Not so long ago, I spoke at a China round-table where someone asked me what sort of US businesses Chinese companies are interested in buying. I mentioned how Chinese companies typically buy US companies for one of two reasons: expertise or brand name. Later that night I thought about how Chinese companies should be buying US companies for their brand names, but they really are not doing so in any large numbers.
Newsweek Magazine recently did an interesting article (h/t All Roads) seeking to explain China's lack of brand names. The article is entitled, "Generic Giants:Why China Can't Create Brands" and it is subtitled, "China is the world's factory, but its top firms remain oddly anonymous." It posits cutthroat domestic competition and lack of IP protection as the cause:
The simplest explanation for China's failure to build global brands is cutthroat domestic competition. In most product categories, hundreds or thousands of firms compete for domestic market share, leaving profit margins razor thin. China has 150 firms licensed to make cars and other motorized vehicles, and more than 500 bicycle manufacturers. And because foreign brands have taken much of the market's high end, most companies are forced to compete on cost, leaving little room for investment in R&D or marketing. China's weak protection for intellectual-property rights—the patents and ideas that are the solid core of any brand—makes it risky for companies to invest heavily in innovations that could make them famous worldwide but could easily be stolen by rivals at home. Finally, the recent string of product recalls—including poisonous pet food and faulty tires—has left consumers wary of made-in-China goods.
I disagree.
First off, China's intellectual property protection for most companies is just not that bad. Yes it is horrible for companies requiring copyright protection, like software companies that sell their product on CDs and movie companies that sell their product on DVDs and publishing companies whose products are books. It is also horrible for pharmaceutical companies whose products can be easily duplicated, at least in appearance. And yes, China's patent protections are not nearly as rigorous as those in the United States, for instance. But, China's trademark protections are actually pretty good and there are a whole slew of foreign consumer and industrial companies making money head over fist in China, while doing a great job of building and protecting their brand name. KFC, Nike, Audi, Shangri-La, and Emerson Electric immediately spring to mind and there are hundreds of others, both big and small. China's IP protection may explain the lack of international brands in some product categories, but it does not even begin to explain the lack of Chinese brand power across the board.
The same is true of the alleged cutthroat competition. Yes, China has cutthroat competition (what country doesn't?) and yes price is central to the Chinese consumer. But many foreign and domestic brands are thriving. (Haier and Huiyuan, for example). No, that cannot be the explanation.
My explanation is more elemental. Most Chinese companies just do not value brands as highly as Western companies. At least not yet. For the most part, they do not understand the value in spending massive amounts of money to create positive brand name recognition in places like the United States.
I love telling a story of a matter in which I was called in to represent a US home goods company that was going to be entering into a joint venture with a Chinese company. The US company was based in the Midwest of the United States, where it had a really strong name. It had originally made its own product, but was now buying well over half of its products from a Chinese company, with whom it had a very good relationship. The plan was for the US company to help the Chinese company branch out into manufacturing more product and for the two companies to work together in expanding the products' footprint in the United States. The Chinese company would be expanding its product line while moving into the US wholesale and retail market and the US company would be getting access to Chinese product that would allow it to expand much more cheaply than if it were to make the product itself or even purchase it from some other Chinese company in a straight outsourcing deal.
The plan was to form a new US company, jointly owned by the Chinese and the American company and to market these home goods. The deal quickly fell apart, however, when the Chinese company insisted it wanted the new products to bear its company brand name. My client's insistence that using an unpronounceable Chinese name would be disastrous only seemed to cause the Chinese company to trust my client even less. These two companies still do business together, but their plans for worldwide domination have been put on hold. I initially thought their model would be duplicated again and again between US and Chinese companies, but that too has not been the case and I attribute much of that to Chinese companies simply not valuing brand names highly enough.
Not all that long ago, another Chinese company retained us to try to purchase a US trademark out of bankruptcy. The Chinese company made the product for the bankrupt US company and this product had an incredibly strong name within its relatively small niche. The trademark should have been worth more to the Chinese company that to anyone else. Eventually, the trademark went up for auction in bankruptcy and nobody could bid more than the amount it had deposited into escrow or had in cashier's checks. Our Chinese client kept asking us what we thought the trademark was worth and our answer was that we did not know that particular market and they should either retain an expert appraiser or just give us the absolute maximum amount of money they would be willing to pay for the trademark. They chose the later strategy and we went to the auction to bid. Well, within about a minute, we were out of funds sufficient to keep bidding and three bidders zoomed past us, all bidding at least three times what my client had bid. Even though this trademark should have been worth way more to our client than to anyone else, it valued it at well under the price of three other bidders.
What do you think?
