MARKETING U.S. PRODUCTS AND SERVICES

A. Distribution and Sales Channels
B. Selling Factors/Techniques
C. Advertising and Trade Promotion
D. Product Pricing and Customer Service
E. Sales to the Government
F. Intellectual Property Rights (IPR) Protection
G. Professional Services
H. Due Diligence

A. Distribution and Sales Channels

Trading Companies:
Generally, foreign companies are not permitted to directly engage in trading in China, with the exception of the direct marketing of a portion of the products manufactured in China, or the establishment of wholly owned foreign trading companies in some free trade zones with limited access to markets outside these zones. Distribution rights may change after WTO accession but not in current trading activities. Accordingly, U.S. exporters need to use a domestic Chinese agent for both importing into China and marketing within China. Only those trading companies authorized by the central government to handle exports and imports are permitted to sign import and export contracts. Since the beginning in 1998, some private and collectively-owned enterprises in the manufacturing sector have been granted this authorization. Some import/export trading firms extend their scope of business to represent foreign manufacturers as their distributors, in arrangements similar to a "manufacturers representative."
With careful selection, training and constant contact, a U.S. exporter can obtain good market representation from a Chinese trading company, many of which are authorized to deal in a wide range of products. Some of the larger companies have offices in the U.S. and other countries around the world, as well as a network of offices and affiliates in China. However, given transportation and communication difficulties as well as regional peculiarities, most of these trading companies cannot provide diversified coverage throughout China.

Local agents:
In addition to trading companies, China is witnessing an explosion in local sales agents who handle internal distribution and marketing. Most of these firms do not have import/export authorization. They are the next layer down the distribution chain, buying imported products from those that do. They may be representative offices of Hong Kong or other foreign trading companies, or domestic Chinese firms with regional or partial national networks. Given China's size and diversity, as well as the lack of agents with wide-reaching capabilities, it makes sense to engage several agents to cover different areas, and to be cautious when giving exclusive territories.

China can be divided roughly into at least five major regions:
the South (Guangzhou), the East (Shanghai), the Central/North (Beijing-Tianjin), West China and the Northeast.

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The U.S. & Foreign Commercial Service's (USFCS) Agent/Distributor Service (ADS) program was designed to help U.S. exporters find appropriate sales agents and representatives in China. This service may be ordered through any U.S. Department of Commerce district office or U.S. Export Assistance Center. For a fee of $250, USFCS searches for potential agents or distributors for your product in a specific geographical area. Regional ADSs are available from the USFCS offices in Beijing, Shanghai, Guangzhou, Shenyang, and Chengdu, but nation-wide searches are not available. An ADS is an excellent way to gauge interest in your product and begin the process of finding a suitable representative.

Establishing a Representative Office:
Representative offices are the easiest type of offices for foreign firms to set up in China, but these offices are limited by Chinese law to performing "liaison" activities. As such, they cannot sign sales contracts or directly bill customers or supply parts and after-sales services for a fee, although most representative offices perform these activities in the name of their parent companies. Despite limitations on its scope of business activities, this form of business has proved very successful for many U.S. companies as it allows the business to remain foreign-controlled. China's Company Law, which has been in effect since July 1, 1994, permits theng of branches by foreign companies but, as a policy matter, China still restricts this entry approach to selected banks, insurance companies, accounting and law firms. While representative offices are given a registration certificate, branch offices obtain an actual operating or business license and can engage in profit-making activities.
Establishing a representative office gives a company increased control over a dedicated sales force and permits greater utilization of its specialized technical expertise. The cost of supporting a modest representative office ranges from $250,000 to $500,000 per year, depending on its size and how it is staffed. The largest expenses are rent for office space and housing, expatriate salaries and benefits.

