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Chinese Market Entry Strategies Tentative Guide For MNES

Purpose and research methodology

The Chinese market is a very wide and attracting one to all sorts of businesses. This was the main factor that drove me to choose the topic of entry strategies to china. In order to do so, I identified the subsequent keywords: entry modes, MNEs (multinational enterprises), investment, FDI (Foreign Direct Investment) and China. I used those keywords to search for relevant articles in peer reviewed journals. The latter were accessed through the databases provided by the Grenoble ecole de management. The databases used are the following:

ABI inform global (ProQuest)

Business source complete (Ebsco)

Science direct (Elsevier)

Emerald management plus (Emerald)

Proper filters were applied along my search in order to correctly direct the results. A concrete example to this procedure was to limit the search to a certain period of time: from 1995 till the present. My search resulted finally in 15 articles from which I selected 8 to include in the systematic literature review (SLR). Please check appendix A for a more detailed explanation concerning the inclusion/exclusion criteria.

Following the choice of the articles, I thoroughly read the chosen articles and drew a table summarizing the topics and their presence in the different articles. Please check appendix B for the detailed table generated.

The table was a very useful tool that allowed me to trace easily the topics and write the relevant information in the following literature review.

Literature analysis

Introduction

China’s growth rate during the past decades is appealing to MNEs to set up operations in the Chinese market. However, the cultural, social, political and economical environment is difficult to handle from the international firms’ perspective. This point is crucial for international corporations Vis as Vis the choice of their entry mode to that particular market (Luo 2000). Since it opened up to the international market in 1979 and then entered the WTO in December 2001, the FDI rules in the popular republic of china are constantly changing. Multinational enterprises that are willing to invest in china have a lot of conditions and factors to take into consideration when studying their entry strategy.

Entry modes and different strategies

Equity joint ventures, EJV

According to the EJV law, the foreign investor’s share must be at least 25%. Each partner is supposed to supply tangible (cash, material, facilities…) assets and intangible (intellectual property right…) assets. The duration of the EJV according to Sino-foreign agreements is unlimited. Practically set to 50 years and extendable upon the mutual agreement of the multiple parties in the EJV (Luo 2000). According also to Luo and Chen(1995), this mode has many benefits: risk reduction, economies of scale and scope, improved local acceptance. The EJV assures a long-term relation between the foreign firm and the Chinese market. From the Chinese government perspective, EJVs helps the transfer of technology to the domestic partner, and thus this mode is favored from the Chinese authority point of view. The mentioned above authors state that these benefits are challenged by several factors: China is a really hard market, different in every location and extremely changing: the marketplace is dynamically changing and becoming more and more competitive. Also the distribution channels in china are not as developed as in the west, thus making it hard to supply correctly your product in China. Also, the negotiations with the Chinese present several difficulties and become a burden to foreign companies (demanding the state-of-the-art technology when the adequate infrastructure is nonexistent) and the domestic partner often tries to avoid cash funding, presenting land and existing facilities instead (Luo 2000).According to Luo and Chen (1995), EJV are faced by several difficulties: these complexities are relevant especially in the field of operation and management since the outcome of the company depends heavily on intangible variables (personalities, cultures, etc). Establishing a joint venture in china means that you established a legal local entity (Cheung and Leung 2007). This entity will allow you to conduct business. Cheung and Leung (2007) also agreed that for MNCs to have business growth in china, they should have a physical presence in the Chinese market. But the licenses for a joint venture are difficult to obtain; hence even if they are preferred over some entry modes, it is difficult to be eligible for a JV.

Wholly foreign-owned enterprise, WFOE

Luo (2000) stated that this entry mode offers the foreign investor more flexibility and more expandability potential, avoiding the drawbacks of an uncooperative domestic partner. WFOE are established faster than EJVs since the Chinese authorities are bound to reply to a proposal within 30 days. This type of entry mode is offering little technology advancement for china and is therefore we see that the Chinese authority is always in favor of an EJV over a WFOE. In order to fight it, the Chinese set up several rules and regulations in order to complicate the process, especially in some sectors like the automotive and telecommunication sector. Despite the regulations that are making it the setup of a WFOE in china difficult, the rules can be tailored depending on what the foreign company is offering of value to the Chinese government. Some sectors totally forbid the setup of a WFOE; however the Chinese are opening up more and more and will therefore allow WFOE in some new industries. Another drawback is that the Chinese are reluctant to the idea of foreign companies taking over their country. Adequate decisions like appointing locals in managerial positions are crucial to the success of the setup of the WFOE: Motorola employs only Chinese managers. Moreover, a foreign company will rarely succeed in a foreign environment, especially like in the surroundings of china, and therefore will have to cooperate in a certain way with the locals which will make the situation more viable for the WFOE. (Luo 2000)

Puck, Holtbrugge and Mohr (2007) concurred with the same definition concerning the joint ventures and the WFOEs.

