Guide Supply chain management: issues to consider when doing business in China

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If their suppliers or subcontractors tinkered with a product at any point along the supply chain, in most cases the customer would never find out. Defense contractors, which make products infinitely more complex than sneakers or even smartphones, face even trickier problems with their Chinese supply chains. Defenders of the current order argue that fear of the economic losses that would result if such subterfuge were revealed provides sufficient deterrence.

But political pressures and national conflicts have overridden economic reasoning plenty of times in the past, and the hostile intelligence agencies that might insert backdoors into components have no vested interest in global economics. Tinkering with economic supply chains for intelligence- and other national security-related reasons is not a new idea; indeed, Western countries have long done just that.


Five years ago, Edward Snowden revealed that the U. National Security Agency had inserted backdoor espionage tools into U. Just as parents are scared away from baby food by the report of a single piece of glass, so the damage done by sabotage could cause permanent distrust in a given product or manufacturer. Hundreds of years ago, attacking a supply chain meant cutting off supplies to a besieged castle or sinking merchant ships.

William Fung on China and changing supply chains

Today, governments can conduct these attacks covertly through proxies. Chinese companies have cornered the market for inexpensive high-tech parts and products. If these suppliers abruptly decided to stop servicing their Western clients, there would be little U. Sure, manufacturers would revert to alternative suppliers—yet in countries where empty shelves are unknown, the social shock alone would be highly destabilizing. Thus far, Western fears—and attempts by countries and companies to protect themselves—have largely focused on China, with claims of hardware backdoors and worries about the 5G giant Huawei.

While a government may have no malign intent, local terrorists or criminals often do. For example, a chip may be designed by a specialized U. That means that the company has 1. So does the risk of attack. Software supply chains can be just as murky. Identifying every risk may be impossible. And diversifying away from every possible risk would result in crippling costs. So firms and governments should focus on improving resilience, not just mitigating risk.

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Disruptions, backdoors, and sabotage might be inevitable; how companies cope with them will make a critical difference. For businesses, that means taking a lesson from militaries, which regularly prepare for different threats—and for unpredictable scenarios. They can also identify which components are most critical and ensure they have a second, safer supplier—ideally one close to home—lined up in case their first is compromised.

Crucial manufacturing expertise has been lost in the West, especially in high-tech manufacturing. Western conglomerates—and even ministries of defense—may want to consider supporting the creation of critical businesses on their shores. As such, it is certainly no exaggeration to state that rather than representing a single, unified market, China is actually a collection of individual sub-markets defined by vastly differing demographic, economic and cultural characteristics.

The nature and make-up of markets in different parts of China also varies considerably, which means that foreign companies should think carefully about which geographical location offers the best vantage point to target the broader China market. In the past, foreign businesses have often been drawn to coastal provinces such as Zhejiang, Guangdong, Jiangsu and Shanghai, due to higher populations and incomes in those areas. In particular, foreign companies involved in consumer markets have tended to focus their attentions on these higher income coastal regions. Although foreign companies in the b2c sector still remain focused on coastal cities, business-to-business markets are often far more geographically scattered.

As in many countries, China has actively encouraged the setting up of industrial clusters in specific cities or regions, and in many cases entire industry supply chains can be concentrated in a small handful of cities. In many b2b markets, such clusters can help foreign companies to know where its target customers are, which cities to focus on and even where to base its operations particularly where local manufacturing will take place. The first step of any effective China market entry strategy is therefore to identify the geographical location of the target market s and the best specific location to target first.

Shanghai, Beijing and Guangzhou — highly populated areas with a large, middle-class representation and income levels well above the national average. Although being based in a Tier 1 city may offer the lowest risk point of market entry , it will also mean that the company faces higher operational costs and more competition. Not only do Tier 2 cities have the advantage of lower set-up and operating costs, but the increase in consumer spending power in these areas is creating a rapid growth in demand for foreign manufactured goods and products.

Shifts in China’s Industrial Supply Chain and the US-China Trade War

In particular, cities such as Shenzhen, Tianjin, Wuhan, Chongqing, Chengdu, Nanjing, Qingdao, Dalian, Suzhou and Hangzhou all offer strong commercial opportunities for foreign companies across a range of sectors. Over the long term, including Tier 2 and even Tier 3 cities in their strategy can enable foreign companies to gain first-mover advantage in these cities and lead to greater long-term market success.

Whether to set up in more tried and tested locations or to take the risk of setting up in a less developed market is likely to depend on a variety of different factors, and ultimately this decision will be based on having thoroughly research the market landscape. For example, it is critical to spend time mapping out the location of customers and suppliers, understanding how distribution channels vary between different locations, and fully researching any local regulatory barriers that could block market entry in specific regions.

Companies planning to set up a local manufacturing facility will be required to research a broader range of factors, such as local manufacturing and transport infrastructure, access to key raw materials, local investment policies, the availability and cost of human resources, and a myriad of other factors.