For more on the topic of China branding, check out Aimee Barnes' very interesting post entitled, "Chinese Brands in America: A Conversation with Scott Markman, President of The Monogram Group." Also check out "Industrial Designers Tasked With Creating More ‘China Brands,'" which shows that the Chinese government recognizes China needs to improve on its branding and that it is trying to do something about it.
UPDATE: China Esquire did a post on this, entitled, "Lack of brand innovation in China?"
My law firm represents a fairly substantial number of companies that sell product worldwide over the internet. This stems from many years ago when we represented about forty such companies in an international lawsuit against one of the largest third party credit card processing companies. This work has given us considerable insight into the legal issues these companies often face and since I just did up a client memorandum analyzing the key legal issues this particular company will be facing as it ramps up its international business over the internet, I figured I might as well pull the highlights and set them out right here. The following is a list of the basic law related questions we typically grapple with when assisting companies that are starting to sell internationally over the internet.
1. What type of legal entity(ies) are you going to want? Where will you want them? These two questions must be answered in tandem.
2. From what countries will you accept purchases? Are you going to accept purchases from every country or are you going to limit yourself? Selling into multiple jurisdictions means you are going to be subject to multiple tax regimes. Who is going to figure out your taxes in each country? Are you going to use a third-party merchant of record to do this for you?
3. Selling into multiple jurisdictions means you are going to be subject to the privacy and consumer protection laws of multiple jurisdictions. We need to know the jurisdictions in which you will be selling to know what laws will apply to your company. Many countries have very strict shipping date and return requirements.
4. Is your product legal in all of the countries to which you intend to sell it? Is it legal for foreign companies to sell that particular product into all of the countries in which you intend to sell it? Is it legal in your home country to export your products into all of the various countries in which you intend to sell?
5. It would be nice if we could set you up with one law applying everywhere in the world, but most countries do not allow this when it comes to the sale of consumer goods. So we are going to have to discuss where you will be focusing your efforts.
6. Are you going to sell your products in local currencies or in just the major ones or in just dollars? Are you aware that some countries forbid its citizens from using foreign currencies?
7. Are the electronic contracts you propose using enforceable in all of the countries in which you will be selling?
8. Let's talk about dispute resolution. Arbitration? Where? Will all of the countries in which you are selling enforce this? Many will not enforce an online provision requiring their consumers to arbitrate in a foreign country.
Not that easy, is it?
Read more: Setting Up Your Worldwide Internet Sales Empire. China Too.
Evan Osnos's most recent New Yorker article [this is just an abstract, you will need to pay $4.99 or subscribe to see the full story] is so chock full of juicy China law and business (and even tax) tidbits I just know I am going to be rambling a bit in this post. So to make it at least somewhat readable, I am going to take the unprecedented step of breaking this post into sections so I can really ramble, completely guilt free, yet with some semblance of cohesion. Please do not turn away for fear of rambling, for if you stay, I guarantee you will learn plenty. I guarantee it.
SECTION I. I Love Writ Large. I have said it before and I will say it again: the best articles on how to do business in China are those that talk about the trials and tribulations and successes of a particular business. It is easy and not unimportant to say something like how one must conduct due diligence on your China partner, but if that sort of advice is going to stick with you, you need some great story as to why. At least I do.
I got a complimentary email just yesterday from a reader who touted our "anecdotes" that he "would not be able to get any other way." I emailed back with the following:
I just wish I could share more of them [anecdotes]. As it is, I usually need to wait a long time and then camouflage them so nobody knows of whom I am speaking, especially the clients/near clients.The funny thing is that we’ve had only one complaint and that was from some tiny American company in China that told Steve (my co-blogger based in China) it was pissed off at me for having talked about them in a post. The weird thing is that I had NEVER once communicated with this company and Steve had done so only once and he had NEVER told me anything about that conversation (not even that it had taken place) and I never even knew this company existed, much less knew anything about them that would be blog-worthy. So to this day I have no clue even what they are talking about or to which post they have their beef. But that’s what’s so great about the anecdote posts -- they absolutely apply to far more people/companies than just the one or two or three companies of which we am writing.
SECTION II. China Taxes and Going Offshore. We seldom discuss taxes on this blog because they tend to be boring and they tend to be so particularized to one's own particular situation that posts would end up having to be super long to be very helpful. It also bothers me how many small and start-up companies focus too much on taxes and not enough on setting up a strong and legal foundation for generating profits. One of my mentors when I first started practicing law used to tell me that the start-up company that wants to talk more about taxes than anything else never makes it. He would analogize it to the wide receiver in football who starts running away from defenders before he has caught the ball. I too am always surprised/unimpressed by companies that seem more concerned about how to avoid paying taxes on money they have yet to earn and may never earn than on how to set themselves up so that their operations can thrive.
