For U.S. firms seeking overseas expansion opportunities, China is perhaps a natural candidate. Given its vast population of 1.4 billion, rapidly growing middle class and loosening economic restrictions, China is now one of the most lucrative international markets in which to conduct business.

It's also a market undergoing a significant transition. China has historically been one of the world's most prominent low-cost, high-labor-intensity manufacturing centers, with a manufacturing economy 50 percent larger than that of the United States. As China's middle class has grown—and the cost of domestic labor has risen—China has tilted toward technology-intensive, high value-added production. Other countries, such as Vietnam, have begun to replace China as preferred centers of manufacturing.

While the conditions within China are undoubtedly attractive, there are some significant political and cultural challenges of which to be cognizant. Additionally, China's ongoing trade war with the U.S. has injected a considerable amount of uncertainty.
However, despite these hurdles, China remains an indispensable market for global-focused businesses. In fact, without a presence in China, it would be difficult for many multinational businesses to consider themselves truly "global" in nature.

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Reasons for Doing Business in China

The Fastest-Growing Major Economy

China's economy is the second-largest globally and is on track to become number one by 2030. China accounted for more than a quarter of global GDP in 2018 and is projected to reach that same figure again in 2019.

The rising prominence of the Chinese business sector is illustrated by the fact that Chinese companies now account for 129 of Fortune Global 500 firms. That's a figure that exceeds the 121 Fortune Global 500 firms headquartered in the US—the first time in history a nation other than the U.S. has led the list.

Following decades of U.S. consumers buying inexpensive Chinese-produced goods in vast quantities, Chinese consumers are now purchasing high-quality U.S. products in greater numbers, making China a crucial export market.

The Chinese government has also taken steps to stabilize debt levels through more vigorous regulations and firmer federal control over local government investment. By tamping down debt and passing stronger regulations, China is taking key steps to mitigate risk within financial markets. This has occurred against a backdrop of greater openness in the Chinese economy. Tariffs have been lowered, a new foreign investment law has been passed and the country has revised its negative list for foreign investment entry.

A Growing Consumer Base

Few countries in history have modernized at the pace and scale of China. In just a few short decades, the country has transformed itself from an agrarian society with a traditional outlook to a consumer-based society powered by urban development.

As China's manufacturing industry boomed, many rural Chinese have moved to urban centers for work. This has created an enormous market for cars, luxury goods, seafood, mobile phones etc. Importantly, this transformation is still ongoing. According to McKinsey, three-fourths of China's vast urban population will be middle class by Chinese standards by 2022. That's up from a mere four percent in 2000.

A Spirit of Innovation

China is a global leader in product innovation, digitalization and research and development. Mobile payments have helped make urban China a largely cashless society, e-bikes have transformed public transport and e-commerce platforms have enabled on-demand consumption.

Chinese scientists and technologists are also at the forefront of many cutting-edge fields. Companies such as Baidu, Tencent and Alibaba have become global behemoths known for their innovative offerings.

U.S. companies, meanwhile, can take advantage of this rapidly developing technological market, as Chinese consumers are very eager to discover and use new technology-focused products and services.

An Improving Business Landscape

Doing business within China has become easier thanks to a variety of recent reforms. This is demonstrated by China rising to number 31 in the World Bank's 2019 Ease of Doing Business rankings report—a jump of 14 places over 2018's ranking. This leap was enough to earn China recognition as one of the world's top ten most improved economies for ease of doing business for the second year running.

When compiling its ranking, the World Bank cited eight key business reforms recently enacted within China, including simplifying business registration, easier access to electricity and water, easier construction permits and simplifying exporting and importing. Martin Raiser, the World Bank's Country Director for China, said, "China has undertaken substantial efforts to improve the domestic business climate for small and medium-sized enterprises, maintaining an active pace of reforms."

