from EuroBiz Magazine

April 2008

by Bill Dodson

While a South Korean associate and I were working in the mountainous region of Chongqing investigating its investment environment, he wryly described the city’s business climate as having “21st-century hardware and 19th-century software.” Chongqing has been the focal point for the Chinese government’s Go West program to develop the interior’s infrastructure.

Western companies all know central and northeast China holds great promise as a colossal consumer base, as well as a possible refuge from the increasing costs of doing business along the coast. Indeed, many say the interior of China is like Shanghai was ten or fifteen years ago. So, though the Central Government may be plowing billions of euros into developing the infrastructure of provinces like Chongqing, Tianjin and Anhui – and in connecting remote locations through rail and roadway arteries – the interior is still a long way from becoming a viable, wholesale investment target for any but the largest Western companies.

Great hidden costs lay in store for potential investors like: government corruption; changeable policies; inflated costs of production inputs; a lack of skilled labor and experienced management; and reasonable salary levels for Chinese nationals.

John, a friend with whom I’d worked in Kunshan, near Shanghai, on a project, has been building an American factory in Chongqing. John explained to me, “The township where the factory is located ran out of its allotment of natural gas half-way into the year [2007]. Cheap supplies of natural gas was the ONLY reason the company had put the operation there. It’s even in the contract that the company will receive supplies of natural gas without interruption. So when the local government told me, ‘So sorry, no more gas for you,’ I was angry. One of the Vice Mayors of the township offered that if my company gave him 2 million RMB the local government would look the other way while I hooked up to the gas supplies in the next town over.”

After tense negotiations the provincial government opened local supplies of natural gas to the project, without extra monies paid out. Still, by the end of 2007, the national government raised natural gas prices 40% and repealed VAT rebates, nullifying any cost savings the export operation expected to gain by putting its operation inland.

John’s greatest challenge, though, has been resource constraints. “Components and parts for machines and facilities have been difficult to come by out here,” John said. He conjectured, “Ford must have all their parts imported, because I can’t find what I need here.”

Another constraint was supervisory: “If you consider it took me four times the resources I had planned to build my Kunshan operation; it is taking me ten times more in Chongqing. There just aren’t very many engineering supervisors, construction supervisors, safety inspectors and the like out here that know what quality work is and can watch over construction and engineering teams that know even less.”

Hiring qualified staff has been another of John’s investment demons. “All of my staff are either locals who already live here or who wanted to return home. They’re young, in their twenties, early thirties, with little experience. I have no intention of staying on past my three-year contract, so I have to find a replacement now; a local, trustworthy, with experience, someone I can train. It’s not going to be easy.”

Even junior level positions can be difficult to fill in China’s hinterlands.

Another friend, Robert, told me recently that an Australian avionics-parts plant he was in charge of establishing between Beijing and Tianjin, in a county-level district, had a difficult time even hiring an experienced, bi-lingual secretary into the area. “We received a lot of calls from people in Tianjin and Beijing; but when they found out where the plant was they were no longer interested in the position.” Roger added, “In the end we had to pay a young lady twice what she was being paid in Beijing to hire her, supply her with a rent-free apartment in the nearest thing to an ex-pat compound here, and provide her with a ride wherever she needed to get in the area. Hiring engineers was the same: we had to double their salaries, provide nice housing and drive them around. They all essentially had ex-pat-style packages, though they were Chinese!”

Werner, the Financial Officer of a German multinational auto-parts maker in Wuhu, in Anhui province, told me that some of the Western companies in the area are indeed paying actual Western expat packages to Chinese nationals to retain them as managers. “Those Western companies are paying six-figures US-dollars to get some of the Chinese to come out from Shanghai.” Even though Werner’s company did not pay that level salary to Chinese staff, the company did have to pay allowances to Werner and another German colleague so they and their families could live in Nanjing, an hour-and-a-half drive from Wuhu. Wuhu – and most other third- through fifth-tier cities in China – does not support Western-style medical facilities, schooling, shopping and entertainment venues.

Until the interior is able to update its “operating systems” to match 21st-century international standards, investors need to approach potential investment locations with deep, up-front investigation and analysis of hidden costs. Only then will China’s interior be a viable platform from which Western businesses can to sell into regional domestic markets and export to markets throughout Asia.

Copyright ©William R. Dodson, 2008