Establishing a Chinese Subsidiary:
A locally incorporated equity or cooperative joint venture with one or more Chinese partners, or a wholly foreign-owned enterprise (WFOE), may be the final step in developing markets for a company's products. In-country production avoids import restrictions -- including relatively high tariffs -- and provides U.S. firms with greater control over both intellectual property and marketing.
The role of the Chinese partner in the success or failure of a joint venture cannot be over-emphasized. A good Chinese partner will have the connections to help smooth over red tape and obstructive bureaucrats; a bad partner, on the other hand, can make even the most promising venture fail. Common investor complaints concern conflicts of interest (e.g., the partner setting up competing businesses), bureaucracy and violations of confidentiality. American companies should bear in mind that joint ventures are time-consuming and resource-demanding, and will involve constant and prudent monitoring of critical areas such as finance, personnel and basic operations in order for them to be a success.
Some companies prefer to establish a wholly foreign-owned enterprise (WFOE, often pronounced "woofy") rather than a joint venture, with a view to retaining greater management control, due to concerns over intellectual property rights (IPR) protection, desire for simplicity, or for other reasons of corporate policy. The law on WFOEs requires that they either provide advanced technology or be primarily export-oriented, and restricts or prohibits them in a number of service and public utility sectors. However, an increasing number of U.S. companies find WFOEs, which now account for roughly 20% of all foreign-invested enterprises (FIEs), to be a viable entry vehicle to the China market, taking much less time and money to set up than a joint venture (see Chapter IV).

Licensing:
Technology transfer is another initial market entry approach used by many companies. It offers short-term profits but runs the risk of creating long-term competitors. Due to this concern, as well as intellectual property considerations and the lower technical level prevailing in the China market, some firms attempt to license older technology, promising higher-level access at some future date or in the context of a future joint venture arrangement.
Licensing contracts must be approved by and registered with the Ministry of Foreign Trade and Economic Cooperation (MOFTEC). A tax of 10-20% (depending on the technology involved and the existing applicable bilateral tax treaty) is withheld on royalty payments (see section F of this chapter).

Franchising:
China has no laws as yet which specifically address franchising, but many foreign companies are beginning to establish multiple retail outlets under a variety of creative arrangements, including some which for all practical purposes function like franchises. Virtually all of the foreign companies who operate multiple-outlet retail venues in China either manage the retail operations themselves with Chinese partners (typically establishing a different partner in each major city) or sell to a master franchisee which then leases out and oversees several franchise territories within the territory. Within three years of WTO accession, restrictions on equity share, number of outlets and geographical area are to be eliminated.

Direct selling:
Major U.S. direct selling companies entered the China market in the early- to mid-1990's, when China's legal and regulatory framework for this industry was not very clear. Direct selling was quickly modeled after by domestic Chinese companies, some of whom abused this legitimate format of doing business and operated scams to rip off consumers and evade taxes. In early 1998, the Chinese government started implementing a series of strict controls over this industry, culminating in the re-licensing of all direct selling companies. Although a few major U.S direct selling companies were re-issued the business license, restrictions are severe and requirements many, resulting in difficult business environment. The U.S direct selling industry is working pro-actively with various Chinese government departments and agencies, as part of an overall effort toward China's WTO accession, to construct a fairer business climate in this industry.

E-commerce:
The Chinese government has adopted anattitude towards the advent of electronic commerce in China. Interest among both Chinese and international businesses focuses on investing and on establishing vertical integration and sales channels on-line. Investment is risky, however, due to the lack of clearly defined regulatory powers over the industry, an effective Chinese certificate authentication system, secure and reliable on-line settlement system, and an efficient physical delivery system. Many U.S. IT sector companies have been actively engaged in jointly developing these systems in China, and WTO accession will increase the speed of these developments.

B. Selling Factors/Techniques

Relationships:
Personal relationships in business are critical. The Chinese feel more comfortable dealing with "old friends," and it is important for exporters, importers, and investors to establish and maintain close relationships with their Chinese counterparts and relevant government agencies. It is equally important that American exporters encourage strong personal relationships between their Chinese agents or distributors and the buyers and end-users. A web of strong personal relationships will help ensure smoother development of business in China.

