Challenges: Global and Chinese economic trends affecting entrepreneurs by Becky DeStigter @IntlEntreprenr

Part 5 of 5 - today

Part 4 of 5 - published Thursday, May 19

Part 3 of 5 - published Wednesday, May 18

Part 2 of 5 - published Tuesday, May 17

Part 1 of 5 - published Monday, May 16

(Series to run Monday, May 16 - Friday, May 20)

Formal Economy

The formal economy generally has better and more varied financing and capitalization options. According to Carl Walter of JP Morgan, this includes the 200-300 companies that get outside funding (out of about 20 million private firms). Banks now provide 60-70% of business financing in China’s formal economy. This is similar to Western countries, where bank loans also comprise a large percentage of start-up financing. Next, there are some investment funds like the one that Sunny Capital started. The Sunny Capital fund pools investor money together, but according to CEO Helen Jiang is not a private equity or venture capital fund in the western sense. It funds initial public offerings and supplemental capital, some of which finances privatized formerly state-owned firms that have been broken up into smaller business units. Another option in the formal economy is issuing publicly traded stock on a stock exchange. Currently there are over eighty Chinese companies listed on the NASDAQ exchange alone. And though the Shanghai Stock Exchange we visited did have a handful of entrepreneurial companies out of the 842 listed at the end of 2006, a majority of the companies listed are state-owned enterprises. Most Western companies use an IPO to raise capital for expansion to buy out early-stage investors. Helen Jiang said that in a Chinese IPO, most owners want to cash out instead.

Informal Economy

The informal economy’s financial options are fewer and leaner. Most of a start-up company’s capital comes from entrepreneur’s network of family & friends. For those in the “gray market” there are a group of “gray banks” that have emerged as unofficial lenders. The rates are much higher than can be found at an official bank. Any later expansion would need to be organic – relying on profits to fund growth. Carl Walter also mentioned that when an informal economy company was successful, the company had no outside financial institution to maximize interest earned.

Challenges: Global and Chinese economic trends affecting entrepreneurs

Entrepreneurs in China will face several challenges in the next several years stemming from the global and Chinese business environments.

Higher World Commodity Prices

One of the most pressing challenges will be the rising cost of commodities as oil, gas, corn, and other foods reach record levels. Entrepreneurs are disproportionately hit by high commodity prices because they do not typically have the financial resources to buy commodities on futures markets nor the deep pockets to weather the increased production costs. Since entrepreneurs in China often compete on price, these small businesses’ margins will be squeezed.

Stronger Competition from Other Asian Countries

With business costs rising in China up to 20% per year, some Chinese companies are getting priced out of price-competitive industries. Chinese entrepreneurs must increasingly compete against companies in nearby countries, many of which have similar advantages to China (Vietnam, Cambodia, etc.). China has already seen its textile industry move a significant number of textile factories to other countries with even lower production costs than China. Individual companies would need to ask: is my ability to compete with overseas companies at risk if the cost of doing business in China keeps rising? If so, the entrepreneurial leader needs to plan how to avoid being out priced in the market. One route may be to reposition away from the low-cost market niche.

Lagging Demand in the World’s Mature Markets

North America, Europe, and Japan are all experiencing slow downs in consumer spending and economic growth. Since these are the main export markets for China, this leaves Chinese entrepreneurs with a challenge. One consolation to shrinking export markets is the growing domestic Chinese market. But this may take repositioning. There also may be different opportunities in the mature markets that are either counter-cyclical to a recession or recession proof.

Risk of Government Changing the Business Regulations

Finally, the Chinese government is actively involved in the Chinese economy. Since entrepreneurs are often on the cutting edge of what is possible, the government especially in communications mediums like the Internet, can restrict or even prohibit any business activity it deems harmful to the public. The government has opened access for foreign companies to certain industries. Entrepreneurs in these newly opened industries will definitely feel increased competition and typically tougher price competition. For entrepreneurs in closed industries, they should always have a contingency plan for if the government changed access rules.

