China's New BusinessClimate Warms Up

Medical Device & Diagnostic Industry Magazine
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An MD&DI July 1997 Column

Understanding the Chinese political and economic culture is just the beginning of successfully tapping into this market, which is ripe for medical device manufacturers.

China will soon become the world's biggest market for almost every product and service. Unfortunately, many horror stories are told about what happens to foreign companies that try to deal with the inscrutable Chinese. Ask almost anyone, and they will tell you what they have heard about the Chinese market: "It's closed to almost all foreign products; they have no money; the government controls or owns everything; the import barriers are insurmountable; there is no information on the market and you can't get any; they hate the United States and its companies and products."

With one-fifth of the world's population, China is on its way to becoming the world's biggest market for products and services. Photos courtesy of Rongquan Wu/China National Tourist Office

Fortunately, negative comments about the most important aspects of doing business in China are often based on misinformed, or uninformed, hearsay, as opposed to knowledgeable experience. The objective of this article is to separate fact from fiction, so device manufacturers can make informed decisions.

Exciting as the prospect of overseas sales might be, for thousands of U.S. manufacturers with limited or no experience doing business internationally, the obstacles appear daunting. Almost immediately they are faced with a myriad of problems, including the language barrier, how to find agents or distributors, a plethora of export conditions and regulations, locating and communicating with prospective buyers, and the financial uncertainty associated with unproven customers.

All of these problems are solvable, as demonstrated by successful large and small multinational companies, and the process of solving them enhances the business skills of any company's management. This is particularly important for U.S. device manufacturers who have relied on the historical growth and appetite of domestic markets, a condition that can no longer be the only, or even primary, denominator for tomorrow's business plan.

Experienced manufacturers know that even in the familiar domestic market there are significant differences in how potential buyers should be identified, appealed to, sold, and serviced. Because such differences are considerably greater outside the United States, geographic market selection is a critical first step.

Before committing resources to a specific country or region, the following basic information should be obtained:

Every region in the world has unique characteristics that may be perceived as positive or negative, based on the bias and experience of the analyst. The following brief comparison illustrates how a typical U.S. medical device manufacturer might view two regions. Western Europe has political and economic stability, relative wealth, technological advances, and a well-organized infrastructure. However, it also has entrenched competition, mature markets, low growth prospects, and complex regulatory requirements. By contrast, South America wants capital investment, has high growth prospects, and needs all kinds of medical products. On the downside, it is also volatile politically, has unstable and poor economies, and lags technologically.

The government's recent commitment to economic reform has fostered a modern approach.

MARKET OF THE FUTURE

The region increasingly lauded as the market of the future is Asia, excluding Japan and India. The countries represented are often divided into two groups, Greater China--the mainland, Hong Kong, and Taiwan--and the southeastern countries--Indonesia, Malaysia, the Philippines, Singapore, South Korea, Thailand, and Vietnam. All are rapidly diversifying, expanding economies with some of the highest projected rates of growth in the world. Among the Asian countries, China seems to have a mystique and appeal transcending all the others combined.

China is a nation of superlatives: one-fifth of the world's population, the third biggest country in area, one of the largest GNPs, and a higher growth rate than any other major economy. And, what is certainly important to the device industry, the United States has the leading share--40%--of the Chinese medical device import market. Here are some specific facts about China's potential for medical products that should justify investigating China as a potential market.

All of these enticing facts notwithstanding, to successfully do business in China requires more than a unique product, a lower price, or a superior marketing ability. A long-term commitment from top management, a well-conceived plan based on accurate market information, and a lot of patience are imperative.

In addition, reaching this market demands an acknowledgment of China's unique business culture, history, and methods. By understanding these, a device company will have not only a true competitive advantage, but also a better chance to achieve a desirable return on investment quickly.

FREE MARKET SYSTEM

The most positive sign that exporting to China is becoming easier is the nation's new free market system, which is working well for many industries. At the end of 1996, according to the Chinese government, 90% of domestic trade was conducted this way. The remaining 10%, still under the state plan, was mainly military, infrastructure, and high-technology products. Through the market system, dealers and manufacturers' representatives are now found in most metropolitan areas. This system allows freer competition and better opportunities for foreign companies to access Chinese end-users, who in most cases make their own buying decisions with little or no government involvement. The government is relinquishing much of its control and converting what was a highly centralized system into a very successful free market.