Foreign Currency:
Chinese companies are not permitted to retain foreign exchange. In business deals with Chinese companies, U.S. companies have been asked to keep a portion of the Chinese companies hard currency earnings in foreign bank accounts to avoid reporting and turning it over to the foreign exchange control authorities. As part of an effort to clamp down on corruption and tighten foreign exchange control, the Chinese government is coming down hard on such practices.
In contrast, FIEs are permitted to retain foreign exchange contributed to or earned by the enterprise. On December 1, 1996, China made its currency convertible on the current trade account. However, foreign exchange balancing requirements remain in effect in other Chinese laws and regulations and in joint-venture contractual arrangements.
Chinese companies are, however, able to purchase the foreign currency necessary for authorized imports and foreign-currency obligations such as licensing fees, royalties, and loans by authorized entities.

C. Advertising and Trade Promotion

Advertising:
Advertising is an effective way to create product awareness among potential consumers in China. Channels for mass advertising include publications, radio, television, billboard displays, internet, and sports sponsorship.
China's retail boom and increasing competition among retailers is making China's advertising industry grow even faster than the economy as whole. According to China's National Advertising Association (under the State Administration for Industry and Commerce, or SAIC), over-all advertising spending reached $ 7.5 billion in 1999, a 15.4 percent growth over 1998's volume. China has about 64,000 advertising businesses, including more than 500 foreign joint ventures. Foreign advertising firms are limited to taking an equity stake of up to 51 percent in joint venture enterprises. All of the major international advertising firms are present in China.
Television advertising takes the largest single portion of the Chinese advertising market. China's regular television viewing population is 84 percent of China's 1.2 billion people. Major articles sold on television include toiletries, foodstuffs, pharmaceuticals, liquor, and home electronics. Television stations in big markets (Beijing, Guangzhou, Shanghai) require advertisers to book and pay for specific spots two to ten months in advance.
Now that China is in the midst of a consumer revolution, foreign products, complete with advanced marketing, advertising and research techniques, are leading the way. Brand awareness is increasingly important and sophisticated advertising is beginning to play a crucial role in charming the Chinese consumer. Foreign products are expected to continue making inroads despite 1999 regulations calling for more control over customer surveys that help foreign firms enhance their marketing effectiveness.
China's 1995 Advertising Law contains guiding principles that set broad requirements. For example, one of the requirements is that advertising should "safeguard the dignity and interests of the State." Comparison advertising is not allowed, nor is the use of superlatives. Chinese restrictions within the advertising sector include requirements for the verification of safety and hygiene from the relevant ministries that monitor various consumer products. Censorship standards vary considerably throughout China.
MOFTEC and SAIC are the primary regulatory organizations for the advertising sector, but many other organizations, such as the Ministry of Culture and the State Administration of Radio, Film and Television, play an active role in controlling what ends up in print or on television.

Trade Shows and Missions:
Hundreds of exhibitions are now held annually in China. Most are sponsored or co-sponsored by government agencies, professional societies, or the China Council for the Promotion of International Trade (CCPIT). Shows are also organized by U.S., Hong Kong, and state trade departments, and other professional show organizers. Show participation costs are sometimes high and may only reach a local audience so companies are advised to scrutinize which shows to participate in. A list of trade shows that are screened by the U.S. Department of Commerce are listed in the appendix.

Electronic Commerce and the Internet:
The rapid growth of the internet raises interest in using "e-commerce" in China. Though China remains a developing country, the ambitious use of high technology has made inroads with the growth of governmental and business-to-business forms of e-commerce. Government at all levels seeks to use technology to inform the public about laws, deal with customs and simplify procedures, and businesses are beginning to conduct bidding, process sales and handle contacts on-line. In addition, direct marketing and sales-on-line have begun despite the lack of credit card usage and distribution difficulties. Beijing and Shanghai SAICs have begun a licensing process to create a "reasonable and reliable market." In May 2000, nearly 30 internet companies were awarded licenses to sell online advertising.

