University of Nottingham

International Businesses Entry Mode in China

By

Zhanyuan Cai

MSc International Business

15/09/2006
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Abstract
Today economic globalization is more and more deepening and to develop the domestic economy through utilization of foreign capitals is becoming every countrys common consensus. Foreign investment becomes an essential part for the healthy growth of the host countrys economy, but the attitudes and the policies taken by the host countries especially the developing countries are varying. Therefore it is important to learn and know the attitudes and policies of the host countries for foreign firms before making investment. In addition, the countrys culture and market environment greatly affect different types of entry modes. This dissertation explored the characters of different types of entry modes and seeking through various aspects that affect the decision making on choosing the right form of entry mode in China. Now China becomes the largest country in attracting foreign capitals among developing countries. A comprehensive examination and adjustment of Chinas strategies in utilization of foreign capitals has been an important topic that can not be ignored.

The dissertation has been divided mainly into seven parts: the first part is the Introduction. The introduction for the topic and the definition of the basic concepts are given. The second part is the Types of entry modes. In this part, four different types of entry modes: Exporting, licensing, franchising, and FDI- Joint Venture are introduced and described in details. The third part is the Chinese Culture. The aim for this part is to point out how it affects the choice of entry mode in China and what are the advantages and disadvantages of Chinese culture relating to different types of entry modes. The fourth part is the Chinese regulations and policies against foreign firms (for different types of entry modes). A case study of KFC is offered in the fifth part to confirm and proof the concept of the dissertation. The sixth part is an interview of a foreign company (Lvbang) in China. And the last part is the conclusion.

Acknowledgement
Firstly, I would like to thank my Supervisor- Dr Tian Xiaowen, for his continuous support for the writing up of my dissertation. Dr Tian Xiaowen is always there to listen and to give advice. He taught me how to ask questions and express my ideas and how to write the dissertation in the correct way. He showed me different ways to approach a research problem and the need to be persistent to accomplish any goal.

During the writing up of this dissertation, I faced many problems and thanks to Dr Tian, who is responsible for helping me to complete the dissertation. Without his encouragement and constant guidance, I could have not finished this dissertation. He was always there to meet and talk about my ideas and mark up my papers and chapters, giving me advices and supports.

Beside my Supervisor, I also would like to thank Mr. Cai Rongzhuang, the chairman of Lvbang international company Co., LTD. Thanks for his time and great passionate support during the interview.

Last, but not least, I would like to thank my whole family. Without their support, especially my parents, I cant finish this dissertation on time.

Content
Chapter1: Introduction.....................................................................6 1.1 Chinas opening up.......6 1.2 Chinese economy..................7 1.3 Why foreign investors choose China........8

Chapter 2: Types of entry modes ..10 2.1 Introduction.10 2.2 Exporting.11 2.3 Licensing.11 2.4 Franchising..14 2.5 FDI- Joint venture...15

Chapter 3: Chinese Culture ...........22 3.1 Introduction......22 3.2 Culture affects on Exporting....26 3.3 Culture affects on Licensing and franchising..27 3.4 Culture affects on Joint venture (FDI).....30

Chapter 4: Chinese regulations and policies against foreign firms ...........34 4.1 Introduction.34 4.2 Exporting.36 4.3 Licensing and franchising ..42 4.4 Joint venture44 Chapter 5: A Case study (KFC).........................................................................49 5.1 Introduction.49 5.2 Internationalization of KFC50 5.3 Choosing the Chinese market.50 5.4 Recommendations...51

5.5 Market entry options...51 5.6 Recommended entry mode: Joint venture..52 5.7 Recommended location..54 5.8 Central control versus local responsiveness...55 5.9 Conclusion..55

Chapter 6: Interview with a foreign company (Lvbang) in China ............................57 6.1 Introduction.57 6.2 Interview.57

Chapter 7: Conclusion .......61 7.1 Chinese market environment......61 7.2 Comparing different forms of entry modes....63 7.3 Best choice- Joint venture...65

References .....................................................................................................................66

Chapter 1

Introduction
1.1 Chinas opening up
China is one of the most ancient countries in the world that has history of more than 5000 years. Since the great Cultural Revolution from 1966 to 1976, China has adopted a gradual approach to economic reform and opening up under the authority of leader Deng Xiaoping. This approach leads China to open its door to the world and allow foreign companies to run their businesses in this huge market with enormous potential for development. Under the gradual development of economy approach, the country has set up many restrictions and regulations against foreign firms and in the beginning, it was very hard for them to set up and run their businesses in china. However, since China joined WTO and the introduction of globalization lead China to change its policies and regulations, and the economy in china has been hastily growing. This rapid growth of the Chinese economy has attracted many foreign firms to come and invest in China. Because china is still adopting the gradual development approach, it is important for foreign firms to learn and know the Chinese governments policies and the forms of entry modes that are suitable for particular industries in China. Failure of doing that will result many negative effects to foreign firms, such as losing of opportunities, profits, and even unable to survive in the Chinese market. This dissertation will mainly introduce and discuss different types of entry modes for different industries and various aspects that affect the choice of entry modes in China, such as cultural and political. In addition, provide

information for foreign companies of making decisions on choosing the right and most suitable entry modes in China.

1.2 Chinese economy

From the UNs world investment report in 2003, China has become the world number one that attracted 53 billion US dollar in 2003 and maintained the largest FDI recipient globally. The economy of the People's Republic of China is the second largest in the world when measured by Purchasing Power Parity, with a GDP (PPP) of US $9.412 trillion in 2005. When measured in USD-exchange rate terms it is the 4th largest in 2005 with approximately US $2.22 trillion, set to overtake the German economy by 2009. It is the world's fastest growing major economy, and its continued growth is vital to the overall health of the world economy and to the benefit of its population of almost 1.3 billion (most of whom have yet to enjoy western style affluence). Its per capita GDP in 2005 was approximately US $1,703 (US $7,204 with PPP). As of 2005, 70% of China's GDP is in the private sector. The smaller public sector is dominated by about 200 large state enterprises concentrated mostly in utilities, heavy industries, and energy resources. Current GDP per capita grew a paltry 17% in the Sixties, rising to 70% in the Seventies, and China surged ahead of India registering a remarkable growth of 63% in the turbulent Eighties and finally reaching a peak growth of 175% in the Nineties. However, Chinese prosperity still remains concentrated in the coastal and southern provinces and efforts have been made in recent years to expand the prosperity to the inner provinces and the industrial North east rustbelt. The graph below shows Chinas GDP trend after the reform until 2005:

(http://www.unctad.org/templates/WebFlyer.asp?intItemID=2412&lang=1)

The Central Committee of the Chinese Communist Party recently has published and approved the plan for the 11th 5-year plan for year 2006 to 2010. The plan stated that the Chinese economy will run for a further 45% increase in GDP and 20% reduction in energy intensity by 2010.