According to Luo and Chen (1995), a WFOE offers is better seen as a mode that restrict opportunistic behavior and is therefore more controllable than an EJV. The holder of a WFOE has a greater bargaining power over the domestic government. For Luo and Chen, a WFOE is more probable to do better than the EJV concerning financial risk aversion.

Contractual joint ventures, CJV

Luo (2000) explained what differs between EJV and CJV is that the profits and other responsibilities are assigned to each partner according to what is agreed upon in the contract and not necessarily proportional to the total capital contribution by the partners in the EJV. The CJV is often used in joint exploration projects (oil exploration is an example). Concerning liability, a CJV has the choice between having limited or unlimited liability (Vis a Vis the capital invested in by the partners) versus the EJV that is bound to the limited liability. CJVs with unlimited liability do not require the foreign investor to contribute a minimum of 25% of the total registered capital. For Luo (2000), both CJV and EJV have import tax exemptions on imported equipment used as part of the capital invested in. CJV has a greater flexibility versus EJV regarding managing assets, production and operation. This is a great advantage for foreign investment since it gives the MNEs greater flexibility. A CJV may allocate profits in cash and in operation output (petrol in the case of oil exploration) versus the EJVs’ restriction to cash distribution. It is a great advantage to build-operate-transfer businesses and will keep its advantage in the foreseen future (Luo 2000)

For Zhang, Zhang and Liu (2007), joint ventures are the most adequate entry strategy from the perspective that it minimizes the environmental risk and helps acquiring the resources of the domestic associate. But also according to Zhang, Zhang and Liu (2007), this method has its drawbacks from the perspective of that the foreign investor takes the risk of having opportunistic behavior from the domestic partner.

Shapiro, Tang and Ma (2007)’s article talks about three main categories of FDI in china. They defined EJVs, CJVs and WFOEs the same way that Luo (2000) did.Teng (2004) argued that joint ventures have been the way of entering the Chinese market. However he states that wholly owned subsidiaries are becoming more and more appealing because of the fact that the foreigners are in more control that the Chinese compared to a joint venture.

Umbrella companies

Luo (2000) explained that the proliferation of MNCs’ operation in china has led to the necessity of a sort of simplifying structure. The MNCs opted for what is called an umbrella enterprise or also known as investment company or holding company. The advantage of such structure over the traditional structures is that the holding is able to combine all existing investments (sales, procurement, manufacturing and maintenance) under one umbrella; it also eases the establishment of new investments. This model is mostly effective for multi-disciplinary companies that are using several entry modes adequate to each division. For Luo (2000), the model eases profits’ transfer among the different business units of the same company for strategic purposes and also transfer of the profits outside the host country. The holding model helps the foreign investor centralizing the management of his various businesses and this helps in removing several operating barriers. The facilities for the strategic business units (SBU) provided by this model can be used without special approval from the Ministry of foreign trade and economic cooperation provided that the investment company hold at least 25% of the SBU’s equity capital. However this model does not entitle the company to do whatever business it wants. And to establish such holding, foreign companies should have at least two foreign-invested enterprises (FIE). In order to benefit from the holding model, companies are subject to various criteria and conditions according to Luo (2000):

minimum total asset value of US$400 million in the year prior to its application

established one or more FIEs in which it has contributed at least US$10 million in registered capital

A minimum of 10 FIEs in China established whose activity is based on manufacturing or infrastructure construction and that contributed at least US$30million in registered capital.

The Chinese tax authority treats the holding company and its several FIEs as independent companies.

Acquisitions

According to Luo (2000), it is a relatively easy method, consisting of acquiring local or foreign businesses. This method has its advantages in entering sectors that were exclusive to the government. China acknowledged its lack of technological advance, satisfactory capital and management expertise. The acquisition of companies in the mentioned sectors by foreigners is seen as a complementary activity to what the Chinese are doing for their development. This policy is a long-term plan. Luo (2000) argues that this strategy is considered advantageous for the foreign investors since these acquired domestic companies have a great profitability potential with the right management and proper technology usage. The profitability of such companies if existent or will be existent has the tendency to come faster than in an EJV or WFOE; the reason for that is fairly simple: the companies have an already built capacity and are not startups. Such companies are mostly attractive when their market is a niche market. Proper information concerning the company and its liabilities should be well researched and investigated in because the ownership procedure can be an obstacle. The Chinese corporate law does not let a minority shareholder to have a say in the management of the company. Attention should be taken in all cases since the Chinese’s culture of state is very strong and privatization by foreigners may be clear on paper but the practicality of this transfer is not well under control (Luo 2000).

