Penetrating the Chinese Market

Penetrating the Chinese Market: A Feasibility Study of Market Conditions in China as regards the Decision of McLaren Motors to set-up a manufacturing plant in China
Feasibility Study carried out by:
Advent Consulting

TABLE OF CONTENTS
1.Executive Summary ..........................................................................................................4
2 Background of Feasibility Study........................................................................................5
3. The State of Manufacturing in China..................................................................................6 3.1 The Automobile Industry in China..............................................................................7
4. Doing Business in China: Culture & Business Systems.....................................................8
5. Trade between America and China...................................................................................10
6. Exchange Rate Processes between China and America...................................................11
7. Entering into China: Joint Venture Arrangements...........................................................12
8. Operating in China: Political Risks..................................................................................12
Conclusion & Recommendations.........................................................................................13
References............................................................................................................................14

1. EXECUTIVE SUMMARY
The CEO of a Multi-National Corporation (MNC) –MClarensMotors which is based in the United States, has approached a team of researcher(Advent consulting) to prepare a report on the company’s decision to penetrate the Chinese market.
In carrying out this feasibility study, issues like the cultural and business systems in China, nature of the automobile industry in China, nature of trade relations between America and China, exchange rate systems between America and China, and the level and nature of political risks within the Chinese business environment.
There is no doubt that the America and China differ in several regards, particularly in the nature of their political and economic systems. In spite of this, enormous opportunities exist within the Chinese market, especially for an automobile firm like McLaren Motors. Based on the analysis contacted, there is need for McLaren to develop sustainable relationships with local Chinese business and government contacts; this will help the company to wade through the rigid bureaucratic processes that exists within the Chinese economy. Finally, when it comes to the preferred mode of entry into the Chinese market, Joint venture arrangements should be the preferred mode of entry for McLaren Motors. Joint venture arrangements will enable McLaren Motors to take advantage of the enormous domestic market in China.

2. BACKGROUND OF FEASIBILITY STUDY
This feasibility study was conducted to examine what the business environment in China is like and whether it favours the international expansion plans of Mclaren Motors, an American automobile manufacturer. In accordance with the rapid growth of the Chinese economy, Mclaren Motors seeks to take advantage of both market opportunities and cost efficiencies that are obtainable within the Chinese market.
As mentioned earlier, Mclaren Motors is a manufacturer of road cars. The company’s headquarters is located in the United States of America. At present, the company has production facilities in America, the United Kingdom and Mexico. Its consolidated annual revenue for the year 2010 was US$456 million and its net profit in the same year was US$235 million. The company has been in existence for the past ten years and has become known as a global brand. While the company has leveraged on the North American and European market, it is yet to fully take advantage of the enormous market size of most of the Asia-pacific economies. In line with this particular observation, the company seeks to penetrate the East Asian market by first establishing an enormous production facility in China. The company believes that if it can consolidate is operations in China, it can succeed in penetrating other countries in the East Asian region. With a population of over a billion people (CIA, 2009), China has an enormous domestic market; this is one of the reasons why McLaren Motors wants to enter into the Chinese markets. The company wants to set-up a production facility in China and also intends to sell its cars in China.
In accordance with these observations, this feasibility seeks to examine what the market conditions in China are like and whether it favours the decision of McLaren Motors to penetrate the market.
3. THE STATE OF MANUFACTURING IN CHINA
Ghimire (2006) suggested that with China’s economy growing in average of about 7.5% annually, investing in the manufacturing sector in China tends to be favourable for foreign firms. The World Bank (2008) noted that the manufacturing industry in China is now ranked 4th globally after America, Japan and Germany. The same report by the World Bank added that China’s rapid growing domestic market, global demand for goods made in China together with the cost efficiencies that the Chinese economy offers to manufacturers is responsible for the growth of the manufacturing industry in China.
Electronics Weekly (2008) noted that China controls about 45% of the global camera market, 30% of air conditioners, 25% of washing machines and 18% of refrigerators. Furthermore, the same report by Electronics Weekly (2008) noted that the main industry segments in China that have attracted a huge deal of foreign direct investment includes; Metallurgy (with the increasing demand for steel, raw steel manufacturing in China increased by 28.5% in the year 2006), Electronics (bearing in mind that China is the preferred location for producing cheap electronic commodities, foreign and domestic investment in the production of consumer electronic commodities continues to be increasing even though the profit realized decreased by about 4.1% in the year 2006 in contrast to 2005), and Pharmaceutical (the sale of pharmaceutical products increased by about 23% in the year 2005 compared to the year 2004). Other sectors of the Chinese economy that has attracted a huge deal of foreign investment includes; petrochemical, paper manufacturing, textiles, coal and automobile. This statistical information highlights the fact that manufacturing is profitable in China; in addition, one can note the lucrative nature and diversity of production activity in China.
According to Bloomberg News (2009), the manufacturing industry in China grew at the most rapid pace in more than six years in October, to 55.6 from 55.2 in September, according to a purchasing managers’ statistics put together by HSBC Holdings Plc. One must note at this point that figures or readings that are higher than 50 reflect expansion and growth. BBC (2009) noted that China’s ever growing manufacturing sector poses a global challenge, especially to the major industrialized nations of the world, notably in the West. The aforementioned statistical information on production activity firmly supports the decision by Mclaren Motors to set-up a production facility in China. The information contained above shows a forecasted growth in manufacturing activity although not accompanied by an increase in domestic consumption. With regards to the decrease in domestic consumption, Bloomberg News (2009) noted that domestic consumption is forecasted to increase significantly in four years especially as the Chinese are becoming more well-to-do.

