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A structural view of MNCs’operation in China

Simon. F. Huang

Dept. of Project Approval

Shanghai Foreign Investment Commission

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• Three stages of Foreign Investment

• Present “One Face ” in stage two

• How to present “One Face”

• Conclusions

Content

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• Entry

establish a presence, begin to build a brand, and learn about the operating environment

• Country Development

involving more than one operating division, establishing brands, developing markets and

following a geographic expansion strategy. coordination problems with the home office

begin to occur

• Global Integration

becomes a “normal” location with particular resources, rather than a place that requires

a specialized country effort

Three stages of Foreign Investment

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• Entry: business divisions dominate

• Country Development: regional headquarter dominates

• Global Integration: business divisions dominate again

Each stage and its corresponding structure

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• Most MNCs’ investment in China has moved into Stage Two

• Coordination of different business units calls for a more

sophisticated and centralized structure

• Most global corporations currently downplay country management,

putting more power in the hands of business units and product line

managers

Why structural change is desperately called for?

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• Business unit autonomy does not work well there because the Chinese

government views corporations as single entities and largely treats them

as such

• Instead, it pays to show “one face to China”- that is, to establish a

corporate identity that highlights the compatibility between the company’s

goals and the country’s goal

--- Quote from “the great transition” ,

Harvard Business Review, October, 2003

Kenneth Lieberthal and Geoffrey Lieberthal

Shift to One face Structure

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Viable legal vehicles for one face structure

• China Holding Company (CHC)/ Regional Headquarter

• Company Limited by Shares (CLS)

• Foreign-invested Commercial Enterprise (FICE)

How to present “One Face”?

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Holding company, or umbrella company, is defined by Ministry of

Commerce as a foreign-invested company that specializes in

investment and management of investing companies exclusively.

What is a holding company?

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CHC structure

CHC

WOFE/JV WOFE/JV WOFE/JV

Branch Branch Branch BranchBranch

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• Parent companies total asset over 400 million USD, and have at least 10 million USD paid-in register capital in China

• Or, Parent companies have at least ten invested companies in China and have at least 30 million register capital been paid in

• Minimum register capital for holding company is 30 million USD

• If register capital of holding company exceeds 100 million USD, the holding company will be granted RHQ status by MOC and will be granted an expanded business scope

Requirements to set up holding companies

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Advantages of Holding companies

Held shares in subsidiary FIEs

Consolidate procurement and sales function

Provide centralized services such as HR, finance

Leverage financing ability

Cash pooling

Image building and commitment to Chinese market。 Incentive from Local government

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Drawbacks of Holding companies

High fresh capital requirement

Liabilities to undertake investment projects in due time

High income tax rate and lack of tax holiday

Business tax in shared service

Adding another layer in the current structure and may induce

more management cost

Cash trap

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Holding companies in China

Beijing43%

Tianjing2%

Guangdong7%

Shanghai39%

Otherprovince

9%

Among 273 holding companies

Shanghai 105 Beijing 118 Guangdong 20Tianjing 5 Fujian 6 Jiangsu 5 Zhejiang 3 Other provinces 6

As of Dec. 2004

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Holding companies in Shanghai

Shanghai hosts 130 holding companies, more than any other cities. 13 holding companies relocated in Shanghai, among them are: BASF, Bayer, Philips, Robert Bosch, Ford, Baxter

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6 6

129

57

1012

19

25

befo

re 9

5 96 97 98 99 00 01 02 03 04 05

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A foreign-invested company limited by share (CLS), refers to a

business legal entity whose capital is made up of equal value

shares contributed by both domestic and foreign shareholders,

with total value of the shares purchased and held by the foreign

shareholders exceeding 25% of the company’s total registered

capital .

What is a company limited by share (CLS)

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• Promotional methods

Transition Model

New Co. Model

• Share Float methods

Methods set up a CLS

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• Minimum registered capital (or the minimum share value at the inception of the CLS) RMB 30 million

• At least 2 promoters (shareholders), more than half of them should be companies register in China

• The foreign shareholders should hold at least 25%share • If the CLS is to be established in Transition Model, the

existing FIE to be converted to a CLS should have been profitable for the previous three years consecutively

• If the CLS is to be established in Share Float Method, at least one promoter should have been profitable for three consecutive years

Requirements to set up a CLS

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Use CLS structure for corporate restructuring

CLS

Branch Branch Branch BranchBranch

Note: Branches are transformed from previous independent legal entities

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Advantages of use CLS for restructuring

Have a broad business scope to manufacture different types

of products

Provide comprehensive services, including channel cash and

balance the financial needs among branch operations

Enjoy low income tax rate and tax holiday

Enjoy tax savings by utilizing the tax losses of loss-making

branches to offset the profits of profit-making branches

Have an indefinite life term and eligible for public listing

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Drawbacks of use CLS for restructuring

Potential conflict with local Chinese promoters (shareholders)

in the future

A painful negotiation process with partners and governments

corporate income tax

Hidden cost

bar code, tax-free equipments

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Example: Unilever

Set up in 1999, First CLS for restructuring in China

Four FIEs merged into one CLS, Unilever owned 77% shares

and Shanghai Light Industry Holding owned 23% shares

Change back into a Unilever wholly-owned limited company in

2002 after Unilever bought Chinese partner’s shares

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Example: Alcatel

Set up in 2002 by transforming Shanghai Bell into a CLS

Alcatel owns 50%+1 shares, two Chinese partners owns

50% - 1 shares

Alcatel signed MOU with Ministry of Information Industry, put

most of its Chinese and regional business into the new CLS

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Example: Henkel

Set up in 2004 by transforming one Henkel-invested company

into CLS

Henkel owns 86.29%, Henkel CHC owns 11.2%, a local

company owns 2.33% and two trust companies own 0.09%

each

Then use the new CLS to absorb the other four Henkel-

invested companies as its branch companies

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What is a FICE?

A foreign-invested commercial enterprise (FICE) refers to a foreign-

invested enterprise engaged in any of the following four business activities

Commission agency

Wholesale

Retail

Franchising

FICEs are granted both import and export right and domestic

distribution right, subject to the restrictions on certain goods

such as medicine, agriculture chemicals

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Minimum capital applied to new PRC Company Law, which is 30,000 RMB

Register capital should be in line with the business scope and volume

Requirements to set up a FICE

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Advantages of FICE

Consolidate procurement and sales function

Establish own distribution network

Improve logistics efficiency

Exercise better credit control

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Drawbacks of FICE

High income tax rate

33% compared to 15% of manufacturing companies

No tax holiday

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FICE structure-operational center

FICE

Local suppliers

Overseas customers

Local customers

Overseas suppliers

Sister manufacturing companies

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Overseas Parent company

FICE structure-operational center

FICE

Vendor Vendor Vendor

Overseas customers

Overseas customers

Overseas customers

Flow of order

Flow of payment

Flow of finished goods

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• From Jun.1 to Dec.31, 2004, 22 FICEs were approved, most of them were

under CEPA

• In 2005, 431 FICEs were approved, among which 92 are pure retail

companies, 339 are wholesale companies or wholesale retail mixed

companies

• More than 110 non-commercial FIEs were approved to expand business

scope to include distribution, including 24 Waigaoqiao bonded-zone trading

companies which were converted into FICEs

• From Mar.1, Shanghai Foreign Investment Commission has approved 50

new FICEs.

The milestones of FICE

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Challenges and our value

• Structure is important to performance

• Different stage, different structure

• Current challenge: to find out a viable structure to consolidate

Chinese operation

• Our value: working with professionals to advise investors our

practical and first-hand experience