A CHANGING ATTITUDE

Besides the political factors that have helped to change the nation, the government's behavior has changed due to economic issues. For example, nationwide, the government shut down 5500 factories by the end of 1996 that were considered to be a major pollution source. A law has been passed to further control industrial pollution. Other new laws now limit the maximum number of work hours per week and set a minimum wage to protect the interests of employees. Several other factors have also led to changes. In 1994 the first copyright laws were passed. And finally, the Customs Department, now capable of clearing more than $800 million in goods per day in international trade, is one of the most efficient in the world.

The Chinese government's behavior has been checked by two powerful incentives: the threat of domestic unemployment and the survival of the nation's international trade. Domestic unemployment, which was 20% in 1994 in some major cities, currently averages about 5%. Unemployment has been considered a major threat to the existence of the Communist Party, so the government seems willing to do almost anything to keep a labor force of 540 million employed. China's international trade has created approximately 30 million job opportunities, many of which would be lost if China's trade decreased. Therefore, greater involvement in international trade reflects the government's concern about both its domestic and international behavior.

GOVERNMENT CONTROL OF THE ECONOMY

Double-digit economic growth in 1993 and 1994 drove inflation up to 20%. Instead of using traditional administrative orders through its planning system, the central government brought inflation under control by reducing the fund for capital investment in 1994 and 1995. Technically, the government now controls the nation's economy by adjusting the amount of funds available for capital investment through a new method--the government's Macro Adjustment and Control. With Macro Adjustment and Control, the government adjusted the fund supply via the central bank and inflation fell to less than 7% in 1996; however, economic growth still remains at 9%. Adopting the new method has still not produced the same economic balance as Western monetarism, but it has successfully controlled the nation's economy. It also has proven that the Chinese government is firmly committed to a free-market system.

In the future, although another year of double-digit economic growth is unlikely, the inflation rate may be much more stable. This will cause steady growth in the economy and standard of living. It will also strengthen the newly established market system and stabilize the Chinese currency Renminbi (RMB) value against hard currency standards. All these factors are especially important for U.S. exporters.

INTERNATIONAL TRADE GROWTH

China's rapid economic growth in the past few years has amazed and attracted investors worldwide. As an example, between 1993 and 1994, exports increased by 31% to reach $121 billion. By the end of 1996, international trade had reached $285 billion, compared with $115 billion in 1990. This made China the eighth-largest trading nation. Forecasters say that estimated imports and exports in 1997 will surpass $320 billion.

The inflow of foreign investment is continuously increasing. Due to increased exports and a more rapid influx of overseas investments, China's hard currency reserve has greatly increased. According to the International Monetary Fund, China had $100 billion in reserve by the end of October 1996, compared with $21 billion in early 1994. This high reserve of hard currency is one of the major factors enabling the Chinese government to convert its currency internationally at its current balance. It also caused the conversion plan of RMB to occur about four years earlier than originally planned, thus making importing much easier.

Higher Personal Savings. Amazingly, the personal savings rate of the Chinese people is around 30% of the nation's GDP, or about $340 per capita, compared with 16% of the GDP in the United States and United Kingdom. This high savings rate is caused by a combination of higher bank interest, the limited availability of quality products and services, and the frugal Chinese culture. For the Chinese, this also shows consumer confidence with the current economic and political condition. Two cuts in the interest rate were made in 1996, one of 1.2% and the other of 1.5%, and the government encouraged consumers to spend their money. Currently, the country's personal investment system is still far from ideal, and the best way for people to use their money is to spend it on quality products.

Better Services. The development of service industries has benefited foreign companies that want to import their products to China. Foreign banks, insurance companies, accounting and consulting firms, and even forwarding houses have been allowed in major cities, although some services still operate under governmental restrictions. Some foreign banks now handle local businesses as well as international transactions. The government is allowing service industries more and more freedom to operate progressively.

Shipping was monopolized by the China Ocean Shipping Company until the government opened the market to foreign shipping lines in 1988. Today, the selection includes U.S., South Korean, Taiwanese, and Japanese lines.

Licenses and Tariffs. The government has consistently removed the import license requirement from more than 5000 products. It has only about 300 of them still to remove. In recent years, tariffs have been lowered several times. The current tariff for most products averages 24%, but it has been falling regularly and quickly. In order to join the World Trade Organization, China must cut its tariffs to around 15%, which will smooth exports and also promote increased imports.

BETTER OPPORTUNITIES

In the late 1970s, when China officially announced its economic reform, joint ventures between foreign investors and Chinese companies were considered the primary way to access the market. Twenty years later, the situation has dramatically changed. The nation is becoming one of the biggest importers in the world, and exporting from the United States is emerging as a more cost-efficient way to access the Chinese market.