Zhang, Zhang and Liu (2007) stated that the acquisitions of domestic firms are the fastest way to set foot in the domestic market, but is burdened by several factors including cultural clash and overpayments due to reluctance of the authorities regarding this entry strategy of foreign firms into the Chinese market since it means that the foreigners fully own the firm.

For Teng (2004), the acquisitions have numerous appealing benefits: fast entry strategy that allows the foreigners to acquire the already existing resources of the firm and it means that the foreigners do not start from scratch. These benefits are challenged by the potentially very high cost of the operation of merger or acquisition.

Exporting

Exporting is a way of reaching the Chinese market with minimal cost regarding the exit strategy in case of the occurrence of some problem. (David, Yigang and Kevin 1997). According to Teng (2004), exporting is an entry strategy that allows the MNE to operate in the domestic market without having the trouble of a setting the business in china: it is fast, has a limited entry cost and risk and allows the total control of the foreigners concerning the operations they wish and can undertake in the Chinese market.

Representative offices

According to Luo (2000), if a certain foreign investor is risk-averse, depending on his business, he can choose the strategy of opening representative offices. This entry mode helps getting acquainted with the domestic market, building the firm’s connections and reputation. Several conditions bound this type of entry strategy: its activities are fairly limited to non-commercial, product promotion, market research and negotiations on behalf of the headquarters of the company abroad. For Luo (2000), with these limitations come advantages such as flexibility, non bounding commitments with domestic partners and openness towards multiple sectors that are not as easily available when using different entry modes. Since the structure is moderately simple compared to other strategies, it is easier to close the office if a reason to do that occurred. Several disadvantages should be taken into account: startup cost might be difficult to preserve. It is a relatively small office whose business is quite big, and with little resources is hard to sustain, especially that the office cannot issue invoices to his domestic customers.

Quick review on some other options

Branch offices: the action of opening branches in several regions of the country (Luo 2000).

Build-operate-transfer (BOT): useful in the utilities sector, to do a certain project and then move on (Luo 2000).

Franchising and licensing: to profit from a large market without committing large funds, giving the subsidiary in the host country a package of resources and rights to exercise the business (Luo 2000).

Greenfield investments are also a way to enter a market according to Zhang, Zhang and Liu (2007) and this mode consists of investing in virgin lands from scratch. It also means that the foreigners are the exclusive owners of the firm and that is why the Chinese authorities are reluctant vis a vis this foreign strategy.

Conclusions and results

The authors mostly agreed regarding their results and conclusions. Before 1997, joint ventures were the predominant entry strategy used by MNEs to enter the Chinese market. After 1997, MNEs preferred to establish WFOEs: it is explained by the fact that the Chinese authorities changed their regulations concerning numerous sectors and hence facilitated the creation of WFOEs that are more beneficial to the foreign investors. (Puck, Holtbrugge and Mohr 2007) According to the table below, provided by Zhang, Zhang and Liu (2007), we can see that the entry strategy of companies in china has changed from joint ventures to WFOEs also known as FIE. This conclusion is concurring with what the other authors are saying about the current situation of market entry in china.

The entry mode choice depends on a choice affected by the tradeoff between the amount of risk affordable versus the return expected proportionally to that risk, and mostly firms tend to minimize the risk. The authors also point that that the entry mode should be dynamic and not static to one strategy (Zhang, Zhang and Liu 2007). It is the strategy of using sequential FDI, i.e. the strategy changes dynamically in response to what is more adequate to the firm. This approach agrees to what Cheung and Leung (2007) said. WOFEs’ share in FDI rose to 35% in 2000. CJVs’ share decreased until 1995 and EJVs’ share is more stable but declining a bit declining: it had 43% of FDI in 2000 (Shapiro, Tang and Ma 2007). Companies at first try to open a representative office, to test the waters of the market and then attempt a joint venture for a better exploitation of the Chinese market (Cheung and Leung 2007) According to Luo and Chen (1995), the mode of entrance is correlated to the strategy of the firm. If the foreign investors are aiming to reduce the risk and are opting for an optimal asset management, a WFOE is more adequate to their goals than a JV. However if their goal is pursuing local market share, a JV is more conventional. For David, Yigang and Kevin (1997), on a statistical approach, examining 2998 foreign operations in the Chinese market they found that 35% of the companies relied on exporting for their entry mode, 20.8% on licensing, 41.5% on joint ventures and 2.7% on wholly owned subsidiaries. Teng (2004), is agreeing with Luo and Chen (1995): JVs are better if the foreigners are in need of the local resources. However if they are aiming a better control of the firm, they ought to opt WFOEs. He also adds that the fastest solutions are exporting and acquisitions. The latter is more costly and in more need of commitment than exporting.