And going "offshore" plays into this. Many years ago, a company came to us with forty or so offshore companies. Yes, forty. I asked them how all these companies were working for them and they said they were a "pain." I asked why they had set up so many companies and got a somewhat convoluted explanation that I translated to mean that this company's previous lawyers and accountants had, over time, convinced them of the need for each of them. Note that lawyers and accountants have a bias for advising you form lots of companies. They/wenot only make money in the formation, once the companies have been formed, their upkeep becomes a virtual annuity. To make a short story even shorter, we consolidated the forty companies into five and we get "thanks" for this nearly every time we speak with this client for having saved them considerable time, headache, and money.
Anthony Noto, a Shanghai based Financial Planner for expats (mostly) recently sent me an article he wrote for CFA magazine on the potential perils of investing offshore, entitled, "Siren Songs: offshore investors are sailing in treacherous waters." and "Offshore Misconceptions."
I am NOT saying there is no place for offshore investments and offshore companies, because there most certainly is. But you should be wary of an adviser who seems overeager to set you up "offshore" or who touts going offshore as a panacea. Always weigh the costs against the benefits.
SECTION III. China Taxes.Yes, Again. But This Time With Even More Feeling. In the last six months or so, China has become so serious about collecting taxes that I estimate my firm's work on such matters has tripled. My firm does nearly all its work on a flat fee basis. And about half the time when we do not flat fee a matter, we do it hourly with a billing cap. We were doing this before the BigLaw crash and we are used to it. Being used to it means we are usually really good at figuring out a fee that is fair for both our clients and for us.
But what we are finding on our more recent China tax/customs matters is that they are taking about twice as much time as we anticipated and that is because they have become not so routine as China is really starting to crack down on foreign company tax reporting. In particular, China is auditing/not trusting valuations and it is holding up all sorts of things to confirm pricing. We are especially seeing this in transfer pricing, where the Chinese tax authorities have been told from above (Beijing) to generate more taxes and they are absolutely seeking to do so by questioning transfer prices between foreign companies and their related Chinese entities. China seems to be issuing a new circular on transfer pricing every other week. We will write more later on how China's massively increased enforcement of its tax laws is having profound impacts on foreign companies doing business in China, but for now, suffice it to say that it really really is.
SECTION IV. China in the Mainstream Media. I used to complain fairly often about the quality of reporting on China, but then things started to improve, I started confining my reading to only the better publications, and I also may even have mellowed out a bit. But the overly harsh and uninformed criticisms of President Obama's trip to China made me realize anew how so many of the people writing for the MSM do not know much about that which is outside their own countries. Three things really bothered me about much of the reporting on Obama's trip. One, that the stories purported to know what was going on behind closed doors and that Obama had achieved nothing. Two, that they failed to understand that using a bludgeon against China has a long history of ineffectiveness. Three, many of them sought to contrast Obama's conciliatory approach with the ineffective bludgeoning approach used by GW Bush, but Bush did NOT use a bludgeoning approach with China during his second term.
Anyway, if you want really good writing on China, you should be reading the Atlantic for James Fallows, and the New Yorker for Peter HesslerandEvan Osnos. You should also be reading the Wall Street Journal, The Financial Times, Forbes, Business Week, The Washington Post, the Economist, and the China Economic Review as those are the places in the mainstream media where you will consistently see well-written, accurate and informative writing on China. The New York Times is fine too, but its "when in Shanghai, one must dine at Jean-Georges approach" tends to turn me off.
And speaking of Osnos, and speaking of the main purpose of this post:
SECTION V. China Business Today, As It Really Is. Taxes Too. The November 23 issue of the New Yorker has an absolutely great article by Evan Osnos, in his Letter from China series, entitled, "Reds" [this is just an abstract, you need to subscribe for the full article]. The article is both fascinating and informative. If I could write like Osnos, I could have and would have written ten such articles, it is that true to life.
The article is about Donald St. Pierre, Sr., who founded A.S.C. Fine Wines in Beijing in 1996, and has taken that company to amazing heights, but who also faced (and mostly beat off) serious customs claims/charges of "falsifying prices" for customs purposes. The article does a great job explaining how A.S.C. so deftly managed to market its wines in China and should be read for that alone. But the parts on how the legal landscape of doing business in China has changed so drastically over the years were what really grabbed me.
The article talks about how it was believed that many (most?) in the wine business were under-reporting the prices they were paying for their product and of how the wine industry, like so many others, had grown too fast for Chinese regulators "to keep pace." When China really stepped up enforcement against those in the wine business, it secured "punishment" in 29 cases (presumably against 29 different, mostly foreign(?) China wine importers).
Why did so many companies think they could get away with violating China's laws? Donald St. Pierre has the absolute right answer:
When you first start doing business in China, "No one sits you down and says, 'You've arrived in China. These are the laws.' Because people just don't think they apply to them! And they do now.