3.1 The Automobile Industry in China
As at the year 2009, China became the biggest automobile market in the world. The rapid growth and development of the Chinese automobile industry can be traced to the early 1990s (Harwit, 2001). The annual automobile manufacturing capacity of China first went passed one million vehicles in 1992. By the year 2000, China was manufacturing about 2.5 million cars (see Figure 1). After the entry of China into the World Trade Organization in the year 2001, the development of the car industry in China was accelerated further (Harwit, 2001).
In the year 2009, China manufactured 14.76 million units of automobile out of which 9 million units consisted of passenger cars (SUVs, Multi-purpose cars, sedans and crossovers), and 4.1 million units consisted of commercial cars (trucks, buses and tractors). Out of the aggregate sum of cars manufactured in China, 43.4% consisted of local Chinese automobile brands namely; Chana, Geely, Hafei, Jianghuai, Great Wall (see Figure 2), Lifane.t.c. The rest of the vehicles manufactured in China were manufactured via joint venture arrangements involving foreign automobile firms like Volkswagen, Nissan, Toyota, Honda, General Motors e.t.c (ChinaAutoWeb.com). The Economist (2009) noted that majority of the cars produced within China are usually sold in China, with only about 459,000 cars that are being exported as at the year 2009. This is evidence of growing domestic consumption. Such information yet again favours the decision of McLaren Motors to enter into China. Reuters (2009) noted that between the years 2002 and 2007, China’s vehicle manufacturing capacity rose by 40% while its national automobile market rose by 22%. Reuters (2009) again added that in the year 2007, China manufactured over nine million vehicles.

