Risks for foreign investors

Although investing through V.I.E.s can be extremely lucrative, it also comes with a risk to foreign investors. Because V.I.E.s evade Chinese regulatory supervision, they lack official approval from Chinese authorities. Normally, for a foreign company to invest in a Chinese company, the Ministry of Commerce of the People’s Republic of China (MOFCOM) must approve the equity transfer, but gaining approval is very difficult to acquire. V.I.E.s circumvent this approval process and Chinese authorities might view it as a foreign investment in a restricted industry without proper MOFCOM approval. As a result, these foreign investors risk the chance of Chinese authorities invalidating the V.I.E. contracts. Additionally, Chinese shareholders of the V.I.E. and Chinese courts may refuse to uphold the contractual agreements made through these V.I.E.s and cause investors to lose their holdings. Companies may also struggle to find trustworthy Chinese shareholder nominees for their operating companies unless they already have trustworthy connections in China.

Recent developments of VIE in China

Our research shows that recent developments and rulings by Chinese courts have made V.I.E. contracts seem even riskier than before. In 2011, Alibaba terminated its V.I.E. contracts, dramatically hurting the shares of Yahoo, who held a 40% stake in the company. Then in October of 2012, China’s Supreme People’s Court’s ruling invalidated certain contracts that concealed illegal intentions. Although these recent developments undoubtedly increase the risk of investing in these Chinese companies, the Chinese government does not want to cause the over 200 Chinese companies using V.I.E.s to panic by eliminating all U.S. listed stocks. Investors may continue to experience difficulties with Chinese authorities, but V.I.E.s are unlikely to be completely unwound in the country.

Sources:

New York Times 1

New York Times 2

K&L Gates

Reuters

This article China Research: uncertain future of VIEs is the first one to appear on Daxue Consulting - Market Research China.

China’s current nuclear energy infrastructure

Nuclear power currently contributes a mere 1.97% of total energy production in China, but this number is soon to rise. Following the 2011 nuclear disaster in Japan, Germany announced it plans to decommission all its nuclear plants, Italy and Switzerland halted any plans to build additional plants, and Japan shut down all its reactors. Unlike these countries, China is choosing to ignore the possible dangers with the belief that nuclear energy will provide more good than bad. Mainland China currently employs 17 nuclear power reactors, but there are 28 reactors in production and even more to come. The country has become largely self-sufficient in the construction and design of nuclear reactors and plans to improve on current western technology.

Development of more advanced designs

In addition to increasing the quantity of nuclear plants in the country, China plans to develop new and improved models that would reduce toxic waste and improve safety. Westinghouse Electric recently developed a safer reactor design with a cooling system capable of averting a meltdown for up to three days after generation failure. China has already developed a larger version of this model and expects to begin construction this year. The country also is developing a pebble-bed model that has yet to be perfected, but would be more efficient than the currently used pressurized-water reactors.  Pebble-bed models use helium as a coolant and graphite as a moderator in place of water. Although the pebble-bed model would be superior to existing models in theory, scientists and engineers have run into problems when trying to produce one in the past. At high temperatures, the graphite pebbles in the model tends to stick causing them to overheat and disintegrate. The result is radioactive graphite and a dust of fuel products. Beijing’s Tsinghua University is currently designing the Chinese pebble-bed model, but could lose billions of dollars if the model is unsuccessful. Germany’s pebble-bed prototype ended in failure and cost about $7.3 billion to clean up.

In a project led by Jiang Mianheng, China is also exploring the idea of thorium reactors. These reactors would reduce the reactors toxic waste and be safer to operate. Jiang recruited 140 PhD scientists at the Shanghai Institute of Nuclear and Applied Physics and plans to have 750 by 2015.  China is estimated to have enough thorium to meet its electricity demands for an estimated 20,000 years. Thorium is also plentiful in the US, the UK, and many other countries.  In addition, these thorium reactors would be able to incinerate existing residue from old reactors and nuclear weapons, cleaning up the already existing nuclear waste. The project is so promising that Xu Hongjie, director of the Shanghai project, says the US Department of Energy is seeking collaboration the project. If China succeeds in developing these advanced models, the country will soon become the leader in nuclear power.

