Clement Chan

Tuesday, 27 April 2004 13:57

Foreign affairs

For years, American companies have viewed China as an attractive, low-cost option for manufacturing and product outsourcing. As economic reforms transform China's economy, however, U.S. companies are recognizing that the country also offers a significant potential market for their products.

The experience of companies that have already entered the China market bolsters this view. An annual survey by the American Chamber of Commerce in China indicated that U.S. companies operating in China reported their strongest profits in the survey's four-year history in 2002. Three-quarters of the respondents said they were "profitable," while 10 percent described themselves as "very profitable." Almost half of the respondents reported substantial revenue increases, with a similar number reporting that their profit margins in China outpaced their worldwide margins.

While the opportunities are promising, U.S. companies seeking to establish themselves in the China market can expect to confront a confusing business, legal and cultural landscape, requiring companies to exercise caution.

The importance of due diligence
U.S. companies pursuing acquisitions in China find due diligence plays an essential role. Often, due diligence for foreign acquisitions cuts a much wider swath than typically required in domestic acquisitions.

For example, one U.S. company in the international printing industry wanted to buy back its distribution channel from an appointed distributor with operations in 17 countries across Asia and Africa. The parties had agreed on a tentative price, but the company needed to examine the distributor's books for its operations in each country before agreeing on a final price.

Because the distributor handled multiple companies' products, its operations, items, assets and liabilities related to the acquiring company's products had to be separated from the distributor's other books prior to analysis, a potential financial due diligence nightmare.

Successful execution hinged on careful planning, as well as close coordination and rapid communication between the outside financial project team members working at multiple sites. Creating a shared understanding of the company's business goals and concerns was critical. The project team used a dedicated Web site to facilitate instant communication between team members and project managers. Accountants at the distributor sites e-mailed questions and concerns to colleagues in the United States, so even major issues were resolved in a matter of hours.

Another challenge inherent in such a complex multinational project lies in understanding legal and accounting differences between countries. In this case, the acquisition target operated in multiple countries, with different laws that led to discrepancies in intercompany balances.

The company completed its acquisition within seven months, and comprehensive due diligence work gave it a much more accurate valuation of the transaction. The valuation turned out to be 25 percent to 30 percent less than the initial price, saving the company a substantial amount of money.

The future looks bright
The China market grows more attractive every day. The country continues to rapidly evolve from offering foreign investors solely an option for production to boasting a market that investors should consider as a stepping-stone to future selling opportunities.

China's consumer market is particularly appealing. Chinese consumers tend to disdain products manufactured in China, while products made in the West rate very highly. With one-quarter of the world's population and dramatically increasing individual spending power, China represents an ideal long-term market for consumer products.

Nonetheless, companies setting out to take a foothold in China should expect challenges. Negative environmental factors such as fiscal, banking and currency problems, labor unrest, human rights issues, logistical problems and pollution can present hurdles. But the long-term positive benefits of engaging the China market far outweigh the risks.

Clement Chan is an executive with consultants Horwath Hong Kong Group Ltd. Reach him in China at Clement.Chan@horwathcpa.com.hk