1.3Why foreign investors choose China

The great development of the Chinese economy has attracted large number of foreign investors to come and invest in China with various forms of entry modes. Why foreign firms go aboard and invest in China? The answer is obvious: firstly, foreign firms need to over come the liability of foreignness. The inherent disadvantages foreign firms experienced in China due to their non-native status such as numerous differences in both formal and informal institutions (Regulations, Culture, Language, Policies and environment, etc). Secondly, the tremendous market opportunities have stimulated

numerous foreign companies to expand their business in China. Lastly, globalization has pushed firms to expand their businesses globally and China is a developing country. As a

result, one of the most important objectives for China is to developing its economy globally in order to merge the global market. Attracting foreign capital becomes the major source for the rapid growth of the Chinese economy. The joining of WTO is the latest accomplishment for China and raises its position in the global competition. From above, it is obvious that studying and learning the forms of entry modes are significant for foreign companies especially multinationals. Choosing the right and suitable entry mode may help foreign investors to gain more profit with higher efficiency from their investments. In addition, selecting the most suitable entry modes for the right industries may achieve better government supports and face less negative cultural effects. In other words, it can be stated that entry mode is the key for foreign investment, selecting an entry mode is one of the most important strategic decisions that a firm has to make when it enters a new market, which often determines that success or failure of the firm in the new market. Foreign investors choosing the wrong entry modes may result to fatal failure.

This dissertation will mainly focus on four different types of entry modes: exporting, licensing, franchising and Joint Venture. Each type of entry modes will be inclusively defined and described under the framework of the Chinese economy. Then each type of entry modes will be compared with the cultural and political aspects and both advantages and disadvantages for all four types will be specified. It is important to know that different companies should choose different forms of entry modes and its all depend on individual circumstances. It is almost impossible to say that which form of entry mode is better than another. There are many factors that affect the choice of the right entry mode in China. However, after evaluation of each factor that affecting the decision making of entry modes, conclusion can be made on which entry mode is better for particular businesses in a given time in the Chinese business market.

Chapter 2

Types of Entry Mode

2.1 Introduction
There are many forms of entry modes that a firm can choose from when entering the Chinese market. Basically, they can be classified by two criteria: trade versus investment; direct investment versus indirect investment. In the first criteria, trade represents exporting and importing; investment corresponds to representative office, assembling, processing, licensing, franchising, equity joint venture, cooperative joint venture, and whole foreign owned subsidiaries. Each method will have its strengths and weaknesses in general terms. Often the greatest obstacle for organizations when entering foreign markets is the array of standards which the company has to meet, for example; safety, environmental, packaging, labeling, patents, trademarks and copyrights, these factors can make it hard for businesses to success in the Chinese market. This dissertation will mainly discuss and investigate on exporting, licensing, franchising, and Joint venture.

Since China opens its door, foreign investment becomes more favorable than trade, Joint venture becomes more favored than partnership and assembling and processing are more favored than licensing and franchising. Each of the entry modes has it own advantages and disadvantages, therefore many multinational companies adopted a combination of different entry modes to minimize the disadvantages and optimize the advantages. Now the combination approach of different entry modes has been 10

increasingly adopted by many MNCs in China. However, it is quit hard for them to manage their businesses with many forms of entry modes and the risks for adopting different types of entry modes are high.

2.2 Exporting
Exporting is the simplest form of trade that allows foreign companies to enter Chinese market. Export is the provision of goods, services or knowledge across national and international boundaries. Exporting is a traditional and simple method of entering foreign markets. Because exporting does not require the production of goods in the target country, therefore no investment in foreign production facilities is required, which reduces risk if the project fails. In addition, exporting is usually seen as a low key method of entering a foreign market as it avoids the often substantial cost of establishing manufacturing operations in the host country such as, factories, machineries and employees.

There are mainly two types of exporting; one is called direct export which means export to a distributing importer and export using a commission agent, another is called indirect export, which includes manufacture under licensing and franchising and project management. The advantages for exporting embrace maximizing resources, optimizing prices, increasing competitive advantage and combating foreign competition. The approaching disadvantages for exporting are financial risks, intellectual property matters and the risks associated with inadequate resources. The import and export license system is a key governmental measure in China's foreign trade management.

2.3 Licensing
The definition of licensing is defined as a business arrangement in which the manufacturer of a product or a firm with proprietary rights over certain technology,

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trademarks, etc. grants permission to some other group or individual to manufacture that product (or make use of that proprietary material) in return for specified royalties or other payment (Web definitions from Google). Instead of selling products or services directly to customers overseas, some small companies adopting exporting as an entry mode enter foreign markets by allow licensees to use their patents, trademarks, copyrights, technology, processes, or products. In return for licensing such assets, the small company collects royalties from the sales of its foreign licenses. Licensing is a relatively simple way for business to extend their assets into global markets. Small companies tend to license their assets in order to enter foreign markets as they are less risky compared to some large companies which decide to use foreign direct investment which requires massive amounts of investment and can hold very high risks. In conclusion, licensing mainly holds advantages for small companies as it allows them to enter foreign markets quickly, easily, and with virtually no capital investment.

Licensing business was existed in China only a few years ago. The huge Chinese economic market has provided an excellent circumstance for China to become the second largest country with licensing market in Asia, even through the Licensing business existed in China only a short period of time. In 2001, the total retail sales of licensed products reached 600 million US dollar, nearly the same as the combination of sales in all East Asia economies (Licensing in China, Hong Kong trade development council 25 July 2003). However, the Chinese licensing market is still new and can be developed further as the number one in Asia or even number one in the whole world.

Under the fast, strong economy development and rising consumption power, the Chinas licensing market has enormous growth potential. As the Chinese income raises, the purchase of licensed products, especially higher end consumer goods leapfrog significantly. According to the states estimation report, by 2010, the Chinese licensing market could reach approximately 1.5 billion US dollar a year. In high-income cities such as Beijing, Shanghai, Guangzhou, Shenzhen and other major regions in the Pearl River Delta and Yangtze River Delta, retail sales of licensed products for one person per year

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could rise to over 5 US dollar (Licensing in China, Hong Kong trade development council 25 July 2003).