Sources

• World Nuclear Association
• Businessweek
• Smithsonian
• The Telegraph

This article Market Study: China set to become a leader in nuclear energy research is the first one to appear on Daxue Consulting - Market Research China.

Caterpillar’s struggles in China

Even though China’s recent increase in interest rates has slowed the Chinese construction industry, the country remains as one of the largest market for excavators. Market studies show that last year, Sany maintained its dominance in this market with a total market share of 11% for excavators compared to Caterpillars 7%. Caterpillar, the global industry leader, struggled to gain market share in the Chinese construction boom from 2008-2012. Although Caterpillar’s excavator sales quadrupled from 2005-2010, its market share shrunk from 11% in 2005 to 7% in 2012. Ed Rapp, a group president at Caterpillar, recently stated, “the best way to beat the Chinese outside of China is to compete and win with them inside of China.”  Despite this, Caterpillar is struggling to compete with China’s domestic manufacturers like Sany as shown by its recent write-down in the value of a Chinese mining-equipment manufacturer it bought last year.

Obstacles impede Sany’s entrance into the U.S. market

Similarly to Caterpillar’s struggle in China, Sany is struggling to penetrate the U.S. market. Although the company opened a factory in the U.S. in August of 2011, its lack of a dealership network poses as an immense obstacle in its entry into the U.S. market. The new Sany plant can produce about 20,000 excavators per year, but currently produces only about half of that due to the lack of demand. Since opening the factory, Sany has sold only a few hundred excavators compared to the 24,000 sold in the U.S. last year. In addition, the company lacks the core skill and technology to build some of its parts, which it purchases from other companies. This puts Sany at a disadvantage to companies like Caterpillar, especially in an unfamiliar market.

Sany is working hard to improve its presence outside of China as it hopes to attain its goal of $47 billion revenues within 10 years. Despite the company’s reliance on the Chinese market, international sales have increased in recent years.  Sany is also looking for more acquisitions and joint ventures to diversify its product line and increase sales. Sany’s investors applauded its 2012 acquisition of German Putzmeister, a manufacturer of concrete pumps. Due to increased competition in China and uncertainty in foreign markets, Sany’s future is unclear, but the company hopes that its recent string of ambitious endeavors will pay off.

Sources:

CNN

Wall Street Journal 1

Wall Street Journal 2

Forbes

Sany official website

This article Market Study in China: Sany looks to reduce dependence on Chinese market is the first one to appear on Daxue Consulting - Market Research China.

Growing environmental concerns

Many companies in China are notorious for violating many environmental standards and regulations. These unsustainable practices have created near irreparable damage to the Chinese environmental and Chinese consumers are beginning to take notice. Air pollution is becoming so bad that simply stepping outside can be dangerous for many people. Readings above 500 on the Environmental Protection Agency’s air quality scale are now fairly common in Beijing. Water pollution is also a problem as more than half of China’s surface water is so polluted that it cannot be treated to be drinkable and a quarter of it is so polluted that it cannot be used for industrial purposes. The air pollution has even created “cancer villages” where pollution is so poor that simply living in these areas can cause cancer. These issues have grown so large that the public can no longer ignore them.

Food scares

China has experienced numerous high-profile food incidents within the past decade. Many food suppliers in the country have been using pesticides and dangerous food additives to make food appear fresher and last longer. In 2008, six babies died and 300,000 became ill after drinking baby formula containing melamine. In 2011, consumers discovered pork that glowed blue due to a contamination phosphorescent bacteria. More recently, police in Nanning confiscated more than 20 tons of low-quality chicken feet from a meat warehouse, some of which had expired 46 years ago. With food safety concerns growing in the Chinese community, many foreign companies are beginning to market their green credentials to gain a competitive advantage over some of their native Chinese competitors.