Source: Reuters (2009)
Figure 1: Aggregate number of cars produced in China

Source: ChinaAutoWeb
Figure 2: Great Wall SUV (local Chinese brand)
The Economist (2009) noted that the automobile sector in China still possess enormous growth potential. The Economist went further to add that still less than six people in 1000 own a vehicle of their own. Drivers in China purchased 8.6 million cars (5.4 million vehicles, minivans and SUVs and 3.2 million commercial cars). Reuters (2009) forecasted that the sale of automobiles in China should rise by one million cars every year until the year 2015. Again, Reuters (2009) added that the number of households that can afford to buy a vehicle is expected to rise from 9 million in the year 2006 to 70 million by the year 2015. This is supported by the fact that the government of China is putting in place measures to encourage a car culture and as such, developing a car industry unlike never seen before. The major car manufacturing clusters are situated in Guangzhou, Tianjin and Shanghai (ChinaAutoWeb.com). Reuters (2009) noted that it is the intention of the Chinese government to make Guangzhou the ‘Detroit ofThe People’s Republic of China’.
4. DOING BUSINESS IN CHINA: CULTURE AND BUSINESS SYSTEMS
China presents a paradox of sorts. The manner in which it adopts some dictates of capitalism whilst still holding on to its communist ideals has amazed many countries. The economic system of China is capitalist in nature but its political structure is communist. As a nation that adopts Confucianism, the nature of Chinese society is such that it is widely collectivist in nature. From a cultural perspective, the Chinese value family, relationship and trust a great deal. The need to understand the culture of a nation is an essential requirement of global and transnational corporations. Proper understanding of cultural systems can enhance the ability of an organization to adopt rapidly in a foreign or new environment (Hofstede, 2001). In this regards, a Western business operating in China cannot expect to behave in the same way it will behave in its homes country or the country where it is domiciled to (Dunfee, 2001).
In China, the development of relationships is essential. The Chinese value relationships a lot and will not deal with anyone that they have not had a previous relationship with. This is the reason why trust is a vital part of relationship-building in the Chinese context. As a result of this situation, many foreign businesses seeking to establish in China must first make themselves known to their local Chinese contact before proceeding with other formalities that border on getting the business going. Another effective means of building relationships in China is through the exchange if gifts. In China, giving gifts is an essential part of their customs and traditions, and this also extends to business. Gifts can speed up the development of relationships rapidly. Again, Dunfee (2001) noted that the giving of gifts is an essential component of the ‘guanxi’ concept. The guanxi concept can more or less be interpreted as, “if you scratch my back, I will return the favour by scratching yours’. The guanxi concept has been the subject of debate among business and academic circles for some time especially as it seemingly and supposedly goes against business ethics. For one, the guanxi concept can be interpreted as a form of corruption or bribery of some sort. Dunfee (2001) noted that the guanxi concept is a form of discreet bribe. While the giving of bribes to business and government officials in return for favours is not common in Western society, it is widespread in Chinese culture. Transparency International (2009) ranked China number 78 on its corruption perception index. The offering of bribes or guanxi is an essential aspect of the business system in China. In fact, Transparency International (2009) noted that most of the foreign businesses operating in China have at one time or the other offered bribes to a government official in return for certain favours. This can be interpreted as, “when you are in Rome, you behave like the Romans”.
Mclaren Motors must be aware that in order to penetrate the Chinese market, it must adopt some aspects of Chinese culture. Relationship-building, especially with local government or provincial officials, through the exchange of gifts is something that McLaren Motors must engage in if it is to find its way around the excessively bureaucratic structures that lie within the Chinese business environment. Again, McLaren Motors must understand that in China, it is essential to establish a relationship with a local Chinese contact if it is to blend into the Chinese market. Hofstede (2001) was of the opinion that the process of appreciating and understanding the culture of a foreign nation can be costly hence, organizations must be willing to invest towards an understanding of the cultural systems of a foreign market where there operations are located. This is an essential component for success. This is why most multinational corporations presently have what is called ‘global managers’. Such global managers are there to ensure that the foreign operations of the firm are constantly adapting to changing cultural patterns.
5. TRADE BETWEEN AMERICA AND CHINA
The nation of China maintains a trade surplus with the globe’s main economic nerve centres; America, Japan and the European Union. Since the year 2000, the American economy has earned its greatest bilateral trade deficit with the Chinese economy (US$202 billion in 2005, representing a 25% increase from the year 2004). By the year 2003, China had taken over Mexico as the second biggest origin of imports for America. China’s percentage of American imports stood at 15.5% in the year 2005, though this percentage is still lower than Japan’s 18% of the early nineties. America is China’s biggest foreign market and second biggest origin of foreign direct investment (Lum& Nanto, 2007). IMF (2006) noted that the rate of exports from the American economy to the Chinese economy has been rising steadily although it is still lower rate compared to Chinese export to America. This imbalance has been the source of America’s huge trade deficit with China. What this implies is that China’s huge trade surplus is a function of America’s huge trade deficit.
IMF (2007) noted that in 2004, China took over Germany and the United Kingdom to become the fourth biggest market for American commodities and is still the fastest rising main American export market. The fact that China maintains a huge trade surplus with America and the other major economies does not eliminate the fact that China grapples with trade deficit problems of its own. Lum& Nanto (2007) noted that China has been maintaining trade deficits with some of its Asian trading partners, particularly South Korea and Taiwan.
In the last decade, the most dramatic increases in American imports from China have not been in labour-centred segments but in some advanced technology sectors, like office equipment, sound equipment, telecommunications equipment and electrical equipment. Again, exports from China to America tend to be taking over market share from other Pacific Rim nations, especially the East Asian new industrialized nations, which have taken a majority of their low-end manufacturing facilities to China (IMF, 2006). In addition to the fact that America is consuming more Chinese goods than China is consuming American goods, another factor that is largely responsible for America’s huge trade deficit with China stems from the difference in their currency systems; a major source of current global trade and financial imbalances. This problem has not been helped by the fact that many American businesses are increasingly moving their manufacturing activity to China in a bid to take advantage of reduced production costs. The issue of different currency system will be addressed in the subsequent section of this study.
Figure 3 shows the discrepancy or imbalance, especially as it concerns imports and exports, that exists in America’s trade with the rest of the world, especially with countries like Mexico and China. Figure 3 shows that while America’s trade with Mexico stands at about US$195 billion and its trade with China stands at about US$165 billion, 41% of America’s trade with Mexico consists of exports while only 15% of America’s trade with China consists of exports.