Lots of foreign licensors and licensing agents from all over the world are attracted by the Chinas licensing market. this is because the Chinese market is still new and has not meet the requirement for breeding large number of local licensors and licensing agents, therefore it is an advantage for foreign licensing companies as they are spearheading the development of the industry in China.

Chinas licensing market is currently dominated by major foreign licensors such as Warner Bros, Nike and Adidas, who are large international companies that existed in China over long period of time and with dynamic energy to develop new products or technologies or management to control the Chinese market. In China, more than 90% of best selling licensed products are belongs to foreign companies. For example, most of the well known cartoon products such as Mickey Mouse, Tom and Jerry, Snoopy, Hello Kitty, etc. Child related goods with cartoon driven characters such as toys, games, apparel, stationery and childrens goods are particularly popular in China, and therefore foreign licensors paid huge attention design and produce these types of properties.

As stated above, licensing is still new for Chinese local companies and Chinese still lack of experience on adopting licensing as an entry mode in the Chinese market in the early time. Foreign companies, especially large international foreign enterprises play the key role with their strong concept of globally standardized IPR protection and business practices. At present, foreign investors have invested more than 60% of the licensing companies in China; the majority of these companies are from Hong Kong, and Taiwan. Foreign investors adopting licensing as an entry mode to China have highquality distributaries channels such as Carrefour or Wal-Mart that focused in the middle range with lower price products.

Under the effects of rising popularity of licensed products in China, many local Chinese firms have so far recognized the huge benefits of selling licensed products and

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the suitable and appropriate ways for building up for a licensing business. It is therefore essential to educate the local Chinese licensees about the benefits and correct practices of the licensing business and to build access to these potential local licensees with pro active marketing strategies. Compared to licensees in other countries, especially in Asia countries, Chinese licensees require greater support from licensors or licensing agents in terms of product development, methods of promotion of their licensed products, and business model formulation.

2.4 Franchising
The definition of franchising is defined as a continuing relationship in which the franchisor provides a licensed privilege to the franchisee to do business and offers assistance in organizing, training, merchandising, marketing, and managing in return for a consideration. Franchising is a form of business by which the owner (franchisor) of a product, service, or method obtains distribution through affiliated dealers (franchisees). (From Web definitions from Google)

Franchising is comparatively a very successful and intensifying method of marketing, selling and distributing goods and services. It combines the skills and experience of the franchisor and the goodwill created by the brand. Correctly bringing together the property rights and the extra financial resources provided, plus the entrepreneurial skills and drive of the franchisee, achieves success. In addition, franchising is also another method of entering a foreign market (From

www.Franchisetraining.co.uk). Over the past decade, a growing number of franchises have been attracted to international markets to boost sales and profits as the domestic market has become saturated with outlets.

In short, franchising is a strategic alliance between groups of people who have specific relationships and responsibilities with a common goal to dominate markets, i.e., to get and keep more customers than their competitors. There are many misconceptions

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about franchising (http://www.china-markets.org/); a franchisor is not simply buying a franchisee. In actuality, franchisors are investing their assets and resources under the franchising agreement with franchisees to utilize the brand name, operating system and ongoing support. Everyone under this agreement is licensed and permitted to use the brand name and operating system. The business relationship is a joint commitment by all franchisees to get and keep customers. Legally franchisees are bound to get and keep them using the approved marketing strategies and operating systems from the franchisor.

Normally, foreign companies selecting franchising as an entry mode to entry the Chinese market because they have already success their businesses in their home countries, by teaching their franchisees, they believe their successful companies operations can be easily and quickly replicated to their franchisees without significantly increase their debt.

In franchising, the brand identity or trade name is the most important aspect affecting both franchisors and franchisees. Franchisors must set up franchise system with precise methods to service and satisfy their customers. By documenting these practices, the franchisor standardized and institutionalizes customers buying experience. Due to unwillingness to surprises the consistency in operation, franchisors and franchisees build loyalty to the brand.

2.5 Foreign direct investment- Joint Venture (FDI)

International investment means to expand businesses from a single country to cross countries in aspect on production, management and distribution of goods and services, and commerce areas.

FDI means foreign investors intended on control and managing the businesses and seeking for profits with building long term ownerships for those businesses. The definition of long term ownership can be varied from a few years to over 50 years. The

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most traditional form is to form foreign subsidiaries or joint ventures. The main reason for FDI is to allow foreign investors to get control of the businesses they invested in.

The characteristics of FDI are numerous. Multinational companies are the main responsible party for FDI. In China, the market is huge and the competition is high in recent time, lots of foreign companies come and invest in China, and the large multinationals have gradually swallowing the small local companies. Therefore it is quit obvious that FDI in China requires large amount of capital which small private companies are not usually affordable. The fields that foreign companies invested in China are diversified and moving towards to technology, commerce and banking from traditional manufactories and agricultures. This is because those fields are easier and faster to access and profit gaining is much higher than traditional businesses.

FDI have mainly two types, one is called wholly ownership and another is called partnership. Wholly owned ownership can be further divided into two types, green field versus acquisition. Green field refers to starting a project from scratch, for example, building a factory on a virgin site, in a host country. This type of wholly owned direct investment is very time consuming and requires huge amount of capital and resources for foreign investors. On the other hand, the pay back is 100%. Foreign investors adopting green field strategy will gain fully control of the business in host country and gain all the profits from it. Acquisition refers to entering a host country by purchasing an established facility in that country, for example, an existing factory or an existing distribution company. This type of foreign direct investment is easier and faster than green field, however, it faces many problems such as cultural and political. Host government may not support the acquired factory or local people may not accept the new factory that take over by foreign investors. Wholly foreign owned enterprises is entirely owned and controlled by a MNC, that is, a MNC holds 100% of the capital of the wholly foreign owned enterprise and is liable to the wholly foreign owned enterprise to the extent of its investment. The advantages for WFOE are MNC has full control over the subsidiary and does not risk leakage of its technology to its local partner. The disadvantages for it are