D. Product Pricing and Customer Service
Most Chinese consumers are sensitive to price and will usually choose the less expensive product unless they can be swayed by better after-sales service or clearly better product quality. For larger purchases, attractive financing that lowers the effective price is offered by Japanese, European and other foreign governments' companies and may make some U.S. products less competitive.
Foreign companies are normally not permitted to directly provide after-sales service and customer support for their products sold into China. Foreign Invested Companies (FIEs) can provide such services on products that they manufacture in-country. Foreign firms sometimes engage authorized Chinese entities to provide service, often on a contractual basis, or to establish service centers jointly that can provide both spare parts and after-sales service. American companies complain that such arrangements give them inadequate control over the quality of customer service and result in the loss of customer confidence. Some companies opt to provide regular servicing from bases outside of China, such as Hong Kong.

E. Sales to the Government
In 1999, new regulations controlling government procurement were issued by the Chinese State Development Planning Commission (SDPC). While ostensibly making the system more transparent and it also centralizes the procedure much more. In the past, government procurement was conducted through state-owned/controlled companies affiliated with a particular ministry. Since these entities will remain the main end-users of the purchases, their participation in the process will probably continue.
China's government procurement practices have often not been consistent withand competitive bidding and, for the most part, non-transparent. It is unclear at this point how the new regulations will streamline a system that previously was subject to at least one, and usually several, approvals from governments at various levels. While tenders for projects funded by international organizations are usuallyy announced, most government procurement is by invitation only. Competition is by direct negotiation rather than by competitive bid but that is supposed to change under the new regulations. Goods and vendors for large projects that are covered in the annual state plan have been frequently designated during the planning process. All information, from solicitation to award, remains secret and is known only to those companies involved or to officials in the planning and industrial ministries.
Direct sales to the Chinese military are also a possibility. While restrictions on this type of business exist both in the United States and in China, U.S. manufacturers have successfully sold a wide variety of products to the Chinese military through the General Logistics Department of the People's Liberation Army (PLA).

F. Intellectual Property Rights (IPR) Protection
The U.S. and China signed an IPR Memorandum Of Understanding (MOU) in 1992, pursuant to which China improved its laws governing IPR protection over the following two years and joined the Berne Copyright and Geneva Phonograms Conventions. The March 1995 extension of the IPR MOU sets out a plan for enforcing IPR and grants market access to certain products. In 1998, in an effort to improve IPR coordination and enforcement, China established a new organization, the State Intellectual Property Office (SIPO). As envisioned, SIPO will eventually have authority over the Patent Office, the Trademark Office, and the National Copyright Administration. At present, however, SIPO only controls the Patent Office, with which it is co-located. The Trademark Office falls under the authority of the State Administration of Industry and Commerce, while the National Copyright Administration is controlled by the State Printing and Publishing Administration.

Enforcement:
Large-scale violations of intellectual property rights in China, including counterfeiting and smuggling, often overwhelm enforcement efforts. In recent years, China has had considerable success in closing down factories that produced illegal optical disks (CDs, VCDs, and CD-ROMs) computer software products – only to see an increase in such products smuggled across its borders. The authorities have also conducted thousands of raids at both the manufacturing and the retail level, resulting in the confiscation of counterfeit or smuggled products. In 1999, the State Council issued a decree admonishing government agencies to purchase only legal computer software.
At the same time, in 1998, in reaction to continuing IPR violations, over twenty U.S. companies in China formed a coalition to draw the attention of Chinese and U.S. Government authorities to the counterfeiting problem, and to propose ways of strengthening enforcement. These companies estimate their annual losses due to counterfeiting at over $1 billion. Severely limited market access for products such as foreign movies and computer software provides an additional incentive for smugglers and counterfeiters. Foreign companies have devoted considerable on-the-ground resources to combating IPR violations, with mixed results. In early 2000, a coalition of these companies did gain recognition from Chinese authorities as an official organization to protect their products.