China is now a home to more than 1000 local and foreign medical device manufacturers. Fierce competition and a previously weak legal system had provided the opportunity for illegal deals between medical products suppliers and buyers, which also involved hospitals and retailers. Illegal payback from sellers to buyers has been a part of nationwide corruption. A press release issued in June 1996 by China's Ministry of Public Health showed that 812 "irregular transactions in medicine" were being investigated by the Administrations for Industry and Commerce so far that year. Of this number, 234 cases involved bribes in 17 provinces and cities. Additionally, 2888 cases in 23 provinces and cities were reported during 1996. Such nationwide corruption has not only caused complaints from Chinese consumers, but is also leading to reforms that will improve the environment for U.S. companies that can deliver quality products and services in a more ethical fashion.

China's economy and international trade will continue to grow into the next century, when it will become the largest economy in the world. However, the more China increases international trade and its activities in the world community, the more cautious the government will have to be about its behavior, both domestically and internationally. Chinese businesses will continue to make positive changes, the government will be more rational and reasonable, and the nation will no longer be the same as it was prior to the 1980s.

The Reputation of U.S. Products in China. U.S. companies, whose products have a long history of quality, are challenged by companies from Japan, South Korea, Taiwan, and Hong Kong, which are nearer to mainland China. In many markets, U.S. firms still excel in high-end products: electronics, machinery, chemical and pharmaceutical products, and medical devices. In these and other industries, U.S. companies dominate the Chinese market, because buyers believe that U.S. products still represent the best in added value, advanced technology, and reliability.

CHINA'S CULTURE

When describing a foreign nation's culture, many people think about how people dress, the ways they make and serve their food, or how they greet each other. This is just a small part of the overall picture. The concept of culture refers primarily to a nation's political and socioeconomic attributes. The Chinese culture has undergone many changes since the Communist Party became the ruling power in 1949. With the recent commitment to economic reform, a new market system, new products, and an improved lifestyle, a new and modern culture has been created.

The earlier pioneers from the Western business world all knew about China's guanxi (pronounced gwan-shi) culture. The word actually means "relations" or "connections." In a political-cultural context, it refers to an insider who can provide special assistance to someone whom they do business with and trust. A wide range of guanxi helped to show China as a nation that traded products, services, and even the party's internal power. In such deals, the country's law was used for reference only. The guanxi were active at all levels of the business and social sectors because demand for goods and services was high, and only a limited supply, tightly controlled by a few powerful people, was available in each area. After the government initiated reforms, many guanxi disappeared.

As an example, in the early 1900s the government opened the materials supply market to the public, and fierce competition erupted almost overnight. The guanxi provided the metal material supplies, especially the lower-cost, high-quality products. Today, raw materials, both metal and plastic, are available from local dealers in many metropolitan areas. Most of the imported steel and plastic materials are easily found in China's domestic market, and guanxi are no longer involved.

Hard currency exchange used to be very difficult, and when a foreign company needed to convert from Chinese yuan to hard currency, they had to go through several layers of government and make deals with guanxi. On December 1, 1996, the government announced its new policy regarding international currency conversion, which means that the previously spoiled officials and bankers will no longer have the chance to take advantage of foreign companies that need hard currency. Although the guanxi culture still exists in China, in many cases it is being forced out.

As China changes, so does its culture. Viewing the nation today in the same way as 20 years ago, or even five years ago, is a big mistake. It could lead a company in the wrong direction, missing real opportunities. A well-known Chinese philosophy, "crossing the river by touching its stones," provides an excellent analogy for reaching this market. A literal (Western) interpretation would be, "if you are on an unfamiliar course, look carefully and take one step at a time." This is a worthwhile philosophy for medical device manufacturers who want to do business in China. And if it is reinforced with accurate information about the Chinese business culture, the "other side of the river" has outstanding potential for the future.

In addition to dispelling the most prevalent myths about China, it's important to consider the near-term environment in which a company will operate, and some of the alternative directions available. As the U.S. medical device industry approaches the threshold of the 21st century, it confronts a number of trends that will force dramatic changes in the way all companies must operate. Among these, the following trends may have the most impact on revenues, profits, and continued growth.

Suppliers who focus solely on these markets will be subject to increasing competition and decreasing gross margins.

However formidable these obstacles appear, they are more than compensated for by a number of opportunities, one or more of which will be recognized and acted upon by creative and informed device manufacturers.

Joe Chao is founder and president of J.C.I., an international marketing consulting company with offices in eight Asian countries and the Chicago metropolitan area. Ted R. Tyson is president of Tyson Consulting Group (Buffalo Grove, IL), a firm specializing in the commercialization of health-care products and services.

Copyright ©1997 Medical Device & Diagnostic Industry