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MNC cannot benefit from a local partners knowledge and the costs and risks cannot be shared. In addition, MNC is subject to government restrictions and cannot enter certain industries in China. Partnership includes Joint venture and alliances. From Wikipedia, The definition of joint venture (often abbreviated JV) is a legal entity formed between two or more parties to undertake economic activity together. The parties agree to create a new entity by both contributing equity, and they then share in the revenues, expenses, and control of the enterprise. The venture can be for one specific project only, or a continuing business relationship such as the Sony Ericsson joint venture. This is in contrast to a strategic alliance, which involves no equity stake by the participants, and is a much less rigid arrangement. (http://en.wikipedia.org/wiki/Joint_venture) For joint venture, foreign companies may invest financial and other forms of resources or sign up contractual agreements of profits and responsibilities such as research and development, production, marketing, management, etc with local companies. Alliances are voluntary agreements between firms involving exchange, sharing or co developing of products, technologies or services. Since 1990, the second type of foreign direct investment-Joint venture has been increasingly adopted by foreign investors due to the Chinese regulations and policies on ownership restrictions. Wholly foreign owned enterprises can not enter certain industries such as Banking and media businesses in China. Joint venture has many advantages for investors; it spreads the costs and risks to two parties and improves access to financial resources. Joint venture has the ability for companies to access to new technologies and customers, access to innovative managerial practices easily and quickly. The adoption of joint venture as an entry mode may lead to economic of scale and advantages of size. In addition, joint venture can influences the structural evolution of the industry, pre-empting competition, create of stronger competitive units, Speed up to meet the market demand, and improved agility. There are many concerns that influenced foreign investors on making decisions on foreign investment, the most important concerns are: environmental concern, market concern, labor force concern and strategic concern. Environmental concerned involves the consideration of natural resources, looking for sufficient resources all over the world to overcome the lack of resources in one country. This type of concern is suitable to

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maintain the equilibrium of usage and expenditure of natural resources and prevent large instability of costs and prices of natural resources. The second concern is market concern. This type of concern represents that the companies are looking for expanding their products or services to international market. Under the market concern, foreign companies may move into different countries and adopting localization to reduce the tax and other additional costs. Labor force concern corresponds to foreign investors place importance on labor force and labor cost by seeking cheap labor force in different places in order to reduce costs and increase efficiency and profits. Developing countries have competitively cheaper labor costs and larger labor force compared to developed countries, therefore foreign investors always looking for suitable areas in developing countries to set up their product production factories to reduce the costs. The fourth concern is strategic concern. This type of concern is the combination and sublimation of the three. It is hard to implement and risky. Foreign investors making investment based on world competition for particular products or services.

Joint Venture has a number of advantages, the most obvious one is that, companies selecting FDI- Joint venture as an entry mode have direct or indirect ownership (unlike licensing) of the businesses which provide higher level of control in the operation system and management system. Joint venture offers better ability to understand and manage the customers and competitive environments.

One of the most prominent impacts of Joint venture on the Chinese economy is due to the large population and labor abundant. Foreign Joint venture companies have helped China to create millions of jobs. Both total employment and urban employment in FDI firms in China has increased significantly. International joint venture companies have paid higher wages, salaries, bonuses, and other fringe benefits to the local employees than domestic firms. Apart from differences in the distribution of their activities between wage sectors, Joint venture companies record higher labor productivity and have higher capital intensity than their local competitors. In some cases, these higher levels of productivity reflect a higher capital to labor ratio. Joint venture firms are also larger than their local competitors and large firms usually pay higher wages than small

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firms. Most of the time, foreign firms may feel the need to buy themselves into unfamiliar labor markets or to attract workers away from competing employers. In addition, foreign direct investment such as Joint venture also has upgraded skills. There are more technical and professional employees and managerial staff in Joint Venture firms than those in Chinas domestic firms. Therefore it can be concluded that FDI firms are more technically efficient in labor utilization in production because they put more of their total labor force into direct production and less into non productive administrative activities as compared to Chinas domestic firms. In addition to that, foreign joint venture firms have a higher level of labor quality in their employment composition than domestic firms. They tend to hire more employees with university and higher education than domestic firms, particularly in capital intensive and technology intensive industries. They also tend to hire fewer employees with year 9 and lower education than domestic firms. Because foreign Joint venture firms pay higher wages than domestic firms and employ a higher level of labor than domestic local firms, there is a real risk, however, that more and more quality labor will be drawn into foreign firms away from domestic firms. If this is the case, then the spillover effects will regard to the transfer of technology and managerial skills from foreign firms to domestic firms resulting from labor turnover may be quite limited. FDI has increased domestic competition. As foreign direct investment companies entered Chinese market, the domestic local firms need to find their own ways for survive in the same market and various methods were adopted by local firms to compete with large foreign companies.

However there are many disadvantages for Joint venture, the major disadvantage being the high risk compared to other modes of entering foreign markets. Joint Venture also requires higher amounts of resources and commitment as appose to other modes.

The joint venture patterns in china show a great disparity among regions. For the period from 1983 to 1998, joint venture in the eastern region took up 87.8 percent while the central region attracted 8.9 percent and the western region recorded only 3.3 percent. This inequality stems from the FDI policies taken by the Chinese authority. The open door has started with the creation of special economic zone (SEZs) and preferential

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regimes for fourteen coastal cities. This has resulted in an overwhelming concentration of FDI-joint venture in the east. However, at the end of 1990s, the Chinese government has paid huge attention on developing western areas and up to now, the FDI inflows in western areas has increased dramatically. The central and western regions in terms of FDI will be more promising as the development of infrastructure and further openness of the market attracts more FDI into these regions. Their comparative advantages lie in abundant natural resource, further opening up and development of the market. Since the opening up of the state owned enterprises to foreign investors, more and more FDI, especially joint venture companies could invest in these regions.

Since china launched the economic reforms and called for foreign capital participation in its economy in 1979, China has received a large part of foreign direct investment inflows. China has been the second largest FDI inflow recipient after United States and the largest host country amount developing countries. For twenty years from 1979 to 1999, the total foreign direct investment inflow in China has reached 306 billion US dollars which is equal to 10% of the world total FDI flows.

Theory classifies FDI into two categories, one is called market oriented FDI and another is called export oriented FDI. In terms of market oriented FDI, the most important factor to attract FDI is the size and growth of the host country. The export oriented FDI mainly looks for cost competitiveness. Market oriented FDI aims to set up enterprises to supply goods and services to the local market. This kind of FDI may be undertaken to exploit new markets. Apart from the traditional reason for circumventing tariff barriers, the market size, prospects for market growth, and the degree of host countries economic development are very important location factors for market oriented FDI. The general implication is that host countries with larger market size, faster economic growth and higher degree of economic development will provide more and better opportunities for their industries to develop their ownership advantages and, therefore, will attract more market oriented FDI. Even for export oriented FDI, the market size of host countries is important because larger economies can provide larger

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economies of scale and spill over effects (The location determinants of foreign direct investment in developing countries, Chen Chunlai, No. 97/12, 1997).