Enforcement options:
The Chinese government agencies most often involved in enforcement actions are the Quality and Technical Supervision Bureau (TSB) and the State Administration of Industry and Commerce (SAIC). U.S. companies have also reported success in registering trademarks, patents and copyrights with the Customs General Administration, which can then confiscate infringing products. The Trademark Office and the National Copyright Administration also can take action in cases involving trademark and copyright infringement. In addition, China's court system can be utilized to enforce IP rights. In fact, China has established special IPR chambers in the Supreme Court and in many Intermediate Courts, whose judges have had special training in IPR protection. Compared with the administrative agencies (such as the SAIC and the TSB), which reportedly sometimes conduct raids within hours of receipt of a complaint, the court system is relatively slow.

Patents:
Under China's patent law enacted in 1984, domestic and foreign patent applications have increased steadily. Patent protection was extended in January 1993 to pharmaceutical and chemical products, as well as processes; the period of protection was lengthened to 20 years. The amendments also provide the patent-holder the right of importation and expand the scope of patent infringement to include unauthorized sale or importation of products manufactured with the use of patented processes. Under the provisions of the MOU, China extends transitional administrative protection to some U.S. pharmaceutical and agrochemical products for up to seven-and-a-half years. A revised patent law is now under review.
China acceded to the patent cooperation treaty on January 1, 1994, and will perform international patent searches and preliminary examinations of patent applications. Under the patent law, foreign parties must utilize the services of a registered Chinese agent to submit the patent application. Preparation of the application may be done by foreign attorneys or the Chinese agent.

Copyrights:
In March 1992, China established bilateral copyright relations with the U.S. and in October 1992 acceded to both the Berne Convention and the Universal Copyright Convention. China also joined the Geneva Phonogram Convention in April 1993. Following accession to the Berne Convention, China explicitly recognized computer software as a literary work and extended protection to computer programs for 50 years without mandatory registration requirements.

Trademarks:
Although problems remain with enforcement, China's trademark regime basically conforms to world standards. In October 1989, China joined the Madrid Pact for protection of trademarks; the latter grants reciprocal trademark registration to member countries. China amended its trademark regime in February 1993 to add special regulations for criminal prosecution for trademark infringement.

Legal framework:
China is revising its copyright, trademark and patent laws to meet the requirements of TRIPS and WTO accession. The revised patent law is closest to completion, and the copyright and trademark laws are also likely to be revised.
China has a "first-to-register" system that requires no evidence of prior use or ownership, leaving registration of popular foreign marksto anyone. The Unfair Competition Law extends IPR protection to trade dress. Under the trademark law, foreign parties must utilize the services of registered Chinese agents to submit the trademark application. Preparation of the application may be done by foreign attorneys or the Chinese agent.

Trade secrets:
In September 1993, the Chinese government adopted the Law Against Unfair Competition. This law defines unfair competition to include conduct that infringes the "lawful rights" of another business operator, including acts that violate "commercial secrets" rights. Commercial secrets which can bring economic benefits to the authorized users and which are protected by taking appropriate security measures are defined to include technical and operational information not available to the public. Sanctions under the law include civil remedies such as damages, administrative sanctions such as fines, and criminal penalties for "serious violations." China is further obligated to protect trade secrets under the Paris Convention for the Protection of Industrial Property, to which it is a signatory.

Regulation of Technology Licensing:
Technology transfer by foreign companies is governed by 1985 regulations on technology import contracts, which include contract-licensing patents, trademarks, know-how or trade secrets; contracts for technical services; and other technology import contracts. Contracts transferring intellectual property as part of the foreign equity contribution to FIEs are generally regulated by laws concerning foreign investment. Technology licensing contracts must be approved by MOFTEC or its provincial commissions.
Some of the issues of particular concern to U.S. companies include:
the licensor cannot require confidentiality beyond the duration of the contract, except where the supplier provides improvements to the technology, and most technology contracts are not to extend beyond 10 years;
the licensor cannot restrict sales channels or impose unreasonable restrictions on the export of products produced with the licensed technology; and
special approval is required for extended confidentiality, export restrictions, and preferential treatment for payment of royalty tax.