Source: Lum& Nanto (2007)
Figure 3: Trade between America and the rest of the world
6. EXCHANGE RATE PROCESSES BETWEEN CHINA AND AMERICA
In the previous section of this feasibility study, currency differences were cited as one of the main causes of the global trade imbalances that persist today. China and the United States operate different currency systems. In fact, China’s system of managing its currency values differs considerably from what obtains in most countries in the West. Frankel (2007) noted that China operates a fixed exchange rate regime while America operates a floating exchange rate regime. China’s operation of a fixed exchange rate regime means that its currency is always less in value than the American dollar. Frankel (2007) noted that the fixed exchange rate system that China operates is manipulative in nature thus, giving its economy unfair advantage over other economies. Currency manipulation is against the IMF’s Articles of Agreement. This is why in recent times, China has been facing increasing pressure on the need to reform its currency system.
While the fixed exchange rate system being operated by China makes the Chinese ‘Renminbi’ unfairly stable, the floating exchange rate system being maintained by the United States make the American dollar volatile. Extremely low volatility in China’s currency also makes China’s economy more attractive for foreign businesses. This is because currency stability of the host nation is something that multinational enterprises usually take into consideration when appraising their decision to enter into a foreign market. The relative stability of China’s currency makes China a favourable environment for McLaren Motors to establish a part of its operations. The stability of China’s currency means that it can accurately forecast what its revenues and profits will be.
7. ENTERING INTO CHINA: JOINT VENTURE ARRANGEMENTS
Hill (2005) defined a joint venture as a business arrangement in which parties involved agree to develop, for a particular time, a new organization and new assets by contributing equity. As a result of the equity contributed, the parties involved exercise control over the new organization or enterprise and as a result, share profits, assets and costs. Ghimire (2006) likened joint venture arrangements to ‘consortiums’. In the section that addressed the nature of the automobile industry, it was cited that majority of the foreign automobile brands that operate in China, do so through joint venture agreements. This is because since most of the cars produced in China are sold in China, joint venture arrangements with local Chinese auto companies provide a useful platform for penetrating the local Chinese market. In this particular context, joint venture arrangements in China are borne out of a marketing concern. Overall, in this regard, it will be more beneficial for McLaren Motors to penetrate the Chinese market through joint venture agreements with a local Chinese automobile manufacturer as opposed to setting up its own production facility from scratch.
8. OPERATING IN CHINA: POLITICAL RISKS
Hill (2005) defined political risk as the risk that a supposed return on a particular investment could suffer set-backs as a result of changes in political systems and structures. When entering into a foreign market, the level of political risk should be an imperative concern. Policies like nationalism can lead to an investment being designated as a failed investment concern. As a result, there is a need for foreign businesses seeking to enter into a new market to carefully examine the nature of governance and policy undertones in a particular country before committing resources or investment of any kind.
Earlier in this study, it was mentioned that China operates a communist system of government. The communist system of government defers extremely from the capitalist system of government being operated by many countries in the West. The communist government whilst putting in place measures to attract foreign investment, does not tolerate any form of dissent or criticism of its policies. For instance, the recent boycott of the Nobel peace prize award ceremony of the Liu Xiabao, the Chinese intellectual, acts as a useful example of how countries with interests in China seem intent on protecting their political interests. With regards to these observations, McLaren Motors must strictly attend to its business concerns and shun political or human rights issues; such are the concerns of the Chinese government. This is absolutely key if McLaren Motors is to have an uninterrupted existence in China.
CONCLUSION AND RECOMMENDATIONS
Based on the different aspects of the feasibility study examined, the recommendations outlined below should act as a guideline for McLaren Motors to make a decision on its intention to enter into China: * Before entering into China, there is a need for McLaren Motors to first establish a relationship with a local Chinese contact. The building of such a relationship will enable McLaren Motors to wade through the bureaucratic structures that exist in China. Such a relationship must be built on trust if the relationship is to be a long term one. * The formation of strategic alliances (joint venture) with a local automobile manufacturer is the preferred mode of entry for penetrating the Chinese automobile market. Most of the foreign automobile companies operating in China operate through a string of joint venture arrangements. In spite of this, care must be taken by McLaren Motors when selecting a local Chinese partner. Any arrangement being entered into by McLaren Motors must be such that it gives McLaren Motors over the standards and quality of its products. This is particularly important especially in a Chinese market where quality concerns are widespread. * Since it is relatively cheaper to produce in China, McLaren Motors can take advantage of the favourable policies of the Chinese towards encouraging exports to use the Chinese market as a veritable centre for exports to other countries of the world. * If McLaren is to survive in China, it must always put its business and investment concerns. McLaren Motors must not concern itself with the political structures and policies of the Communist government. This lack of interest in local Chinese issues will go a long way in decreasing the potential for political risk variables to materialize.

