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The report evaluates the potential investment opportunities in China's agricultural sector. This will be the first time the company is considering such opportunities in an Asian country. China and the United States are two major players in the import and export business as well as foreign direct investment, yet their business systems are so different. The success of an American business in China depends on the firm's understanding of the nature of their business systems as well as their norms and values. The flow of foreign direct investment between both countries as well as the level of protection against each other portrays the extent of their relationship. This is where competitive advantage is crucial to ensuring a continuous success existence. The globalization of a business makes such a business vulnerable to fluctuations to the exchange rate of other countries which is as a result of different exchange rate regimes. Accounting for all these factors clarifies the issue as to whether or not such investment based on the findings is feasible.
The report will focus on the national business systems and cultural conditions in China and provide a brief assessment of its effect on Vale international's entry into the Chinese market. Secondly, an assessment of the investment patterns and trends between both countries and the competitive advantage needed by the company to compete in the Chinese market, will be conducted. An outline and assessment of the risks posed by exchange rates in both countries and measures, by which such risks can be reduced to the barest minimum. It will also involve identifying the appropriate mode of entry into the Chinese market. Giving advice on the kind of political risk that they may encounter and means by which such risks can be minimized, will also make up part of the report and finally, provide a recommendation on whether or not the company should go ahead with its investment plans.
As an emerging economy, the People's Republic of China currently ranks as the most populated country in the world and is ranked 146th in terms of its population growth rate with a population figure of 1,338,612,968 and a growth rate of 0.66% respectively (CIA World Fact book). With just under 4% of its population being either unemployed or underemployed, and just 8% (CIA World Fact book, 2006) of its population living below the poverty line(CIA World Fact book), more than half of the country's population are living comfortably. This was largely due to the reforms that made the economy more market oriented. In 2007, they were the seventh in the world in terms of stock of foreign direct investment at home valued at $758.9billion and twenty-second(CIA World Fact book, 2008) in terms of stock of foreign direct investment abroad valued at $149.3billion (CIA World Fact book, 2007). Even with their per capita income as at 2008 being $6000, which is quite low, they can still boast of having the best current account balance of $426.1billion as at 2008 when compared to its $371.8billion as at 2007 and the rest of the world.
The United States of America currently ranks as the third most populated country in the world and is ranked 129th in terms of its population growth rate with a population figure of 307,212,123 and a growth rate of 0.98% respectively (CIA World Fact book). As at 2008, they had the biggest stock of foreign investment in the world (both home and abroad) valued at $2.367trillion and $3.162trillion respectively. Although its $47,500 per capita income is very encouraging, its current account is in red with a deficit of $706.1billion.
Both countries have been trading partners since 1999 after China's entry into the World Trade Organization. "A door to history has been opened and now member governments must walk through it together" (Director General WTO, Mike Moore, 1999). This led to their attaining full membership status in 2001 into the World Trade Organization in Doha, Qatar after 15 years of negotiations (WTO). China is one of the largest emerging economies in the world with a torrid economic growth rate of 8.9% in the third quarter (Forbes 2009). This was because of the early implementation of its massive stimulus package of 4 trillion Yuan (US$570 billion Dollars), to battle the impact of the recession in its economy (World Bank, 2008). China presently has the fastest growing agricultural sector in Asia and currently ranks ninth worldwide (Nationmaster, 2009).Their consumption per capita is 75, which places them as the ninth largest consumer of pork in the world (Nationmaster, 2009). About 40% of China's labour force is engaged in agriculture. This makes up 13% of China's GDP (US Department of State, 2009). China produces about 30% more crops and livestock than the United States because of its government efforts at introducing reforms into the sector. China hopes to increase agricultural production of livestock by taking advantage of mechanized processes and technology of the 21st Century. However, the increasing wealth gap between the cities and countryside, as a result of stagnating incomes is becoming a major issue in their economy. The recent recession did not make things any better. These ailing conditions have formed a pattern that has attracted multinationals towards China's investment potentials in that sector.
Vale International is meat-processing company that specializes in providing meat of the highest quality in the most hygienic conditions to retailers for resale. The company has over 60 branches worldwide. The strength of the company lies in its use of state-of-the-art technology, which is used from the slicing stage to the stage of packaging and delivery. The processing speed enables the company meet the need of its clients promptly. Investing in China has a number of benefits attached for them. However, it also brings up a number of questions.
-What kind of political, economic, social, technological, and legal systems do the Chinese use to operate? What are the challenges, especially to foreign investors?
-What are their values and beliefs when it comes to doing business?
-What is the trade relationship between both the United States and China like? Does this pose any challenge to investors?
-If an investor wishes to embark on importing to or exporting from China, what risks do the exchange rates pose?
-What kind of political risks could be envisaged and how can they be reduced?
Tackling these issues would create a clearer picture as to the feasibility of such a venture
National Business Systems
Differences in business systems have a profound impact on the benefits, costs and risks of doing business in different countries (Hill, 2009).