China has a population of almost 1.3 billion, with a vast potential for consumption. Investors regard the Chinese market as the last enormous market that has not been fully developed in the whole world. Over the past decades or more, the sale of Chinas economic reconstruction has been expanding increasingly, with the purchasing power of the people strengthening rapidly and markets becoming increasingly brisk. Although Chinas per capita GDP is still very low, its rapid economic growth and continuously increased purchasing power has made China attractive to market oriented FDI, such as in the field of basic chemical, drinks, household electrical appliances, auto mobiles, electronics, and pharmaceutical industries.

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Chapter 3

Chinese Culture
3.1 Introduction
There are many factors that a multinational company needs to consider when opening a new branch in a new country or making investment overseas, including the market, the government policies relating to the business of the company, environment feedbacks, the economy of the country, religious of the citizen, resources, and etc. However, all the factors are related and influenced by culture. As a result, culture is one of the most significant factors that need to be considered by foreign investors.

The great Chinese culture has made both positive and negative effects for foreign investors to come and invest in the Chinese market. Among those important effects, Guanxi is the one that determines the success or failure of the investment for both foreign and local companies. Guanxi is a well known neutral term referring to relationships and connections that originated from China. It is now so pervasive and important in China. Nowadays, it is clear that doing business in china requires Guanxi. Guanxi can be the strength or weakness for Chinese business model. If a private company experience good Guanxi with the local government officials, or the central governors, it will be benefited by so many factors. However, in order to build this kind of Guanxi with the government

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officials, there are things need to be traded, sometimes possibly will in the form of bribery. Most of the time in China, Guanxi is generated on the dinning table. This means that business men have to treat government official very expensive meals in top ranking restaurants. It seems quit nonsense for people in developed countries such as USA or UK, but it actually happened long time ago and still continuous in the same way under the influence of traditional Chinese culture. While eating or drinking, the project will be discussed between the government officials and private companies, and both sides will conclude a satisfying deal. The private companies will get the project from the government and the government officials will get some benefits in return. In developed countries such as United Kingdom, business men from private companies dont have to build this type of Guanxi and it is inadequate for them to spend the time and money for Guanxi. This is because the cultural differences between Asian and Europe. In Asian countries, people turn to have more comradeship than European countries, and Asian people, especially Chinese are homier than Europeans. For example, in china, parents will nurture their children until they get married, and the children have to breed their parents until them past away. On the contrary, Many British or American people will no longer nurture their children since they are 18 years. Another thing that make Guanxi not that significant in Europe or USA is because the constitutions and laws in developed countries are comprehensive, private companies only need to follow the framework that have already provided by the country and pay attention only on the market. Therefore no matter what types of entry mode foreign investors choose to invest in the Chinese market, Guanxi is always required to be existed and maintained for convenience and success.

The strength of Guanxi can be noticeable when private companies facing problems and the government officials who have good Guanxi with them come for support. Most of the time, private companies will save lots of time and money and generate more profits from their businesses. In addition, good Guanxi with the officials will also reduce the risks of doing business in China. Foreign direct investing companies may receive many useful helps from Guanxi. On the other hand, Guanxi can be the vital tool for private companies on eliminating their rivals and control their market. Guanxi is contextual and may lead to bribery and corruption. In addition, Guanxi is also personal. It

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is risky when there are personnel changes in the Guanxi network. Therefore Guanxi in some circumstances is also one of the weaknesses of the Chinese business model. Guanxi exists not only in china, but the whole Asia. Foreign investors need to take careful consideration on the depth and width of building Guanxi with Chinese parties.

Beside the consideration of Guanxi, negotiation and communication with the local people in China also affect the decision making for foreign investors to choose the right form of entry mode. Negotiate with Chinese partners is far more complicated than with western partners. This is because Chinese negotiators pay much attention to the interpersonal trust and friendship, and tend to know their partners through informal personal contacts and social activities before talking about the businesses. Chinese business men usually build up this kind of relationship through dinning or drinking. They believe that it will help to make a better Guanxi between each other. Beside the legal contact of the business, Chinese belief that a good relationship and trustworthy between them and their partners are more important than the management and marketing skills. The Chinese will not do business with people that they dont trust. This is under the influence based on Chinese culture including Confuciasm, Sun Tzu strategies and holistic way of thinking; political culture such as Maos bureaucratic heritage and Dengs pragmatism. Chinese customers are in fact price sensitive, and the Chinese firms compete with each other in the Chinese market by cutting down the prices of products. As a result, the price wars occurred in China. Now multinationals need to adopt discriminative pricing strategy and predatory pricing strategy to control and success in the Chinese market. Discriminative pricing is the set the prices of the same products differently in various places to be able to compete with the other competitors. Predatory pricing refers to lowering the prices of products to drive out all other rivals in the market and control and dominate the market. This type of pricing strategy will loss money in the short but gain experience curve in the long term. Chinese customers are more conservative than the customers from other countries. They are not willing to purchase unfamiliar products; therefore promotion strategy should also be applied in the Chinese market. Multinationals can choose a hero to present to the Chinese customers. This kind of hero can be some famous athletes or movies stars. Pepsi has signed a contract with many movie stars such

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as Liming, and Faye Wang to promote its sales. In addition, Chinese customers also pay high attention on corporate images, especially foreign firms.