Risks and Considerations for Doing Business in China

U.S. and China Relations

Ongoing relations between these nations have grown somewhat strained in recent years. Significant tariffs placed on China by the Trump Administration have caused some U.S. manufacturers to explore moving to lower-cost labor markets, such as Vietnam.

While tariffs do not affect every U.S. company doing business in China, the trade conflict has had ripple effects in areas such as national security and technology. The U.S. government has banned domestic firms from doing business with some Chinese businesses with government ties. That decision creates downstream problems for suppliers of those banned firms.

Given the size and importance of both nations—and the intertwined nature of their economies—it is likely that we may see a cooling of trade hostilities in the near future.

Not Understanding Territorial Sovereignty

In order to stay in China's good graces, global enterprises have to walk a fine line when it comes to matters of a politically or culturally sensitive nature. This is especially true when it comes to territorial sovereignty. Referring to Hong Kong, Taiwan or Tibet as countries; or quoting the Dalai Lama—whether on a product or in a social media post—can lead to intense criticism from consumers and the government and even boycotts.

Companies find that they have little recourse but to apologize if they wish to undo the damage to their brand and remain in the market.

Human Capital and Management

Multinationals have historically faced challenges related to sourcing, managing and retaining talent within China. Soft skills, such as leadership, dispute resolution, cultural awareness and internal communications are often ignored or not sufficiently addressed.

To help ensure harmonious operations, it's advisable to focus on the following areas:

• Take steps to ensure that the corporate culture remains intact in the overseas office. This can be done by putting the right management in place. It often helps to have people in place who understand both the local market and the existing company culture.
• Make an effort to assess compatibility relating to language, culture, technology and experience.
• Perform reputational due diligence. This can help ensure that governance and ethics prerogatives are the same across the organization.
• Consider government connections and how they may impact organizational decisions. Assess the benefits and risks within this context.

Governmental Influence on Business

Chinese government officials play a much more active role in the management of the national economy than seen in most Western countries. Domestic industries and businesses are often privileged and protected relative to international firms. Market access is often limited for imported goods and service providers. Chinese businesses, meanwhile, often enjoy state, financial, and regulatory support. In fact, many domestic firms are partially or fully owned by national, provincial or local governments.

The Chinese government will also often make market access provisional upon transferring technology to China, conducting research and development in China, or acceding to other valuable, deal-specific requests. A requirement for government involvement may also complicate joint ventures, and local laws are often subject to be changed at will at the behest of the Chinese government, although this practice has been tamed somewhat in recent years in order to provide business owners greater certainty.

Intellectual Property

China has a reputation for taking a less than rigorous line with IP. While the country has modern IP protection laws and regulations, enforcement is still a significant issue. Companies with IP to protect should vet potential partners carefully and research their rights under Chinese law. This means consulting with attorneys and other advisors with specific experience with IP protection in the Chinese market.

Business Culture

Chinese business culture is far more hierarchical than U.S. corporate culture. Chinese leaders and managers expect quiet obedience from subordinates. This extends to things such as meeting etiquette. In the U.S., subordinates freely ask questions during meetings. In China, asking questions or disagreeing with something is a serious breach in protocol and a face-losing proposition for all parties involved.

Doing business in China also takes longer than in the U.S., and business transactions are rooted in personal interactions. To succeed in the Chinese market, it's vitally important to build face-to-face relationships, and staff members should be encouraged to freely interact with contacts.

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Frequently Asked Questions for Doing Business in China

1. What are the main legal entity types in China?

Limited liability corporations, companies limited by shares, partnership enterprises and representative offices.

2. How many languages are spoken in China?

Standard Chinese or Mandarin are preferred for business. However, there are eight major languages within China and hundreds of regional languages or dialects.

3. How do you characterize the Chinese legal system?

China uses a civil law system for business matters that is a hybrid of Soviet and continental European civil law systems.

4. What is the corporate tax rate in China?

The tax rate is 25% for limited liability corporations; 25% for companies limited by shares and taxes for partnership enterprises are paid by each individual.