G. Professional Services
The system for regulation of foreign commercial activity in China is difficult to navigate and non-transparent. Companies new to market are strongly encouraged to retain professional services to structure commercial transactions. Establishing a wholly foreign owned subsidiary, joint venture, or representative office requires compliance with complex contract approval requirements, business registration requirements, taxation regulations and statutes, and labor regulations. Many foreign banks, accountants, attorneys, and consultants have established offices in China and are familiar with Chinese requirements. Some Chinese professional service providers also have substantial experience serving foreign clients.

Accountants:
Chinese law requires representative offices and foreign invested enterprises to engage the services of accountants registered in China to prepare officials submission of annual financial statements and other specified financial documents. Therefore, only Chinese accountants and joint venture accounting firms may provide these services. All the Big Five accounting firms (KPMG Peat Marwick, Pricewaterhouse Coopers, Deloitte Touche Tohmatsu, Ernst & Young, and Arthur Andersen) have established offices in China and provide services ranging from providing advice on taxation matters and preparation of investment feasibility studies, to setting up accounting systems that are in compliance with Chinese law. Among accounting firm clients, multinationals are shifting their focus from market entry strategies to business operation efficiency. During the past six years, their market share has grown from 2% to 30%.

Attorneys:
During the past eight years, many U.S. and international law firms have received approval to register in China as a foreign law firm. Prior to l992, most foreign law firms were registered as consulting firms. More than one hundred foreign law firms currently operate in China, of which nearly thirty are based primarily in the United States. Foreign law firms registered in China are restricted to advising clients on legal matters pertaining to the jurisdiction where they are licensed and general international business practices. Although a foreign lawyer may not offer a legal opinion, clients can obtain assistance with structuring transactions, drafting contracts, and resolving disputes. Only attorneys licensed in China may appear in court and provide legal advice on Chinese legal matters. Foreign law firms are allowed toonly one office in China and are not allowed to employ Chinese lawyers in that firm. Foreign lawyers are not permitted to qualify to practice law in China and are not allowed to form a joint venture with Chinese lawyers

Management Consultants:
Foreign companies new to the Chinese market typically engage the services of local consultants to develop market entry strategies, conduct due diligence investigations, and identify potential investment partners, sales agents and customers. More than 100,000 companies are active in the Chinese consulting industry, of which 65% are foreign firms that generate 85% of consulting industry revenue. Licensed and unlicensed firms compete in the market, and the regulatory environment for this services sector is unclear. Only four foreign consulting firms have received a consulting firm license – BCG, Arthur Andersen, China Consulting Association, and the Lei-Da Group of Hong Kong.

Advertising:
Approximately 64,000 advertising firms exist in China, of which 500 are foreign invested enterprises. Foreign advertising firms are limited to a 51% maximum equity stake. The major international advertising firms have established a presence in China. Companies new to market can gain valuable advice from top-notch advertising firms on how to effectively craft an effective advertising strategy that is responsive to Chinese consumer preferences and cultural differences. Advertising is strictly regulated in China, and penalties for violation of the law through misleading advertisements, unauthorized use of national symbols, or other prohibited forms of advertising are subject to fines of 100,000 RMB ($12,500).
Commercial Service posts in China maintain lists of U.S. law, accounting, and consulting firms with offices in China, as well as lists of Chinese firms that the Commercial Office or its customers have had favorable dealings.

H. Due Diligence
Undertaking a due diligence investigation prior to engaging in a trade or investment transaction can minimize risk of encountering commercial disputes. The primary causes of commercial disputes between Chinese and American companies concern breach of contractual payment obligations, irregularities in accounting practices, financial mismanagement, undisclosed debt, and struggle for control within joint ventures. These problems can be minimized by investigating the financial standing and reputation of local companies before signing contracts with them. Both U.S. and Chinese firms with offices in China conduct due diligence investigations; the former include Dun & Bradstreet, Kroll Associates, and Pinkerton Consulting Services. The fees charged by these companies may be considered a useful investment to ensure that the local customer or partner is financially sound and reliable. The U.S. Foreign Commercial Service's International Company Profile (ICP) is not offered in China at this time.