In the multinational company, the organizational culture is vital as it directly affects the business. This is especially true for multinational companies invest in China. The definitions of organizational culture are defined by various authors, Schein states that: organizational culture is the climate and practices that organizations develop around their handling of people or the espoused values and credo of an organization .When a company is doing business internationally, customers are not the only thing to be considered. A good multinational company should also consider the organization of the company itself and the influences on the employees as well. Businesses are human institutions, not plush buildings, bottom lines, strategic analysis, or five-year plans (Deal and Kennedy). It is important to know the culture of the local people as a multinational company has to hire local people as their employees. Culture can affect technology transfer, managerial attitudes, and even business-government relations. Perhaps most importantly, culture affects how people think and behave (Hodgetts and Luthans, p.60). Deal and Kennedy introduced corporate culture to measure and control the organization of a company. Corporate culture is a cohesion of values, myths, heroes and symbols which has come to mean a great deal to the employees of that corporation. Study of corporate culture helps the company to manage the organization to a better level. A strong corporate culture means each individual part of a meaningful whole with clear core values. Strong culture leads to improved motivation, decision-making, and company-loyalty. A weak culture means core values poorly expressed and not supported by a consensus and individuals unsure about their role with little loyalty for employers. The corporate culture can be controlled and changed by the leadership of the company. Leadership is the ability to step outside the culture that created the leader and to start evolutionary changes processes that are more adaptive (Schein, p.2). Company with strong leadership provides strong culture and thus more advantages in doing businesses. In addition, Deal and Kennedy also presented five alternative ways to change corporate culture: consensus-building, create two-way trust, skill-building exercises, allowing

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plenty of time, and be flexible about implementation. The adoption of those five methods may also provide a stronger culture.

In this part, a detailed description on how culture affect each type of entry modes (exporting, licensing, franchising, and Joint venture) and the advantages and disadvantages for each entry mode with respect to culture are presented. In addition, how Guanxi and negotiation with local Chinese for each type of entry modes significantly influence the decision making for the suitable entry mode in China is also discussed.

3.2 Exporting
Exporting is the type of entry mode that existing the longest period of time compared with other forms of entry modes in China. There are numerous advantages and disadvantages for it. As mentioned above, Exporting is the simplest form of trade that allows foreign companies to enter Chinese market. It is a traditional and well established method of reaching foreign markets. Since exporting does not require the goods to be produced in the target country, and no investment is required in foreign production facilities, which reduces risk if the project fails. In addition, exporting is usually seen as a low key method of entering a foreign market as it avoids the often substantial cost of establishing manufacturing operations in the host country such as, factories, machineries and employees (The global entrepreneur: taking your business international, Foley James F) .

As China joined World trade organization, the regulations and laws against foreign exporting to China is comprehensive and fairly perfect toward global standardization. However, Chinese people still carrying their traditional cultural behaviors and philosophies. It is well known that the counterfeit in China is extremely severe. Chinese domestic companies have the superb skill of copying brand name products, and some fake products are even better than the proper one with the cheaper price. This is the nightmare for private companies, especially foreign international

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companies who adopting exporting as an entry mode to enter the Chinese market. Chinese local firms may copy imported products very easily at a cheaper price; this may significantly affects foreign exporting companies losing the market. The severe counterfeit in China is occurred because the Chinese market environment. China has lower production costs and labor costs compared with most of the countries in the world. These are the biggest advantages for Chinese local firms to produce counterfeits to compete with foreign companies at a cheaper price. Only a few categories of products are suitable for exporting to China, such as those products need unique production resources that not sufficiently existed in China, products that required high technologies to be produced, products that can not be produced in China, and high quality luxury products. Foreign companies adopting exporting as an entry mode face severe obstacles against counterfeits in China. This is one of the disadvantages for choosing exporting as an entry mode in China. In order to prevent or minimize the amount of counterfeits, foreign investors need to protect its manufacturing know-how and improve its marketing strategies, simultaneously, building up good Guanxi with the government and local companies to control the scale of counterfeits of the products.

Another disadvantage for foreign exporting of particular types of products to China is the poor after sale service. According Chinese culture, Chinese people have their own ways of thinking and doing things that are differently compared to Europeans or Americans. When foreign exporting companies sale their products to Chinese local firms via exporting, the Chinese firms are not fully considering the after sale service for that products as they think they dont have such responsibility for it. For example, Japanese popular brand Sony sales their notebooks to Chinese local firms by exporting and receive money directly after the products arrived in local firms hands. The Chinese local firms are responsibility for sale their imported products in the Chinese computer market. However, the Chinese local firms are only considering on marketing for the products and ignored the after sale service. As a result, after the products are all sold out to the customers, there are possibilities for failure or replacement of parts of the products and lack of after sale service will generate many problems such as products repair or

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replacement delay. Customers may dissatisfied with the after sale service of Sony which will influence foreign companies images.

Because there are no productions and distributions of products for exporting in China, foreign companies only sell their products to the Chinese market via exporting, therefore Guanxi is less important for exporting compared to licensing, franchising or Joint venture.

It is quit obvious that beside the advantages for foreign firms to export their products to China, there are abundant negative feedbacks resulted from Chinese culture for it. Foreign investors need to take careful consideration on Chinese culture which affects foreign exporting in various aspects.

3.3 Licensing and Franchising

Licensing and franchising are two similar forms of entry modes that foreign investors may choose when entering the Chinese market. Licensing refers to an arrangement whereby a licensor entitles a licensee to use its intangible property for a specific period, and in return, the licensor receives royalties from the licensee. Royalties can be calculated as a percentage of sales or as a fixed amount per unit sold. Intangible property includes patents, inventions, formulas, process, designs, copyrights, and trademark. Franchising is similar to licensing, or in other words, it is a special form of licensing. The franchiser usually provides the franchisee with the whole business system, including trademark, services, management know-how, standardized operating

procedures, and sometimes even facilities, equipment and materials.

China currently has 1900 franchise systems, with 82000 outlets, growing 49% annually. Nearly 60 industries have applied for franchise operations, including traditional sections such as catering, retailing, and individual services, as well as some newly developed fields of education, commercial services, family services and automotive care.

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Nearly half of top 100 restaurants in China are utilizing franchise business models, and their business earnings significantly surpass those independent local operated companies (Peeling the onion, Lehman Brown, October 2005).

