Learn why foreign companies often fail in China and how to avoid the most common pitfalls.
More and more foreign companies are advancing into China to profit from the country’s growing domestic market. Where else in the world are you going to find a population of 1.3 billion, a growing middle class and a GDP growing at 8 to 10 percent? But succeeding in the Middle Kingdom is not easy. Foreign-owned companies often fail in the Chinese market due to a product-market mismatch, an unwillingness to adapt their strategy to local market conditions, a lack of know-how about the country and simply because they are not willing to commit sufficient resources to their business in China.
In this article we will discuss the five most common mistakes foreign companies make when entering China and how to avoid them.
Committing insufficient resources to the China branch
One of the most common pitfalls for MNC’s is not attaching enough importance and priority to their China operations. As we will discuss later in this article, it is crucial to adjust to local market conditions and allocate sufficient resources to the China business for it to be able to expand. We have seen more than one case in which an MNC missed the boat because of an unwillingness to invest more in their local sales and marketing efforts.
The Chinese market is fragmented, scattered, competitive, and requires your company’s full attention in order to gain success. It is a challenge, but the payoff can be tremendous. However, this also doesn’t imply you should incorporate a Wholly Foreign Owned Enterprise (WFOE) and recruit a large team from the start.
Instead, start by testing the waters, employ an agile approach to your expansion by constantly asking for feedback and consequently push for innovation to find the right product-market fit. Start with distributing your products in China, recruiting a local sales person to offer better sales and after-sales service, and wait with incorporating a WFOE until you have built up enough sales to support your local operations.
Consider initially operating under a third-company’s license, working in shared offices and making use of shared back office services to keep costs in hand. China does not have to be too far, too expensive nor too foreign for smaller and medium sized companies to take a chance. Take a look at our market entry services for more details.
Choosing the wrong investment vehicle
Generally speaking, when entering the Chinese market one can choose between incorporating a wholly foreign owned enterprise (WFOE), a joint venture (JV) or a representative office (REP). Choosing the right investment vehicle will be vital to your business’s success. Important considerations include the need for strategic partners, how to protect your IP rights and technologies, and of course your business’ strategy and long-term view.
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. For example, while WFOEs are often the main choice for high-tech firms with large IP inventories, companies specializing in more commoditized products often find that risk is mitigated by partnering up with a well-established local company.
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. When choosing which form is the 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.
Incorporating a business in China usually requires a long incubation period together with a relatively high upfront investment. This is also the reason why smaller and medium sized foreign-owned companies, particularly in the manufacturing industry, like to opt for an intermediary that can provide a legal business license to operate under along with shared office and back-office services. But be aware, although working under a third-company’s license is a cost-efficient alternative, it also carries risks with it. Choose your partner wisely and make sure to perform an extensive due diligence on any party you are considering working with.
Implementing an international strategy in the Chinese market
We often witness foreign companies make the same mistakes when entering the market. Common mistakes range from not having a localized strategy, to trying to manage the local business operations from abroad. Based on our 15 years of experience with doing business in China we can safely state that having a local strategy is inherent to success. Employing a global strategy whilst resisting to delegate part of the decision making process to the local management team has been the cause of many problems and misunderstandings.
That is how fast food giant McDonalds lost a large market share to KFC and why Ebay failed where Taobao (China’s Ebay/Amazon) succeeded. KFC understood early that they had to adjust their menu to cater to local tastes. McDonalds did not and only recently started offering a more localized selection of foods, e.g. chicken rice wraps. Ebay failed to understand local market demands and payment systems, which Taobao (Ebay’s rival) cleverly used to its advantage when developing a similar website that grew out to become the largest e-commerce platform in China.
Although there is a growing demand for high-quality foreign products, the local competition is fierce and will outperform you unless you have a strong understanding of the local market and are able to navigate through a market/system that is different from your own. For that reason we always stress the importance of having a local staff to assist you in your efforts. Employing a global strategy in the Chinese market simply doesn’t work in the majority of cases. Even Ikea had to adapt to local ways in order to win in China.
Our advice is simple: develop a strong local management team, setout a local sales and marketing strategy, and manage your business’s day-to-day operations from within China, not from abroad.
Unwillingness to adapt product to fit local market demand
Tied to having a local strategy is having a product that fits the local market. Some foreign companies have successfully done so; think about KFC, L’Oreal and Volkswagen. But not all foreign companies have done well in this area. As mentioned earlier, Taobao succeeded where Ebay failed. This was mainly due to Ebay’s poor understanding of the local market. While Ebay was redirecting visitors to their US platform, Taobao was adapting their product to the fast changing consumer market. Taobao knew most Chinese people didn’t have credit cards, so they built an escrow-based payment system. They knew most Chinese people were new to online commerce, so they removed listing fees and shifted their business model to ads. They knew most Chinese people liked to barter and talk with merchants prior to purchases, so they built an instant chat program in their website.
Another example would be Kraft’s Oreo cookies; when they first entered the market, Chinese consumers did not like the cookies because they thought they were too sweet. In response, Kraft lowered the percentage of sweetener in the cookies to adhere to Chinese taste. As a result of their adaption the company’s sales surged dramatically and Oreo became the biggest cookie brand in China.
Our advice: employ an agile approach to product engineering and research how you can make your product more accessible to the Chinese consumer (for instance by offering a less advanced product for a discounted price) as well as what the best ways are to market your product to the Chinese consumer. But be careful with generalizing Chinese consumers…
Targeting China as one big market
Just as you cannot target the whole of Europe, you cannot target China as one big market. China has over 600 cities, 22 provinces and is the third largest country in the world. The existing distribution network and infrastructure are simply not able to support a product launch simultaneously across the country. Not to mention the efforts and resources required for that.
Although the Alibaba Group is developing a new high speed parcel delivery network there is currently no such service available. In addition, the living standard varies from city to city and there are significant differences in wealth distribution between regions. The coastal regions and cities, such as Shanghai, Hangzhou, Guangzhou, etc. are mostly highly developed and its population has a much higher per capita income compared to China’s poorer western regions. Moreover, there are considerable differences in cultures, cuisines, dialects, climate and buying habits in China’s regions and cities.
Hence, when introducing a premium product and targeting China as a whole, you will likely dilute your efforts and drain your resources. Therefore, segmenting the market and choosing the right market segments based on per capita income, city or region and consumer behavior are of crucial importance when targeting a country the size of China. We recommend starting with one city or region to gain more experience in the Chinese market before targeting additional regions.
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