By Edward Tse

Levelling the Field: Foreign Firms will Need to Raise their Game in China with New Investment Law

Original published by South China Morning Post on March 23, 2019. All rights reserved.

China has just passed a new law that will replace existing regulations on wholly foreign-owned enterprises and on joint ventures involving overseas companies. In response to changing global realities and the need to further open up its economy, the new law includes many stipulations that aim to foster a level playing field for foreign and domestic enterprises.

Forced technology transfer, one of the main issues driving the US-China trade war, will now be banned. The law also emphasises intellectual property rights protection for foreign investors and encourages technological cooperation. Other incentives include establishing special economic zones with attractive tax and business regimes, allowing the transfer of profit and capital gains out of the country and shortening the list of prohibited investment projects. Moreover, China will encourage foreign investors to participate in the mixed-ownership reforms of state-owned enterprises.

These changes are certainly welcome news for foreign businesses and the circle of politicians and lobbyists in Washington, who have long complained about a lack of market access in China. For many foreign multinational corporations, China has become one of their largest markets, if not the largest, in the world. Even for those that are only considering first-time entry, such as cross-border payment or credit card businesses, their global business models wouldn’t be complete without a credible presence in China. However, though a favourable signal, these legal changes cannot guarantee foreign multinationals success. The market conditions in China have evolved quite significantly over the past decade.

A major shift in the past decade has been the emergence of Chinese companies as bona fide competitors to foreign multinationals. Whereas foreign multinationals still enjoy advantages in sectors such as luxury goods, premium-branded cars and patented pharmaceuticals, Chinese companies have become serious competitors in e-commerce, fintech, fast-moving consumer goods, appliances and logistics.

Source: SCMP

Some of these Chinese competitors are large state-owned enterprises, especially in sectors that require strong state roles, such as energy and telecommunications. However, the most formidable, and the majority, are private companies marked by their speed, agility and creativity, in sectors where the playing field is practically open and even.

This phenomenon is part of the rise of business innovations in China over the past decade, as a combined result of increasingly prevalent technologies, local and central government policies and grass-roots level entrepreneurship. Ridding itself of the “copycat” stigma, China has nurtured a new internet and tech sector – ranging from ride-hailing to e-commerce, robotics and artificial intelligence – that grew 20 per cent in 2018 to a total value of US$142 billion.

Two Chinese companies, Tencent and Alibaba [the owner of the Post], are now among the world’s top 10 most valuable companies. Unicorns – unlisted companies that are less than 10 years old and valued at or above US$1 billion – are thriving. Ant Financial, a Chinese fintech company and an affiliate of Alibaba, is now the world’s largest unicorn with a valuation of US$150 billion. ByteDance, owner of Toutiao, a popular newsfeed app, and Tik Tok, a popular short video app, is valued at US$78 billion, ahead of the US-headquartered ride-hailing app Uber.

Regrettably, foreign multinationals have largely been bystanders to innovation of Chinese origin. However, the rapid changes in China’s innovation context is forcing them to react.For example, in the automotive industry, transformative trends such as electrification, autonomous driving, connected and intelligent vehicles and “mobility as a service”, which combines multiple private and public transport options for users, are forcing even the leading global carmakers to adapt. Across sectors, foreign companies are eager to connect to digitally savvy Chinese consumers through means such as super-apps like WeChat and online payment systems like Alipay and WeChat Pay.

Belatedly, foreign multinationals have began to recognise the need to learn from China, to innovate in China for China and perhaps even for the world. This will not be easy, as foreign companies need to embrace China as a breeding ground for innovation and for new thought leadership in business strategy. To do this right, they have to put China at the core of their global strategy, instead of seeing it merely as a market, albeit an important one.

So far, most of the foreign multinationals’ localisation efforts have remained basic – hiring local managers and assigning them only roles involving execution, while strategic planning and decision-making take place outside China, either in global or regional headquarters. Not only is this process not fast enough, it also does not take into account sufficiently the changes in the overall China context that can have a disproportionately large impact on a company’s China, and even global, strategy. Foreign multinationals should add substance to their localisation plans by appointing local thought leaders to senior levels, with the appropriate decision-making power and resources.

Foreign multinationals have tended to try to run their business in China by themselves, perhaps with some joint ventures here and there. Going forward, that won’t be enough as the changes in China, especially in innovation, will require capabilities beyond those that foreign multinationals are aware of. They should adopt a more open-minded approach with the idea of business ecosystems in China, and form collaborative partnerships with local companies, including established companies, start-ups, academics and research institutions, to augment their capabilities on the ground.

Like every new measure that comes out of China, the new foreign investment law will not be immune from scepticism from outside. However, the new law signals a friendlier environment that enables foreign multinationals to capture greater value in one of the world’s most important and dynamic markets. In the meantime, they should remember that in this ever-changing, increasingly competitive landscape where innovation is critical, they need to step up their game in China to capture the potential that the market offers.