Promising Markets for Entrepreneurs in China

The Chinese middle class will likely triple in the 3-year period ending in 2009. As an entrepreneur, this prompts the question: what does the Chinese middle class need and want? While on the surface, Chinese consumers want the same things many of us want: food, a place to live, clothing, education, healthcare, and some way to get to work. But within each of those areas are completely different consumer preferences, buying behaviors, and product uses. Given these differences, here are few areas that budding entrepreneurs in China should consider:

Energy. This industry includes alternative energy as well as any product that saves energy for individual households, offices or factories. Right now, the energy sector is attracting entrepreneurs across the globe. Individuals, companies, and governments are looking for ways to lower energy costs, as well as use more sustainable business practices.

Healthcare. Until recently, Chinese people enjoyed free cradle-to-grave healthcare coverage from the government. Now the Chinese government is requiring companies to provide healthcare insurance for employees and dependents. Since half of the economy is not regulated by the government, a large number of Chinese do not have healthcare coverage and pay directly for services. We heard from several ex-patriate Westerners living in China that healthcare services were well below the quality levels that insured Westerners enjoy. There is a shortage of healthcare services as well. High-income Chinese and foreigners alike pay well for high-quality private healthcare services. This includes underserved markets like home healthcare, long-term healthcare, inpatient and outpatient surgical care, as well as medical supplies.

Education. Education can be a great equalizer in China and parents are willing to pay for private education, tutors and any other tools or services that can better prepare their child for school and college entrance exams. This opportunity area is probably best suited for Chinese entrepreneurs over foreigners because of the uniqueness of the Chinese educational system, Chinese learning styles, etc.

Financial Services. Several types of financial services are relatively new to Chinese consumers. Since the market is still in the process of opening, there may be opportunities for early entrants to this market segment, including some types of investment funds and insurance.

Recommendations

Overall, entrepreneurs need to adhere to sound entrepreneurial and business practices. They should develop a long-term business strategy that includes an exit strategy and a budget. Entrepreneurs need to practice writing and presenting a concise and accurate vision (statement and presentation). They also need to keep in mind that many challenges can be overcome or sidestepped by creative problem solving. It is important to erase all previously held market assumptions and conduct thorough market research before launching. And finally, entrepreneurs need to keep learning from others in order to gain from all available expertise. Additionally, I have specific recommendations for Chinese entrepreneurs, Western entrepreneurs interested in the Chinese market, and the Chinese government:

For Chinese Entrepreneurs

Chinese entrepreneurs are poised to make even greater gains in the next few years. To help facilitate the next phase of Chinese entrepreneurship, I have three specific suggestions. First, a company’s products and/or services should be positioned to maximize both the company’s competitive advantages and market demand. This may not necessarily be in the market niche competing on lowest cost. Instead, even an incremental shift in quality and value can justify a higher price and wider profit margins.

Second, in planning out the company’s growth projections and expansion plans, consider when the right time might be to register the company. Joining the formal economy brings advantages that may make a greater difference once the company has grown larger, such as better financing options, intellectual property protections, and other rights.

Thirdly, the Chinese market is large and growing, but the world as a whole is much bigger and even more diverse. There may be markets in other countries that are either larger for a specific product and/or more profitable for your company.

For Western Entrepreneurs Interested in the Chinese Market

Western entrepreneurs who are interested in pursuing entrepreneurial ventures in China should take several recommendations into account. First, learn the Chinese language and culture as soon as possible. According to Dr. Jan Kiely of the Johns Hopkins Nanjing Center, it takes at least three years to learn Chinese. Second, even experienced entrepreneurs need to find trusted Chinese entrepreneurial counterparts in order to better interpret cultural cues and to benefit from the Chinese partner’s business network (Guanxi).

Third, the market and business environment changes much more quickly than in Western countries. Be vigilant of changes in consumer preferences, competition, government regulation changes, then be ready with contingency plans and potentially rapid adjustments to your business.

Finally, objective market research cannot be overemphasized. As an example, a commonly misunderstood Chinese market segment is the “Little Emperors”. Children in China hold a much higher influence on household spending than their counterparts in other parts of the world. As Americans, we assume that this would make Chinese youth very self-absorbed and rebellious given so much financial power. None of these assumptions are true. Overall, Chinese youth tend to be even more traditional in some ways than their parents. They understand that their families sacrifice much to give them opportunities to lift them up socially and economically. Chinese young people feel a great responsibility towards their families and caring for them. Many Western companies have misinterpreted Chinese culture in ways like this.