Donald St. Pierre's son, Donald Jr., makes a similarly prescient comment:
I think what we went through clearly shows that if you are engaged in business you are subject to the same rules as everybody else.
SECTION VI. It is Very Relevant. Trust Me. The next time somebody insists to me that they do not need to abide by China's laws (and trust me, there will be such a next time and it will no doubt be fairly soon) because they have such a great reservoir of guanxi or because some local official will be giving them cover or because they are aware of some other company that has gotten away with doing the same thing for years, I am going to tell them to spend $4.99 to download Osnos's article from the New Yorker. Donald St. Pierre had massive guanxi yet he ended up spending time in a Chinese detention center and his company incurred a six figure fine.
China has laws (plenty of them and they are ever changing as well) and they do apply to foreign companies and individuals (more so than to domestic companies) and a failure to abide by them can lead to trouble. And this has become particularly true in the tax and customs arena.
I guarantee it.
Not sure why, but I have been dealing a lot lately with China trademarks. I think it might be because in the last year or so, we have seen an increase in the ratio of our clients seeking to sell product into China as opposed to manufacturing it.
The key to understanding Chinese trademark law is to understand that the first to file for the trademark virtually always gets it. There are some exceptions to this rule and I might win the lottery tomorrow.
U.S. trademark law is based on first use. This roughly means that the first person/company to use a trademark for a particular category of product or service gets it. Most countries, including China, grant their trademark rights based on who files first. This roughly means that if I am using "my" trademark in China for a few years and someone else goes off and registers that same trademark for themselves, they will almost certainly get it. And once they get it, it is theirs and that means they have every right to stop me from using it.
U.S. based manufacturers tend not to think in trademarks because to a large extent they have never had to do so. U.S. based consumer product companies are more focused on brand names and so even though they too can generally (please note the use of the word generally here because there definitely are advantages to filing your trademarks in the United States) able to get away with not filing trademarks in the United States, they do tend to be knowledgeable on the benefits of doing so.
China does have a well known trademark exception to its first to file rule, but since the odds of anyone prevailing on that are so slim and the legal costs so high to even try, it is never a good idea to forsake a filing in reliance on that. Earlier this year, China's Supreme Court issued an explanation of the issues arising in disputes relating to well known marks here [in Chinese only]. In its explanation, the Court defined the term “well known mark” to mean a mark generally known by the public within China. This means the mark must be known to the general public, not to a restricted group of experts, and it also must be well known within China. United States, Europe and elsewhere simply do not count.
Oftentimes when I stress to my clients the necessity of registering their trademarks in China, they respond by asking what the point is when "everyone knows China does not protect intellectual property." To which I always respond by talking about how the protection of copyrighted material (like books and software and movies) in China is bad, but its protection of patents is not all that bad and its protection of trademarks is actually pretty good. Certainly China is rife with trademark violations, but the bottom line is that the enforcement of trademarks in China has gotten pretty good and it is continuing to get better.
For more on trademarks in China, check out "Which Comes First, The China Trademark Or The China OEM Contract?" and "Hey Sucker, We've Got Your China Trademark And Your're Goin' Down."
Rich Brubaker over at All Roads Lead to China did a post recently, entitled, "5 Characteristics of Successful Companies in China." The post sets out the following five things successful companies do in China:
1. Define their China market. The successful company spends time figuring out what its market will be in China, both geographically and socioeconomically.
2. Develop a "plan of attack" in-house. According to Rich, the first layer of the plan will "focus on company structure (onshore vs. offshore), operations (domestic vs. export), networks (inside sales vs. agents), and commitment (investment vs. outsource), and will create a path for executives to take as the firms begins to grow."
3. Bring in the right people.
4. Leverage successful pilot programs. Successful companies do not roll out a six city platform from day one.
5. Not be afraid to start over. "There are no deals of the century and I have never heard of a case where a souring JV [Joint Venture] agreement was made better by giving the partner more money. China is a place where fortunes are lost far more often than they are won, and for firms who hang on rather than execute a new strategy, lost fortunes are far more likely."
One of the things that I love about being a lawyer is that it gives me a birds eye view of a large number of companies and their operations. From my perspective, everything Rich says above is absolutely true, but in some respects, it is even less complicated than he makes it. Admitting hindsight is 20-20, I "feel" as though I am virtually always correct in predicting which of our clients will succeed in China and which will not and those who succeed typically can be described as knowing their business and wanting to do things right in China at the right price from the very beginning, while recognizing that China is not Kansas. Our clients who fail to succeed in China go into China planning to cut corners from day one and, almost invariably, they hire and overpay an unqualified local (see Rich's #4 above) to run their China business with too little monitoring.
What do you think?
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