The rapid growth of the Chinese economy has forced investors all around the world to pay attention to it, and there are very few businesses that have not been impacted by the awakening of the Dragon. Yet the opportunities that the Chinese market provides bring risks as well. Here are some things to look out for in a company that is competing in the Chinese market:
The Chinese market is huge, and so is competition. Companies which are unable to articulate a strong competitive advantage will find it difficult to survive the onslaught from counterfeiting, piracy, and sheer will of the Chinese themselves to compete away the profits of others. Any product or service which is not able to differentiate itself adequately will quickly become a commodity. As such, companies with established records in developed markets tend to have a greater chance of doing well in China. Their track records of success in developed economies such as USA, Hong Kong and Singapore show that they have quality managerial expertise, quality products, and/or an established brand name which are more likely to withstand the intense competition that they will face in China.
Examples that have succeeded include household brands like Mercedes Benz, Starbucks, McDonalds, Las Vegas Sands and OSIM. They all have established brands in developed economies and have proven business models. Conversely, a company which is simply banking on "the huge China market" and "immense opportunities for growth" and does not have a proven business model will find it difficult to survive in the ruthless environment that is characteristic of the Chinese market.
The Chinese economy also has problems with the enforcement of patents and intellectual property. Bill Gates should know: the vast majority of Microsoft software being used in China has not been paid for. Hence, business models which are not dependent on the existing legal framework to enforce property rights will have a better chance to succeed. Examples of sectors which fit into this category are, transport & logistics, natural resources, food & beverage, computer hardware (even this sector faces problems, though) etc. Examples of sectors which will face intense counterfeiting are digital media distribution companies like video, music, computer software etc. One example of a company that is able to circumnavigate the piracy problem is Blizzard (Vivendi Games) - its World of Warcraft game software is based on a subscription basis, which is not subject to piracy.
Another important point about investing in China is that the ability to compete on costs is not enough. Many manufacturing companies have relocated to China citing lower labour costs as their source of competitive advantage. This advantage may exist for a short while, but for most who entered the market on this premise, the cost advantage has disappeared. Intense competition has competed away this advantage; meanwhile, wage rates have begun their ascent. Municipal governments are starting to impose mandatory wage rises. And the businesses which only compete on costs have suffered as a result. An example of this is Creative Master. A company must not only be able to compete on cost, it must be able to compete based on quality and have other differentiating factors, so that it can establish some pricing power. Haier, for instance, has done so, and is now a global player in the white goods market.
In short, the sheer size of the Chinese market makes it a very tempting one to enter. But just being in the market is not enough. When researching a company, one should look for clues that indicate that it will be able to withstand the intense competition that it is bound to face. Only after establishing this should an investment be considered. Many have bePublishen burnt by the China story, and many will be in the future. Let's hope you're not one of them.