However, this type of entry mode is the most dangerous form when entering the Chinese market. This is basically because of the Chinese culture as some Chinese people now still think about themselves first and focus on their own benefits in running businesses with foreign partners. If a large international companies outside China choose Licensing or franchising with a Chinese local company, an agreed contract will have to be signed by the two companies for an agreed period of time. During this period of time, Chinese firm will continuously build up itself with the support from foreign company that is bigger and stronger than it. When the contract ends, the Chinese companies may take over the existing market and run the business by their own. In Chinese, this is called DuanQiao, which means to cut off the bridge. After learning from foreign companies, Chinese companies understand the whole business system and are able to run the businesses by themselves, and then they may cut all the connections with foreign companies and either enter the market directly or wait until the contract ends. Foreign companies only receive profits temporarily and will lose control to the business and lose the market to local firms. Licensing or franchising doest not give multinational companies tight control over production, marketing, and product quality and, therefore, may damage the firms reputation if the licensee does not perform well. For instance, an American fast food company Kenneys Roast Ribs signed a licensing contract with a Chinese local fast food company to open subsidiary branches in China. After a few years, the Chinese partner has learnt all the business system and know-how, and opened a new fast food company to compete with Kennys Roast Ribs. From this example, it is noticeable that Guanxi is extremely significant for foreign investors adopting licensing or franchising. A good relationship with local partner brings long term partnerships between both parties and continuously achieving profits and benefits with good reputations. For licensing and franchising, negotiation with local partners are the key for building good Guanxi. A careful study of Chinese culture is necessary for foreign companies to success

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its businesses and face less problems when adopting licensing or franchising as an entry mode in China.

Licensing and franchising are often chosen by foreign investors when a multinational company has strong core competencies in technology and design, or intellectual property rights are well protected in a host country, or tariff and non tariff trade barriers are high in a host country, or political risks are too high to invest indirectly in a host country. In the current situation, it is quit obvious that Licensing and franchising are the most unreliable forms of entry modes due to the influences of Chinese cultural aspects.

3.4 FDI- Joint Venture

The establishment of new enterprises such as new foreign funded and joint venture companies has been the main mode of absorbing FDI into China. During the period from 1979 to 1997, equity joint ventures took the lions share of inward direct investment inflows (61.3% in terms of the number of contracts and 46% in terms of the contracted amounts). Wholly foreign owned enterprises took 24.7% of FDI in terms of the contract number and 30% in terms of the contracted amounts. Contractual joint ventures have been the third most important mode. As mergers and acquisitions have become the popular mode of global FDI with more than 60% share, this entry mode presents great potential for the future expansion of FDI in China (A guide to doing business in China and information on current economic conditions, US embassy in China, 2000). Also, the share of wholly foreign owned enterprises is expected to increase as China implements its WTO commitments. Recent trends show that FDI tends to be more and more direct into wholly foreign owned enterprises, which accounted for more than half of total commitments in 1999.

One of the most important factors that attract foreign joint ventures in China is the advantage in the competitive production factors, such as labor forces, land, and natural

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resources. The degree of development of host country is often considered one of the most important determinants of FDI inflows in China because it is positively related to domestic entrepreneurship, education level, and local infrastructure.

With the worlds largest population of 13 billion, China has adequate resources of labor, with average salaries of works remaining at relatively a low level. China has paid great attention of the education of its people such as nine year universal compulsory education. Therefore Chinese labors are relatively highly skilled with comparatively high quality. However, there are some fields are still in short supply, such as experienced managers, engineers, and technicians. This results a huge market with various advantages for both local and international companies to run their businesses in China. In addition, beside the large population support, China is also very rich in energy reserve. Chinese production of oil, its predominant fuel, is among the top of the world in spite the fact that China imports oil and fuels for high its own consumption. China is the largest producer of coal, roughly one third of the world total production. With the globalization of the world economy and the liberalization of international trade and the giant strides in technological innovation, the advantages of cheap labor force has become less important for foreign investors. Chinas disadvantages in terms of technological gaps and lack of labor qualification in some areas are existed and still need time for improvement.

Beside the adequate labor force with high skill and cheap costs, Joint ventures in China also provide abundant opportunities for employment. This is one of the advantages and reasons that many Chinese are welcoming foreign direct investment such as joint venture companies to China. The Chinese culture offers hard working and loyalty personalities and this may benefit foreign joint venture companies. Compared to licensing and franchising, Joint venture is another form of entry mode that needs the help of Guanxi. Because Joint venture involves investing money or assets to China and managing the key things in areas such as finance, marketing, distribution, advertising, etc, negotiation with local people is unavoidable and extremely vital. Investors must pay high attention to every segment in the businesses and build good comprehensive Guanxi with

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people in each segment. Lack of Guanxi in any segment may result many impediments for foreign Joint ventures in China.

China has a huge population and the most of the people have low incomes compared with developed countries. In the beginning of the reform and opening up, chinas own products were under huge pressure from foreign brands that flowed into china. Now Chinese firms have fought back and developed their own brand names such as Haier, Lining, that are competing with foreign brand names both domestically and internationally. The main reason for the accomplishment of the Chinese firms is the cheap price. The labor cost in china is extremely cheap, and this is why many large multinational companies moved their factories in to china, such as Nokia and Nike. The cheap labor cost becomes the most popular and attractive spot for business men all over the world and this is the strength for the Chinese business model. Foreign companies adopting Joint venture with Chinese partners will enjoy the benefits from it. The high population in china also result some disadvantages for foreign business men. For instance, high population in urban areas affects the cost of land usage. The price for renting a house in urban areas such as Beijing or shanghai is very expensive. Therefore investing or running business in urban areas in china may be costly. On the other hand, many rural areas in china have not been fully developed by the government and this may be the beneficial opportunities for foreign companies to invest or run their businesses in rural areas rather than urban areas.

A most outstanding issue faced by multinational companies in China is localization of sourcing. Theoretically, it is cheaper for companies to purchase its materials and parts for producing the final product in the local country than imported from a foreign country. It is beneficial for multinational companies to buy resources from local suppliers. In addition, the Chinese government, especially the local government encourages foreign companies to localize its resources from local firms as it helps to create employment and benefits the local citizen. Therefore foreign Joint venture companies receive plentiful benefits from cultural, political, and environmental aspects. However, it is not easy for do so under the unique circumstances in China. Multinational

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companies facing many difficulties in localization of sourcing such as the level of technology in the local firms are still quit low and the quality of the local produced products are still poor; the local protectionism block the foreign companies to choose local suppliers. Therefore multinational companies need to solve the big problem of localization of sourcing before they lose the benefits from it.

One of the most important things for Joint venture is to select a capable local partner. The Chinese local partner must be capable, reliable, responsible, and feasible for joint venturing with foreign investors. Choosing the right and suitable partner will help foreign investors to build up good Guanxi and obtain high-quality communications with the locals.

Comparing Joint venture with other forms of entry modes in the cultural aspects, it requires the highest level of Guanxi and negotiation with the local peoples. However, Joint venture enjoys the advantages in the competitive production factors and the cheap and plentiful labor forces and resources. In addition, there are less influences on cultural dangerous such as Duanqiao or Counterfeits for Joint venture compared with exporting, licensing, and franchising.

