost centers in China, and have restrictions placed on their activities. They may not invoice. However they can be used to conduct market research, as China sourcing offices, or act as sales facilitation offices between customers in China and the overseas parent. The main benefit of an RO is that no capitalization is required, although tax is levied on their overheads.

A more comprehensive overview of ROs can be found here.

Foreign invested commercial enterprise
Foreign invested commercial enterprises (FICE) act essentially as trading companies, and may both import and export, and buy and sell. Capitalization requirements are generally low, but do require attention to detail. They are also allowed to be 100 percent wholly foreign owned, and have become the investment vehicle of choice for many smaller trading businesses. They may also conduct retailing and franchising activities.

More information on FICE can be found here.

Wholly foreign owned enterprise
Wholly foreign owned enterprises (WFOEs) are used mainly for manufacturing, although they can also be used for service and trading. Capitalization costs are partly location and industry influenced. Siting WFOEs in bonded zones in China still makes commercial sense for added value processes involving a combination of Chinese and imported components.

More details regarding WFOEs may be found here.

An additional examination of the differences between ROs, FICE, and WFOEs can also be found here.

India

Liaison office
Liaison offices (LOs) in India are similar in structure to ROs in China, and may be engaged in market research, sales facilitation on behalf of the parent, and related collaborative projects. They may not invoice directly. LOs are relatively easy to set up and require no capitalization, yet from experience we have found that their initial usefulness declines rapidly over time due to their trade restrictions. However, they may be an option to consider for an inexpensive initial foray into the consideration of the India market.

More details regarding LOs may be found here.

Branch office
Branch offices (BOs) of foreign businesses in India may enter into import-export contracts, provide consulting services, act as a buying or selling agent and provide technical support. An advantage is the relative ease of establishment and exit from the entity. However, they do carry a higher tax band than the next alternative, setting up a limited company. But they remain useful vehicles for foreign businesses in India who may want to test the waters with an initial contract.

More information on BOs can be accessed here.

Private limited company
These may be structured as wholly foreign owned or as joint ventures, as depending upon both regulatory requirements or personal choice. There is a two tier system of approval for private limited companies (PLCs), both of which detail the activities foreign investment may be governed by. However, most general scopes of business in non-restricted sectors do not need to seek such approval once the relevant category is determined. PLCs capitalization is industry dependent but is not typically large for most general trading and manufacturing requirements.

Additional details concerning PLCs can be found here.

The onus is on companies with traditional markets in their own territory (or close to it) to look at expanding overseas. If not, the risk is that eventual stagnation will occur, and with that, increased competition. My own business has expanded far beyond the borders originally intended for it, and that strategy was specifically developed and undertaken to minimize the risk of growing competition in the China market. While it has taken a development program beyond that initially envisaged to implement, and cost a great deal of money, it has also moved our business away from the risk of being in one market, and has the additional benefit now of providing us with income streams from several service lines. Our own experience has demonstrated to us at least, that standing still and relying on traditional markets could be, for many businesses, a dangerous policy. For global businesses new to Asia, both China and India provide opportunities to revitalize your body corporate, and develop new income streams. The moment to begin evaluating the two markets most likely to spearhead growth well into the century is now, and the opportunity never better.

Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates. The firm was established in 1992, and now has ten China offices and five in India. The practice provides foreign direct investment, due diligence, market comparisons, corporate establishment, tax, accounting and business advisory advice to multinationals and small-medium enterprises wishing to examine the potential of investing in China and India. Please contact the firm at chinaindia@dezshira.com for more information or download the firm’s brochure here.