For the Chinese Government

The Chinese government has implemented many reforms over the past three decades that have served to open up entrepreneurial opportunities to Chinese and foreigners alike. Newly created jobs in entrepreneurial ventures help to keep the population gainfully employed. There are some options that the Chinese government could pursue to harness the economic strength of domestic entrepreneurship. The most important recommendation for the Chinese government is to streamline the company registration process to make it less costly and simpler. This would serve to increase the corporate tax base significantly. It would allow the government to more effectively regulate businesses, including product safety, environmental compliance, labor practices and intellectual property protection. It would give the government a greater ability to influence and support the entrepreneurial growth engine.

The second suggestion is to reform the parts of the financial systems that could support entrepreneurial ventures. This could include promoting private equity funds, government grants to entrepreneurs, tax breaks to more than just small groups of Sea Turtles, and government-guaranteed loans for start-ups.

And lastly, the Chinese government could sponsor (directly or indirectly) entrepreneurial education. According to a cross-cultural entrepreneurship study by universities in Spain, the U.S. and China, nine out of ten Chinese students polled were interested in having a course on entrepreneurship. An entrepreneurial course could be included in every university business program’s curriculum. The government could ensure that business faculty receive proper training in entrepreneurship in order to teach this course. For those entrepreneurs already in practice, ongoing online or classroom training could focus on getting a business to the next level of growth and success.

Overall, entrepreneurs have a promising future in China. As a signal of what the future may hold, over half of Chinese students responding to a multi-country 2007 survey have seriously considered starting their own businesses. The growth and changes that China has experienced over the past three decades has created a wide variety of opportunities for entrepreneurs who are willing to take the risk to start a new company and later expand. While the Chinese business environment is not without its challenges, resourceful entrepreneurs can look forward to success.

Layalka, Michelle Dammon, “A Chinese Welcome for Entrepreneurs”, Business Week (online version) January 6, 2006.

Pan, Jeff, “A difficult road for budding Chinese entrepreneurs”, China Daily (online version) February 5, 2007.

“Female Entrepreneur Tops China’s Rich List” by Xinhua News Agency,www.china.org.cn. October 12, 2006.

Yueh, Linda, “China’s Entrepeneurs”, University of Oxford Discussion Paper No. 324. Spring 2008.

CLSA Asia-Pacific Markets, Hong Kong. Quoted in “A Chinese Welcome for Entrepreneurs” by Michelle Dammon Loyalka, Business Week (online version) January 6, 2006.

“A Chinese Welcome for Entrepreneurs” by Michelle Dammon Loyalka. Ibid.

Gereffi, Gary and Vivek Wadhwa, “Framing the Engineering Outsourcing Debate”, Duke University Center on Globalization, Governance and Competitiveness. 2006.

Pan, Yigang, “Louis Vuitton Moët Hennessy: Expanding Brand Dominance in Asia”, Asia Case Research Centre, The University of Hong Kong. 2005.

Magnini, Vincent & Ford, John B., “Service failure recovery in China”, International Journal of Contemporary Hospitality Management, Volume 16 Number 5, 2004 pp. 279-286.

Yen, Benjamin, “Gome Electrical Appliances Holding Limited: The “Tuangou” Challenge”, Asia Case Research Centre, The University of Hong Kong, 2006. pp. 105-177.

Stock Exchange FactBook 2006 (English Version), Shanghai Stock Exchange. Grant, Andrew, “The new Chinese consumer”. The McKinsey Quarterly 2006 Special Edition: Serving the new Chinese consumer

St-Maurice, Ian and Claudia Wu, “Understanding China’s Teen Consumers”, The McKinsey Quarterly 2006 Special Edition: Serving the new Chinese consumer. Pp. 91-97.

Pan, Jeff, “A difficult road for budding Chinese entrepreneurs”. Ibid.