How China's Intense Business Climate Impacts Foreign Companies

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Strengthening of the Chinese consumer market has enhanced the business environment for many companies in the region. Although many domestic firms are growing exponentially, many foreign companies have had difficulty penetrating the market. This is both a result of drastically different consumer preferences, as well as a product of stringent regulation and other artificial entry barriers (also read: Globalization and the Shift in Chinese Consumerism ).

According to a report on China from the American Chamber of Commerce, one in four member companies reported declining revenues, and another one in five companies reported flat revenues in 2015 when compared to the previous year. The proportion of respondents who forecast an increase in revenue from China operations has decreased over the last few years, from 81% in 2011 to 55% in 2015. The report was based on 496 surveys by members of various companies, of which two-thirds were senior-level management within those respective firms.

Current Concerns

Slower economic growth and rising costs are among the reasons that some companies are decreasing investments in China. While these are clearly not positive factors, the report mentions that market access barriers are the main hindrance for one in every six respondents, and is most frequently highlighted by those in the technology and service industries. 77% of respondents across all industries feel that foreign businesses are "less welcome" in China, an effect that is mainly due to the way in which the current system is structured.

57% of companies reported concerns over inconsistent regulatory interpretation and unclear laws, making it the largest proportional worry, while labor costs were a strong second at 54%. Companies were able to select more than one option, hence the values not adding up to 100%.

Preferential Treatment to Domestic Interests

The heightened advantage that China gives local businesses is particularly apparent in its dealings with tech giant Apple AAPL . In May of 2016, the trademark authority of China, as well as a lower Beijing court, dismissed Apple's claims against Xintong Tiandi Technology, a company that was selling leather goods, cell phone cases, and other items under the "IPHONE" brand name. Apple began a trademark dispute with the company in 2012 in order to gain exclusive rights to the brand, but lost the case and had its appeal rejected last March.

Another trademark case involved basketball legend Michael Jordan. After losing a series of battles in lower courts against Chinese sportswear company Qiaodan Sports, Mr. Jordan finally pulled away with a victory last December; China's top court ruled that the company must stop using the two Chinese characters for "Qiaodan," which is the Chinese rendering of the name Jordan.

China also operates the so-called "Great Firewall," a censorship initiative that blocks many foreign services in China. Alphabet GOOGL , Facebook FB , Twitter TWTR , and Snapchat parent Snap SNAP are among the array of companies whose services are blocked by the firewall. According to the above survey, four in every five respondents felt that the firewall has negatively impacted their operations. If anything, this serves as a further testament to the government's resistance against foreign companies.

In April 2016, China's Parliament passed a law that brings non-government organizations (NGOs) under the purview of the Ministry of Public Security. Due to its vague wording, the legislation essentially gives the police far-reaching authority over companies' finances and work. Police will be granted the power to question NGO workers, monitor finances, regulate work and shut down offices. The law, which went into effect on January 1 st , 2017, has prompted criticism from these organizations, as well as foreign governments.

A Difficult Operating Environment

Last August, ride-sharing giant Uber agreed to sell its China division to rival Didi Chuxing for $7 billion worth of the latter's stock. Leading up to this point, Didi operated in over 400 cities and claimed 87% of the private car market, along with 99% of the taxi-hailing sector. Uber, on the other hand, operated in only 45 cities, and was burning through $1 billion a year trying to compete with Didi in China (also read: Who are Uber's Biggest Competitors? ).

Didi is the product of a merger between two companies, Didi and Kuaidi, which were backed by Tencent TCEHY and Alibaba BABA , respectively. At one point, scammers created programs in which they would offer fake rides on retail websites (such as Alibaba's subsidiary Taobao) and collect the per-ride subsidies that Uber and Didi were offering to entice drivers.

However, the Wall Street Journal reported that Alibaba would remove the fake Didi listings while leaving the Uber listings untouched. Tactics like this are apparently "the types of things you have to get used to," as Uber CEO Travis Kalanick once said.

A Brighter Future Ahead?

Not all is as bleak as it may appear to be. The government has instated better protection for intellectual property, and in the aforementioned survey, over half of respondents believe that new legislation has improved the business environment. Still, legislation like the NGO monitoring law has left 75% of respondents feeling that the scope of their operations in China will be notably limited in the near future.

Many companies would be happy to see the creation of a high-quality bilateral treaty between the U.S. and China. It seems that the idea is not quite on the menu yet, but regardless, the next few years will be crucial in defining the long-term outlook for foreign presence in the region.

For those who wish to plant their seeds in China, investment in innovation and the recruitment of talent will be crucial. If the business climate remains as it, we could see companies simply give up on expanding in China's untapped markets, the same way Uber already has.

For a look at more investment opportunities in China, check out this special edition of the Zacks Friday Finish Line, where hosts Ryan McQueeney and Maddy Johnson are joined by Brendan Ahern, the Chief Investment Officer of KraneShares. KraneShares is a leading provider of China-focused ETFs and Chinese investment education.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks
Referenced Symbols: BABA , FB , TCEHY , GOOGL , TWTR

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