Since it embarked on major economic reforms in 1978, China has witnessed tremendous changes over the last two decades. "Although China is still nominally a communist state with substantial limits to individual freedom, in the economic sphere it has moved away from strict adherence to communist ideology" (Hill, 2009). However, the government still control the production and consumption quotas within the country. The effort made by the Chinese government to encourage foreign direct investment inflows is displayed in the table below.
The country's inflation rate shows that apart for the sharp rise in price of goods in 2008, which has been brought under control in 2009, the country inflation rate, is relatively stable. Rising food prices in relation to the rise in consumer spending in China helped to cushion the effect of inflation in their economy. Below is the food price index globally.
Also, the early injection of its stimulus package as well as the Chinese government's refusal to revalue it currency at the demands of the United States contributed to its quick recovery from the inflation rise. China's adoption of a market-based economic system has caused a robust growth in the agricultural sector since the reforms began. In 2008, the decline in meat procurement which resulted from strict macro government policies, was an attempt by the Chinese government to promote local breeding and consumption of local livestock. This is to cushion the effect of high food prices globally(FAO, 2009) This move posed as a problem for exporters who saw their sales to Chinese customers drop. Although it benefitted local producers, the value of their currency still hindered their ability to exploit the situation.
One of the major aspects of the reforms was the dismantling of communal system of farming and livestock rearing and introduction of the household based system, which allows families more power in decision making in this sector. However, property rights and ownership in China is still under scrutiny. Despite the property law enacted in 2007, which identifies the right of an individual to his/her own property (Hill,2009). These findings raise certain questions as to the safety of any foreign investment, particularly agriculture and livestock.
In 2008, 370 billion Yuan out of the 4trillion Yuan stimulus package was earmarked for research and development projects (Economic observer, 2009). One of the projects involved supporting agricultural works within the country. This involved providing the necessary infrastructure to increase productivity and promote internal consumption. This means that investors can utilize the infrastructure being put in place rather than having to spend more on providing the necessary infrastructure for their investment.
China's economy can be described as a relationship-based economy rather than a market based economy (Enderwick, 2007). The existence of "Guanxi" within their economy, makes entry as a foreigner very difficult. This is where associations like the United States Meat Export Federation (USMEF) which is committed to ensuring that US companies wishing to export or invest in foreign markets are given all the necessary assistance and contacts through their offices abroad, come in. They presently have offices in Seoul, Tokyo, Beijing, Hong Kong, Shanghai, Singapore, Taipei, Moscow, St. Petersburg, Mexico City, Monterrey,Â and Brussels. Membership under such an association, which happens to have a branch in the Chinese Capital, will make settling into such a business environment less troublesome since they will be familiar with the terrain. Such economies are vulnerable to problems of corruption especially at government level, which adds to the cost of doing business (Enderwick, 2007). However, recent statistics show that as at 2009, China's seventy- ninth position on the corruption perception index, was a trend (Transparency International, 2009), which is proof of China's ability under the present government to avoid wealth intoxication despite its gains and its status as an emerging economy.
To do business in another country, it is important to gain an understanding of the culture that prevails in such countries (Hill, 2009). For the Chinese, the importance of "Guanxi" which refers to "the concept of drawing on conceptions in order to secure favours in personal relations (Yadong Luo, 2007)" cannot be overemphasized. The relationships between the Chinese are based on this concept. Unlike the western business culture that focuses on what the person has to offer (transaction based), the Chinese business culture focuses existing relationships between both parties involved. These Guanxi networks are very useful especially when it comes to obtaining first hand insider information on certain aspects affecting a business or an industry. Such relationships are mostly existent among immediate family members, followed by probably extended family members. However, the advantage of such relationships is that you do not have to be Chinese to enjoy the benefits of guanxi. Such connections are formed based on either friendship with a Chinese person, which must have been nurtured over the years or doing business on a short term basis so as to earn the trust of their Chinese counterparts. Although the element of suspicion will exist in their minds, the longer the relationship, the less suspicious they become. For the agricultural industry which is closely monitored by government, fostering good relationships, especially with members of the Chinese Meat Association or with people who have friends within the association and probably within government will also help in ensuring the success of the business. The networking process within China is quite different from how people in The United States network. The procedure for business interactions by the Chinese takes the form of a flexible, friendly role, which is supposed to create a comfortable informal environment for business transactions. For the United States, the formality between individuals is maintained to create the impression of seriousness between clients. The motives of Chinese to do business are economic and partly social while for countries like the United States, economic gains are the primary objective. For the Chinese, such networks create a form of mutual dependence amongst themselves while in the United States, such organization stand alone. Also, negotiation with government authorities in China is based on personal trust while in the United States, such form of trust can only be accepted once documents relating to the business agreement has been signed. These four factors clearly explain the strong belief of the Chinese in Guanxi.
Foreign Direct Investment Trends
"The fact that so much foreign money has been of the FDI variety has helped shield China from the kind of jolts recently administered to other Asian economies where a higher proportion of investment was indirect -- such as bank lending or stock portfolios." (National Bureau for Economic Research, 2010).