Green marketing

Euromonitor International’s 2012 survey of 16,000 Chinese consumers revealed that “Green/environmentally” friendly mattered strongly to 81% of respondents. Similarly, a survey by Landor Associates shows that Chinese consumers are more concerned about green issues than consumers in the United States or Europe. Although some experts believe that there is a huge disparity between the claimed and actual sustainable behavior of Chinese consumers, it is undeniable that environmental sustainability is becoming a growing concern for Chinese consumers. China has experienced a surge in environmental NGOs and now as 3000 environmental NGOs in the country. These NGOs are raising awareness of environmental issues in China and some are even showing consumers which brands are operating sustainably. The Green Choice Consumer Action released a “polluter’s blacklist” that lists 20 companies operating in China that violate environmental standards. This list, backed by 34 NGOs, was published online where it was widely received by many Chinese consumers. As more Chinese citizens become more environmentally aware, consumers will begin choosing these green products even over the less expensive big name brands.

Daxue Consulting Marketing Research

Sources:

Euromonitor International

China Daily

CNN

Huffington Post

This article Chinese consumers’ increasingly green lifestyles is the first one to appear on Daxue Consulting - Market Research China.

Current life insurance market

In 2011, China Life, China Pacific Insurance, and Ping An Insurance dominated the market while controlling over half of the total revenue in the industry. Unfortunately for Chinese consumers, this high concentration in the market has limited innovation in life insurance products and diminished these company’s need to offer high quality service. This year, China’s domestic life insurers, who normally dominate the industry, are struggling as cash flows are expected to decrease due to an increase in contract cancellations and a massive increase in maturing policies. China Life Insurance Co.’s surrenders more than doubled, amounting to 20.1 billion yuan in the first quarter of 2013. Many customers are realizing that there are more lucrative investments such as wealth-management products offered by Chinese banks.

An opportunity for foreign life insurance policies

Although many Chinese citizens are beginning to surrender their life insurance contracts, the Chinese upper class has no intention to follow. Instead, they are keying in on foreign life insurance policies, investing in megapolicies ranging from $10 million to $100 million. Although large life insurance policies are expensive and yield modest returns, it gives the Chinese upper class a safety net to offset some of the riskier investments they make. For example, if a company fails, owners are often responsible for payments, but life insurance policies are protected from liquidation.

Offshore insurance policies also offer higher returns due to the cap the Chinese government put on domestic companies to preserve their positive margins. Offshore companies can offer up to 4% compared to the 2.5% returns offered by mainland companies. As a result, customers of mainland companies pay about 48% more in premiums for the same coverage compared to their counterparts in Hong Kong. Additionally, offshore banks allow customers to borrow against policies offshores because they have higher liquidity than other investments.

Despite this growth in offshore policies purchased in China, they also have a downside that may limit some Chinese businesspeople from purchasing their products. To purchase megapolicies, customers must pass a medical examination, but few Chinese business people can pass these tests without red flags. As a result, Chinese businesspeople tend to overpay by 7-10% compared to customers in Singapore or Taiwan.

Sources:

UPenn PDF

Bloomberg

The Wall Street Journal

World Financial Review

China Market Intelligence

This article Market research: Chinese upper class to look towards foreign life insurance policies is the first one to appear on Daxue Consulting - Market Research China.

In his 2012 TED talk, Michael Anti discusses how China has made great strides in online social networks even though the government censors the internet. Unlike the United States where citizens enjoy complete freedom of speech, Chinese internet users are restricted from many foreign sites and are forbidden to talk about certain issues online. Although many foreigners may think that this censorship denies Chinese citizens of an inalienable right, Chinese citizens still receive a fair amount of freedom through its own social networks such as Weibo. The Chinese internet firewall acts similarly to the Great Wall in that it prevents foreigners from getting in while also preventing Chinese citizens from seeing certain things from the outside world.

China boasts the largest population of internet users in the world with a staggering 500 million netizens, yet it is one of only four countries in the world to block Facebook. Although most countries’ citizens would be outraged by the censorship of these major websites, China has been very smart in its censorship. It employed a “block and clone” strategy and replaced major sites such as Google, Twitter, Facebook, and YouTube with their own versions: Baidu, Weibo, Renren, and Youku. The country realized the two-hand rule with social networks: the government must allow for social networking, but keep the server within the country. Using this rule, China can satisfy its netizen’s desire for social networks, but can also maintain control over the server.

