The difficulty of making money in China

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Related tags: Companies, China, Economics, Investment

Foreign companies' profits in China may have increased rapidly in
the past four years, but they remain modest in comparison with
other countries with smaller markets and slower growth, according
to a surprising new report. Anthony Fletcher reports.

China, with its billion-plus population and break-neck economic growth, is seen a reservoir of untapped potential by foreign companies looking for new markets. But a recent survey from independent research service China Economic Quarterly​ (CEQ), which looked at the performance of US companies in China, paints a picture of a market characterised not just by untapped potential, but by cut-throat competition and incredibly challenging conditions.

For example, the survey calculates that total China earnings for US companies rose from $1.9bn in 1999 to $4.4bn in 2003. When royalties and licensing fees are taken into consideration, profits stand at $8.2bn.

But this figure compares unfavourably with the $7.1bn that US companies made in Australia - population 19 million - in the same year, and $8.9bn in Taiwan and South Korea, which have a combined market of 70 million people.

CEQ's editor-in-chief, Joe Studwell told the UK's Financial Times​ that many foreign businesses in China are struggling to make money at all because of low margins and cut-throat local competition. This is a point that Dr Benoit Rossignol, an expert in foreign investment in the Chinese food and retail market, raised when he spoke to a few weeks ago.

"We have seen Fortune 500 companies losing lots of money in PRC by over-investing too quickly, too early and companies with less than $500 000 of investment being very successful within three to four years because they knew where to position themselves, and make the best use of their money,"​ he said.

"Knowledge is the key to taking advantage of this lucrative market."

It is clear from both the CEQ report and Rossignol's experience that the rules of the game in the Chinese food market are not as elsewhere. Payments often depend on the relationships that have been built up, and there is still just a small limited elite class capable of affording what are perceived as western luxuries.

Manufacturing has accounted for 60 per cent of China's GDP growth over the past decade, with the low cost of production, coupled with favourable economic policies and preferential tax rates, among the drivers behind the growth. As a result, foreign companies that make the most money out of the China boom are those that use it as a base for exporting or sourcing cheap goods, such as Wal-Mart.

"One day, the Chinese market may indeed become what it is cracked up to be,"​ claims the CEQ report. "But for now the country's significance for companies can be found elsewhere in the fact that China is the biggest cog in the machine of global manufacturing for export."

This is true, but there are still good opportunities for foreign companies that target not the elite but the mass market. A recent article in the Financial Times written by Jacques Penhirin, a principal in the Greater China office of management consultancy McKinsey & Company, argued that most foreign companies are neglecting 90 per cent of the market - more than 700m people - by targeting just the wealthiest minority.

For example, the US companies that made the biggest profits selling into the China market, rather than exporting from it, were the fast-food giants Yum Brands and McDonald's. Major firms such as Coca-Cola and Nestlé now record sales of over $1billion in the China packaged food market, which is now estimated to be worth over €30 billion.

Indeed, Rossignol thinks that some foreign businesses are now on the right track, and are beginning to successfully target the Chinese mass consumer market. He points to a number of Taiwanese and Hong Kong-based firms, along with western corporations such as Coke.

"These companies were able to target the mass market after they acquired local companies that already had channels in place,"​ said Rossignol. "I would recommend this strategy to start, with since these operators are very professional. This will allow local businesses in these regions to see your products, and if they do well you will start being contacted by other retailers who will want your products on their shelves."

Related topics: Processing & Packaging

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