Since the official start of the recession in 2007 (NBER), China has seen a tremendous influx of Foreign Direct Investment. This move by investors is cushioned on the hope that the Chinese government will revalue its currency. China's export led growth has placed it as a neo-mercantilist nation. With a trade surplus of $210billion and its foreign reserves exceeding $1trillion (Hill, 2009), the country stands in a very good position to become a worldwide economic power. By keeping the value of its currency low, China's availability of cheap labour makes the market an attractive for investors to hire cheap labour. Most of the foreign direct investment as at 2007 came from investors who started projects in China. This is shown in the table below.
Vale international plans to exploit this weakness with cutting edge technology and work processes to deliver quality results in the quickest possible time. Most work processes in China are labour intensive in nature. This is because of the government's interest in ensuring that the huge population is catered for. However, there is always the tendency that they will become sluggish unlike machines that can actually get the jobs done faster and better. Although China presently may seem to have absolute advantage based its vast population's dependence on locally made goods, their economy is still in need of foreign direct investment if it hopes to sustain its continuous growth path, which will contribute to the growth of not only their gross domestic product but also their currency value in the international market. Ohlin Heckscher's theory which established that the condition for two countries to trade must be their difference in the availability of factors of production. In a capitalist economy like America, the literacy level gives an individual the right to bargain for his welfare and if such a person is not treated satisfactorily. Labour organizations will pounce on the firm. This is an advantage which China possesses taking into account the size of their population. Thus, meaning that labour is in abundance at the least cost.
The primary aim of a business is to maximize shareholders' wealth. However, with businesses of the twenty-first century going global, the likelihood that fluctuations or currency movements of any kind, is present. After it announced the revaluation of its currency in 2005, which put the renminbi at 8.11 against the dollar, the Chinese currency rose by about 20%(FRBSF, 2005). Since then, the Chinese currency has remained in a transition period. This is as a result of pressures from the United States Government to revalue their currency. Unfortunately for the United States, the Chinese are of the opinion that such a decision should be made by them, and not for them. "Their exchange rate system is obviously a work in progress" (Eichengreen, 2006). Operating a managed floating exchange rate by pegging its currency to a basket of currencies, the present Chinese government still exerts its influence on the currency, but it does this only when deemed favourable to its country. The pegging will help shield the currency from the fluctuations' that occur in the world market. It helped increase the level of exports as well as increase the country's current account surplus, while being able to control the level of inflation within the economy through its fiscal and monetary policies. The effect of their current account surplus has brought about a reduction in general price level of goods and services in the global market. However, their pegging the currency means that the economy they are pegged to must maintain a certain level of stability.
There are certain risks that as any investor wanting to do business in any economy will face. They include
Economic exposure: This includes the risk of having to denominate your assets and liabilities in their currency (translation risks). For a business that wants to start up in an economy like China, this is favourable. Purchasing the necessary factors of production in their country will be cheaper for investors. However, for an investor who may decide close shop, there is the difficulty of finding a buyer since more than half of their population are impoverished. In addition, the disposable value for such sale makes the asset look worthless (transaction risk). There is also the accounting effects but also incorporates the competitive situation of the firm (Sharpiro, 1992). Even firms that source within the domestic market are not shielded from the currency exposure.
A model has been designed by Flood and Lessard (1985) to analyse a firm's competitive position and the level of its exposure to economy.
Firms with a mismatch between their price and cost sensitivities that import and export, have a high degree of economic exposure, while a firm with either high or low sensitivities to both costs and prices, that are either importers with common costs or domestic producers sourcing g locally have a low degree of economic exposure( Moles; Bradely, 2002). Operational financial hedging is one of the strategies that can be used. Vale international will have to match their input with their output sensitivities. These include their production, financial and marketing decision, all of which has to be harmonized.
Greenfield Investment will be the best option. For a company that is technology focused, Vale International would want to used that technological advantage to capture a sizeable portion of the market. Shenzhen, Shantou, Zhuhai, Xiamen and Hainan, twelve out of fourteen coastal cities, dozens of development zones and designated inland cities, (They all fell under the Special Economic Zones) in China have designated as technology promotion zones (OECD, 2000) by the Chinese government. Special preferences is been provided by the government for companies bringing in high-tech equipment. Using an agent who is Chinese by origin is a good start. That individual will be responsible for negotiations with the appropriate authorities. Also, such a person will speak with the various meat union, so as to register the presence of the company. If possible, such a person should be familiar with both cultures. This will be an advantage to the firm because in each of these provinces, there are prospective clients who only do business with people they trust. But to earn that trust, the company has to use the agent as an opportunity to build a network that will facilitate easy access to the customers.
Corporate Social Reponsibility
Enderwick, P. (2007). Understanding Emerging Markets. China and India; pg 10
Hill , C.W.L. (2009). International business: Competing in the global market place; pg 43
Eichengreen, B. (2006). China's Exchange Rate : The long and short of it. University of Carlifonia, Berkeley
Bradley, K, (Bain & Co) and Moles, P.(2002). Managing Strategic risks exchange rate exposure: Evidence from UK firms; Managerial finance, Edinburgh pg 28