First national public sphere

Although these social networks may be censored, it provides Chinese citizens with their first national public sphere of communication. Before these social networks, it was very difficult for Chinese citizens to voice their political opinions. In addition, local governments lacked the power to do anything about any of their citizens’ complaints, so many petitioners and peasants would travel to Beijing to settle their problems with the central government. The government feared that eventually too many petitioners would come to Beijing, starting a revolution, so they sent them off.

Weibo and other social networks revolutionized the lives of Chinese citizens as members could voice their opinions online without having to go to Beijing. For example, in 2011, two trains crashed in China and local government officials tried to cover it up by burying the train. Thanks to Weibo, 10 million citizens posted about the crash in outrage and the Chinese government sentenced the rail minister to 10 years in jail. Social networking serves as a locus of activism and complaint, something Chinese citizens have never had.

Abuse of power

Despite this revolutionary addition to the lives of Chinese netizens, the government still abuses censorship as a political tool. It supports companies if they agree to abide by its censorship policies and remove anything that goes against the Chinese regime. For example, Weibo agreed to analyze every political post and restrict users from posting anything about Hu Jingtao or the city of Chonqing. As a result, Weibo rose to popularity extraordinarily quick and replaced Twitter within a month of its official blocking. In addition, the government can choose not to censor certain political posts that reflect their own views while eliminating the posts that do not.

In conclusion, Michael Anti states that although Chinese internet still has a ways to go, the Chinese blogosphere allows citizens to voice their opinions on a national stage. This is slowly shifting the balance of power away from the government and to the people.

Sources:

• TED 1
• TED 2
• The Huffington Post
• The New York Times
• China Research

This article China research: Internet censorship is the first one to appear on Daxue Consulting - Market Research China.

Factors responsible for rising manufacturing costs

In 2005, it was common for companies in the US to save about 25-30% on manufacturing by moving their plants to China. This number is no longer a reality as the gap in manufacturing costs has narrowed down to nearly one-third of what it once was. Although factors such as an increase in the value of Chinese currency, an increase in shipping costs, stricter environmental and safety regulations, and higher taxes have all contributed to the increase in Chinese manufacturing costs, labor remains the main factor for this increase. Labor costs have increased an average of 12% per year over the past decade and about 20% per year in the past four years. According to AlixPartners, a consulting firm, manufacturing costs in China could catch up to US manufacturing costs by 2015. Although this would require an annual increase of 30% in wages and a 5% rise in shipping costs, this could be a reality if manufacturers do not change their practices.

Adapting to changing Chinese market

Despite this increase in manufacturing costs, manufacturing is unlikely to leave the country anytime soon. According to Hal Sirkin of Boston Consulting Group, companies are unlikely to leave China due to the increasing demand from Chinese consumers. He estimates that Chinese domestic demand is increasing at about 8-10 percent per year. All manufacturers need to do is adjust their manufacturing plants to serve the needs of Chinese consumers rather than western consumers. In addition, China offers more reliable suppliers of services involved in the manufacturing process compared to other developing countries. Other problems such as less efficiency and a lack of reliable supply chains usually offset the 30% difference in labor costs between China and cheaper countries. Similarly, China’s inland infrastructure and logistics are not developed enough for manufacturers to move west. Only firms planning to serve customers in inland China are likely to move away from China’s bigger cities. Although many low-tech, labor-intensive industries may soon leave China or move inland, high-tech equipment will remain on China’s coastline. China’s immense labor pool is much more productive and flexible than those of other countries and it remains cheaper than manufacturing in developed countries. Until a country can match China in not only price, but also availability of resources, the manufacturing industry is unlikely to leave China.

Sources:

Daxue Consulting Market Analysis in China

The Economist

CNBC

Picture source: The Economist

This article Market analysis: Rising labor costs in China is the first one to appear on Daxue Consulting - Market Research China.