Understanding government policy and regulations is critical to success in Chinese b2b markets. There are still a lot of industries that remain off-limits to foreign companies, and many industries where severe limitations remain in place. China now has a host of different ministries and regulatory organisations with responsibility for industry regulations and laws. In industries with greater levels of regulation such as the healthcare and food sectors , foreign companies will need to attempt to unravel the web of complex laws and regulations, and try to understand which authorities have primary responsibility for implementing them.

Regulation is becoming more stringent, as are to efforts ensure that companies actually conform to them. In the wake of the melamine poisoned milk scandal in , the Chinese authorities have taken a tougher line against companies that openly flaunt the food safety law, whilst the SFDA is also tightening regulations on pharmaceuticals and medical devices to avoid similar events from occurring in the future.

Likewise, environmental problems caused by poor environmental regulatory enforcement and widespread pollution in years gone by have led to the introduction of much tighter environmental legislation. Foreign companies are now required to go through lengthy environmental assessments before gaining permission to produce locally. Government regulations can very often impact significantly on the timeline and costs of market entry, and companies are advised to examine the implications of such regulations prior to committing to the market.

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For example, in the medical and pharmaceutical sectors, long product or clinical trials may be required, which result in a longer sales cycle than may be the case in other countries. It is also worthwhile noting that just because a product has previously been approved by regulatory authorities in Europe or the US does not automatically guarantee that the same product will receive approval in China.

It is critical to spend time researching and understanding the regulatory environment prior to making any decision to enter the market. Having entered the market, it is equally important to constantly monitor for any changes to legislation or regulations and how these could affect your business. Chinese regulatory bodies often operate in a quite opaque manner, making it difficult to anticipate regulatory changes before they happen.

Market Entry Mode. Choosing the right vehicle for entry is one of the most crucial decisions a business can make when entering China for the first time. Equally, while some b2b markets require setting up a local Chinese entity, in other markets using local intermediaries or a small representative office may suffice.

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  • Entry mode often depends on a number of factors, including industry landscape, the geographical size and scope of the market, whether the company plans to manufacture locally or import its products, and the level of on-the-ground sales and technical support required by customers. Ultimately, when choosing which form is most appropriate, a company should consider each of these factors, along with the overall costs of setting up a local entity and hiring local employees. Ultimately, the best vehicle for a foreign enterprise entering the market for the first time will vary according to the size and scope of an enterprise, along with the specific characteristics of the market it is entering.

    Shifts in China's Industrial Supply Chain and the US-China Trade War

    For example, while WFOEs are often the main modus operandi for high-tech firms with large IP inventories, companies specialising in more commoditised products often find that risk is mitigated by partnering up with a well-established local company. Whichever market entry mode is chosen, thorough market research should precede any final decision on how and when to enter the market.

    A growing number of market research companies now have operations in China, and the market is becoming easier to research than ever before. In addition to the numerous off-the-shelf reports available about the Chinese market, there are now a growing number of companies offering tailored market research services whether it be global consultancies and management consultants, government-affiliated agencies or private individuals providing research and consultancy.

    The profusion of English-language publications on China available through the internet makes it relatively easy for Western companies to carry out some initial research on the Chinese market.

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    • An experienced market research company will then build upon this initial foundation of knowledge with more detailed information collected via Chinese-language desk research and in-depth interviews with leading industry experts and decision makers. Along with these qualitative techniques, quantitative research can then help with determining more accurately market size, future growth trends, levels of competition, routes to market, key customer requirements and so on. Effective market research is essential to determining the size and nature of the market opportunity and acts as a benchmark against which firms are able to measure future performance.

      A thorough and well executed market research study can help prevent poor decision-making and establish a clear strategy map for the future. Very often, the enterprise type will determine the human resources available, and foreign companies tend to have greater freedom with WFOEs and rep offices than JVs in this respect. The quality of human resources available will also be closely related to where the company is located, and it is generally the case that the quality of people available is much higher in Tier One cities such as Shanghai and Beijing than Tier Two and Tier Three cities.

      Another key decision to be made is whether to employ expatriates in senior management positions or whether to localise these roles. Employing expatriates tends to be seen to offer greater operational control, although is also more costly in terms of salary packages, relocation costs, insurance and other expenses. Moreover, most expatriate managers have a very limited local knowledge of Chinese cultural and business practices, and very seldom have the Chinese language skills necessary for dealing with Chinese companies on a day-to-day basis.

      A key benefit of hiring a Chinese manager is the local market knowledge and deeper understanding of Chinese business they bring to the role. Unfortunately, in many industries the supply of highly skilled local managers with industry experience is extremely limited, and employers may still be forced to pay a premium to attract the right calibre of employees. Equally, staff turnover rates are extremely high in China and retaining quality managers over the long term is challenging.