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What Type of Risks do Foreign Firms face in China?

Updated: Jan 28, 2021

Factory Headquarters © Carmadesign Studio / CC BY-SA 4.0 / Wikimedia Commons

China is the largest market in the world currently, with no signs of that changing. An impressive 136,997 foreign firms were registered across the country in 2017 (NBS). Foreign firms in China face a whole slew of risks, some they are familiar with from experiences in their home countries or other international branches, some risks are more common in China, so firms may not have the expertise or experience to protect themselves. This article aims to provide a brief overview of just a few of the types of risks that foreign firms face operating in China, outline which industries are the most affected, and briefly discuss risk management strategies firms can take.

Compliance Risk

In recent years, the Xi administration has made efforts to reduce issues of business transparency in order to promote more dynamic business growth. Despite these improvements, regulatory transparency still remains an issue for firms, particularly for more recent entries to the Chinese market. This brings us to the first risk – compliance. Having a compliance strategy is critical, especially in heavily regulated fields or fields with high skilled talents. Failure to properly localize HR compliance can result in being forced to reinstate terminated employees, just to give one example in one aspect of compliance. Even though the rate of perceived transparency is growing, in a recent survey by AmCham Shanghai, less than 40% of their members in the service sector feel there is suitable transparency. In those cases, it is incumbent on the business to find the regulatory standards and have a clear compliance protocol.

Employee Risk

Staffing is a problem not unique to doing business in China. How to find, develop, and retain staff has been written about by experts far smarter than myself and will not be covered in this article. Staff stealing trade secrets, selling contracts, or being forced to retain underperforming or incompetent staff due to poorly worded KPIs or a lack of regulatory understanding IS a more common issue in China, however. Many companies across various industries struggle with the issue of finding and keeping talent. In this case, talent is also someone you trust not to embezzle funds or copy your company chop. Performing due diligence before a hire can be costly and time consuming, but in China, the risk of losing your IP to competitors due to one or two bad agents in your operation is high enough to warrant extra caution. Due diligence does not end with proper employee vetting and monitoring either. At every level of the supply chain a company deals with various agents, middlemen and gatekeepers who act as a liaison between your firm and another link in your supply chain. Everyone who does business in China has had the unpleasant experience, or know someone who has had the experience, of a deal with a middleman going sour, and at best losing the supply chain – or at worst such a middleman running off with your design and deposit to make a cheap copy of your product. Working with middlemen is largely unavoidable, so it is critical to run your own investigation into your supply chain and constantly reevaluate its trustworthiness. Much can be said for a diverse, resilient supply chain, but for the case of many SMEs, it’s simply not possible to invest in multiple supply chains. The only alternative to protect yourself is to make sure you know who you are dealing with.

Competitive Risk

The final form of risk to discuss is market risk, specifically in the form of risk from other firms, or competitive risk. As stated, China is currently the largest market and a dynamic ever shifting business environment, so naturally there will be competition both from domestic and foreign firms (or varying levels depending on industry). This type of competition is simply the sign of a healthy economy, and not the type of competition that a firm should be shocked to encounter. The additional risk in China is the high levels of illegal competition – IP squatters, fakes and knockoffs, “licensed distributors” that are anything but, and outright corporate espionage. If you search for a name brand product on Taobao there is a very good chance that you will find more knockoffs than you will legitimate products. Unfortunately, it is simply the cost of the rapid digitalization China has enjoyed; regulators have not been able to catch enforcement up to the rate of growth, resulting in the perception that the government will not help firms protect their intellectual property. Since the government capacity to deal with illegal competition is still relatively low, the responsibility again falls on the firms.

What should you do?

With all of these risks, what can firms do to protect their supply chains, brands, and bottom lines? As in most cases – knowledge is power. Effective, firm tailored market research that details illegal competition is a must for firms entering China or those that are considering expansion. Investigations on supply chain partners to ascertain trustworthiness are critical in keeping your supply chain functioning. Proper compliance strategies from the beginning or immediate adoption of superior strategies is also necessary to ensure your business in China is as successful, or even more so than your other international branches.

Blake Jeanniton is an economist and researcher based in Shanghai. You can find him on LinkedIn here.

The opinions expressed here are those of the author and do not represent the views of European Guanxi.

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