China is expected to surpass the US as the world’s leading premium car market

Within 7 years, China will top the US as the largest premium car market. The country’s premium car market is forecasted to grow at an annual rate of 12%, 4% faster than its overall car market. Research from a McKinsey report estimates that by 2020, China will be selling about 3 million premium cars compared to only 2.3 million for the US (Forbes). Foreign car manufacturers will primarily fuel this growth, as domestic brands such as Geely and Shanghai Automotive have yet to develop their own lines of luxury cars. Domestic car manufacturers only managed to capture a 38% of the country’s passenger vehicle sales in June compared to the 47% at the end of 2012. As the average income of the Chinese urban population rises, the presence of German luxury car brands such as Audi, Mercedes Benz, and BMW will grow while demand for domestically developed cars declines.

Market volatility and foreign competition may inhibit the growth of China’s car market

Currently, there are over 100 automakers in China, but this number may fall with increased foreign competition and market volatility. Car exports are declining due to the diminishing demand from emerging markets, protests in Turkey and Brazil, and the rising value of the Yuan. (The Wall Street Journal) In addition, foreign competition is growing every year and Chinese manufacturers are struggling to keep up. Changes in urban government policies and consumer preferences are also hurting Chinese car manufacturers. More cities plan to follow Beijing and Shanghai in limiting the number of automobiles on the street (McKinsey). This combined with the urban consumer’s growing emphasis on quality and safety could hurt the sales of domestically developed cars. Unless domestic manufacturers can improve the quality of its cars, foreign luxury auto-manufacturers may increasingly dominate the Chinese car market.

Sources

• Forbes
• McKinsey & Company
• McKinsey China
• The Wall Street Journal
• Market Research in China

Picture: Audi Beijing

This article Research: China’s growing demand for foreign luxury cars is the first one to appear on Daxue Consulting - Market Research China.

Problems with current healthcare infrastructure

Recent reforms have extended basic medical coverage to 97% of China’s population while also decreasing Chinese patients’ out-of-pocket payments. Although this should improve Chinese healthcare in theory, these reforms have created staff shortages in Chinese hospitals. There are only 1.8 physicians and 1.7 nurses per 1000 people in China and many members of medical staffs are unqualified. This shortage has led to extremely long lines in big urban hospitals. As a result, many patients have received improper service or no service at all. In addition, China’s lack of a good primary care infrastructure forces many patients to go to big urban hospitals for matters that do not warrant extensive medical attention. The Chinese government also controls prices on lower priced drugs, services, and devices, but allows hospitals to overcharge for expensive products and services. This has created a conflict of interest between patients and physicians because the policy encourages doctors to prescribe unneeded services and drugs to increase the amount of money made on each patient. Lastly, a lack of high-quality step-down care facilities has forced patients at acute-care hospitals to stay longer than their western counterparts. The average length of stay for patients at these hospitals was 12 days in 2011. This causes overcrowding at hospitals for patients that could normally receive medical attention outside of a big hospital.

An opportunity for foreign investment

Over the course of the past 30 years, China has decentralized its once fully government run healthcare system and opened it up to foreign and private investment. The government realizes that it cannot meet the healthcare demands of its citizens and improve the country’s standards of care without privatizing healthcare. China intends to establish non-public healthcare institutions, particularly in lower-level facilities in rural areas or poor urban area. Although private healthcare services used to have a bad reputation for poor quality, this perception is beginning to change as more foreign investors enter the market.

Private healthcare patients used to be predominately composed of foreigners, but the number of Chinese patients is rapidly increasing. This presents an opportunity for foreign investors to set up wholly owned foreign hospitals that target the premium segment of China’s healthcare market or to partner with local service providers to apply their management expertise to existing Chinese facilities. In addition, foreign pharmaceutical companies could target China’s growing need for new pharmaceutical products to expand into the Chinese healthcare market. China also has an abundance of research funding that foreign medical researchers could utilize to collaborate with Chinese researcher.  Even though it may take a couple of years for the public’s perception on private healthcare to change, several opportunities exist for foreign investors to expand their services into China.

Sources:

• PWC
• Wharton – U Penn
• China Daily
• Market Study in China

Picture Source: Chinese hospital

This article Market study: China’s private healthcare sector is the first one to appear on Daxue Consulting - Market Research China.