REFERENCES
Bloomberg News (2009) Ray of Light: China’s manufacturing sector continues to strengthen. http://www.blomberg.com [12 January 2011]
CIA (2009) Country Profile: China. Accessed from: http://www.cia.gov [11 January 2011]
Dunfee, T., W. (2001) Isguanxi ethical? A normative analysis of doing business in China.Journal of Business Ethics [online] vol 2. Accessed from: http://www.scholar.google.com [13 January 2011]
Electronics Weekly (2008) Manufacturers still hopeful of upturn this year. Accessed from: http://www.electronicsweekly.com [14 January 2011]
Ghimire (2006) Business in China: investing in China. Accessed from: http://scholar.google.com [11 January 2011]
Harwit, E. (2001) The impact of the WTO membership on the automobile industry in China. The China Quarterly [online] vol 2 pp.655-670. Accessed from: http://www.scholar.google.com [13 January 2011]
Hill, J. (2005) World business: globalization, strategy and analysis. London: Thompson Publishing
Hofstede, G. (2001) Culture’s consequences: comparing values, behaviours, institutions, and organizations across nations. Thousand Oaks CA: Sage Publications
IMF (2006) Global Imbalances: a saving and investment perspective. Washington DC: International Monetary Fund
IMF (2007) World Economic Outlook. Washington DC: International Monetary Fund
Lum, T. & Nanto, D., K. (2007) China’s trade with the United States and the World.Congressional Research Service [online] January 4. Accessed from: http://www.fas.org/sgp/crs/row/RL31403.pdf [15 January 2011]
Reuters (2009) China’s fuel subsidy costs the world. Accessed from: http://www.reuters.com [13 January 2011]
The Economist (2009) More cars are now sold in China than in America. The Economist [online] October 23. Accessed from: http://www.ebscohost.com [12 January 2011]
Transparency International (2009) Corruption Perception Index: China. Accessed from: http://www.transparency.org [13 January 2011]
World Bank (2008) Global manufacturing indicators. Accessed from: http://www.scholar.google.com [12 January 2011]

References: Figure 2: Great Wall SUV (local Chinese brand) The Economist (2009) noted that the automobile sector in China still possess enormous growth potential 7. ENTERING INTO CHINA: JOINT VENTURE ARRANGEMENTS Hill (2005) defined a joint venture as a business arrangement in which parties involved agree to develop, for a particular time, a new organization and new assets by contributing equity 8. OPERATING IN CHINA: POLITICAL RISKS Hill (2005) defined political risk as the risk that a supposed return on a particular investment could suffer set-backs as a result of changes in political systems and structures REFERENCES Bloomberg News (2009) Ray of Light: China’s manufacturing sector continues to strengthen CIA (2009) Country Profile: China. Accessed from: http://www.cia.gov [11 January 2011] Dunfee, T., W Electronics Weekly (2008) Manufacturers still hopeful of upturn this year. Accessed from: http://www.electronicsweekly.com [14 January 2011] Ghimire (2006) Business in China: investing in China Harwit, E. (2001) The impact of the WTO membership on the automobile industry in China. The China Quarterly [online] vol 2 pp.655-670. Accessed from: http://www.scholar.google.com [13 January 2011] Hill, J Hofstede, G. (2001) Culture’s consequences: comparing values, behaviours, institutions, and organizations across nations. Thousand Oaks CA: Sage Publications IMF (2006) Global Imbalances: a saving and investment perspective IMF (2007) World Economic Outlook. Washington DC: International Monetary Fund Lum, T Reuters (2009) China’s fuel subsidy costs the world. Accessed from: http://www.reuters.com [13 January 2011] The Economist (2009) More cars are now sold in China than in America Transparency International (2009) Corruption Perception Index: China. Accessed from: http://www.transparency.org [13 January 2011] World Bank (2008) Global manufacturing indicators