Appendices

Appendix A: References

Included articles

Luo, Y, (2000), "Entering China today: what choices do we have?", Journal of global marketing, vol. 14. 1/2, 2000, pp.57-82.

Puck, J. Holtbrugge, D. Mohr, A, (2007), "Beyond entry mode choice: explaining the conversion of joint ventures into wholly owned subsidiaries in the people's republic of China", Journal of international business studies, vol. 40. , pp.388-404.

Zhang, Y. Zhang, Z. Liu, Z, (2007), "Choice of entry modes in sequential FDI in an emerging economy", Management Decision, vol. 45. 4, pp.749-772

Luo, Y. Chen, M., (1995), "Financial performance comparison between international joint ventures and wholly foreign-owned enterprises in China?, the international executive, vol. 37. 6, pp.599-613

David, K. Yigang, P. Kevin, Y, (1997), "How MNCs choose entry modes and form alliances: the China experience.", journal of international business studies, vol. 28. 4, pp.445-474

Cheung, F. Leung, W. , 1st Initial, (2007), "International expansion of transnational advertising agencies in China: An assessment of the stages theory approach.", international business review, vol. 16. , pp.251-268

Shapiro, D. Tang, Y. Ma, C, (2007), "Mode of Entry and the Regional Distribution of Foreign Direct Investment in China", journal of Chinese economic and business studies, vol. 5. 3, pp.261-277

Teng, B, (2004), "The WTO and Entry Modes in China", international business review, vol. 46. 4, pp.381-400.

Note that the article are numbered for the sole purpose of the comparison table in appendix B

Excluded articles and reasons of exclusion

Zou, P. Wong, A., (2008), "Breaking into China’s design and construction market", journal of technology management in China, vol. 3. 3, pp.279-291.

Reason: this article is focused on a certain industry and do not bring relevant value to the studied topic.

Claver, H. Quer, D., (2005), "choice of market entry mode in China: the influence of firm-specific factors.", journal of general management, vol. 30. 3, pp.51-70.

Reason: this article was addressing the issue of characteristics of firms and was not stressing on the entry strategy

Ling, F. Ibbs, W. Cuervo, J, (2005), "Entry and business strategies used by international architectural, engineering and construction firms in China", construction management and economics, vol. 23. , pp.509-520.

Reason: this article is focused on a certain industry and do not bring relevant value to the studied topic.

Beamish, P. Jiang, R., (2002), "Investing Profitably in China: is it Getting Harder?", long range planning, vol. 35. , pp.135-151.

Reason: this article discusses profitability and not entry strategies.

Gaba, V. Pan, Y. Ungson, G, (2002), "Timing of Entry in International Market: an Empirical Study of U.S. fortune 500 firms in China", journal of international business studies, vol. 33. 1, pp.39-55.

Reason: this article discusses too specific firms and is not tackling the entry modes in a deep manner

Burgers, W. Padgett, D., (2009), "understanding environmental risk of IJVs in china", management international review, vol. 49. 3, pp.337-358.

Reason: this article is tackling only one entry mode which is joint venture. It does not help the purpose of this SLR.

Bontempi, M. Prodi, G., (2009), "Entry strategies into China: The choice between Joint Ventures and Wholly Foreign-Owned Enterprises An application to the Italian manufacturing sector.", International Review of Economics and Finance, vol. 18. , pp.11-19.

Reason: this article is focused on a certain industry and do not bring relevant value to the studied topic

Appendix B: comparative table of included articles

This table represents the article included and the topic discussed in the article, i.e. every topic that is ticked means that it is discussed in the respective article

Article

Topic

1

2

3

4

5

6

7

8

EJV

X

X

X

X

X

X

X

X

CJV

X

X

X

X

X

X

X

WFOE

X

X

X

X

X

X

X

Umbrella

X

Acquisition

X

X

X

X

Exportation

X

Other*

X

X

X

X

*other can include: branching, representative offices, Greenfield investment, BOT, franchising, licensing, etc.

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