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Chapter 4

Chinese Regulations and Policies against Foreign Firms

4.1 Introduction
The revolution of the Chinese culture began since 1966 to 1976. The internal predicament during the Cultural Revolution in fact has stopped the development of the Chinese economy and the Chinese were in hot water. After the Cultural Revolution, Deng Xiaoping and others began to establish law and order to drive the Chinese economy on the right track. However, it takes a long time for the Chinese government to create a comprehensive and appropriate constitution that suits both domestic private companies and the large multinational foreign companies all over the world, and the engendered problems from the existing constitution indicated the deficient system of the Chinese business model since China opened its door to the world. After three times of amendment on the constitution, China has a better political system and economic system than the past. In political system, the basic task of the nation is to concentrate its efforts on socialist modernization along the road of building socialism with Chinese characteristics, and achieve this under the leadership of the communist party of china (1999). In economic system, the basis of the socialist economic system of the peoples republic of china is

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socialist public ownership of the means of production, namely, ownership by the whole people and collective ownership by the working people (1999). This means that everyone in the country should be treated the same and has the same right for doing things.

Countrys laws and regulations are the most crucial factors that affect the economy in every country. Every country uses laws and regulations to control and stimulate its economy, protect and maintain its benefits. Foreign investors must understand their target countrys regulations and laws before taking any action on investments and making decisions of choosing the right types of entry modes. For foreign investors who are looking for invest in the Chinese market, fully understanding of Chinese regulations and laws against foreign investors is essential. Up to now, China has instituted a fairly perfect foreign trade legal system with the Foreign Trade Law as the core, involving management of foreign trade dealers, import and export commodities and technology, foreign exchange, customers control, import and export commodity inspection, animal and plant quarantine, protection of intellectual property rights, and economic and trade arbitration related to foreign interests and proceedings (http://en.chinanasdaq.com/). This section will state some of the Chinese laws and regulations that significantly influenced different types of entry modes.

Chinas ministry of Commerce tightened its supervision over foreign investors acquisition of local companies in a modified regulation issued in Beijing recently (reported from XinHua News). It was stated that foreign investors should abide by Chinese laws and policies in their acquisition of domestic companies and should not affect competition rules of the market or lead to loss of state assets. Foreign investors should follow local policies on industrial development, land and environment protection, according to the regulation. For industries not allowed for solely foreign operation, foreign investors can not have fully ownership of the company purchased. Companies required to be dominated by Chinese share holders should remain controlled by the Chinese side even if they are purchased by foreign investors, says the regulation. In addition, this regulation also forbids foreign capitals to buy companies in industries

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where foreign operation is not allowed in China. On the contrary, China welcomes qualified foreign companies that are willing to legally invest in particular industries. For instance, china welcomes qualified foreign companies willing to legally invest in the countrys internet services, said an official with the ministry of information industry in Beijing recently. The government was willing to offer consultations on concerned policies, according to its commitment to the world trade organization; chinas value added telecom market has been opened to foreign capitals. Qualified foreign companies can apply for internet operation license following chinas regulations.

In china, the government officials have extremely power that affects all types of businesses. This is because China has its unique system that is different compared to other countries. The imperfect laws and constitutions generate opportunities for the government officials to use their competencies to help private companies for generating profits and in return, the private companies must pay a respectable recompense either in the form of money or goods. For example, a gang headed by Lai Changxing in Xiamen smuggled a total of 6.28 billion US dollar worth of goods from 1996 to 1999, they bribed hundred of government officials both at local and central levels. Even through the corruption in china will be punished by the government seriously, sometimes even to death, it still exists all over the country from local government officials to the central governors. It can be concluded that bribery and corruption are still unavoidable in developing countries especially in China.

There are many restrictions on marketing in China. Some marketing practices were prohibited by the regulatory restrictions such as direct selling. It is important for business men to learn and understand the government policies and restrictions. In Chinese business model, one of the weaknesses is the unstable and unpredictable government policies.

4.2 Exporting

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From the Chinas business report, the Chinese government has issued a law against foreign trade named the "Interim Regulations on Foreign Trade Management''. This law has stated that while importing and exporting any goods, the importer and exporter must apply to their local foreign trade administrative department for an import and export license (http://www.china-markets.org/). This issue represents the establishment and beginning of the import and export license system after the establishment of the Peoples Republic of China.

From 1959 to 1979, the Chinese government set numerous restrictions and laws to protect the nation; all the imports and exports existed in China during that period of time were belong to the special import and export companies that belong to the Chinese government and under control of the former ministry of foreign trade. The existed imports and exports were severely under the Chinese governments policies and strategies by these companies, therefore the function of import and export licenses was reduced. During this period of time, the Chinese government only interested and planned to import certain goods for particular purposes, and export small amount of non- trade commodities to other countries. However, after China opened its door to the world and adopting the policy for reform, the development of Chinese foreign trade was noticeably constant and the number of special import and export national companies is decreasing and more and more individual private companies outside the ministry of foreign trade started to import and export goods in China. This evident has resulted losses to the Chinese government on various aspects, therefore further action has made to reinstitute and strengthen the import and export license system.

Later in 1984, the Chinese government issued the interim regulations of the Peoples Republic of China on license system for imported and exported goods. In these interim regulations, it is stated that for the import of all goods that require licenses to import according national regulations, it is necessary to apply for import licenses in advance and only then orders could be placed with the relevant foreign trade companies. In addition to that, the ministry of foreign trade and economic relations was responsible to sketch and adjusts the list of goods whose import calls for licenses. During this period

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of time, the control from the government was enforced on all foreign trade companies dealing with import and export business in China. As china moves toward globalization and internalization, since 1992, the control over import was gradually relaxed by the Chinese government. Later in January 1994, the Chinese ministry of foreign trade once again released the interim provisions regarding import quota control over commonplace commodities. These new approach made by the Chinese government indicated that the Chinese laws and regulations on foreign trade system was in line with global standardization. In year 1998, China removed control by import licenses and import quotas over the great majority of commodities that required licenses to be imported formerly, at the same time, only continuing to enforce import license control for a small number or variety of products in infant industries and major industries that are required for special protection.

From 1950 to 1998, China has modified its laws and regulations on Chinas import and export several times according to the high speed development of the Chinese economy and increasingly high degree of opening up. In 1998, Chinas import and exports reached 323.93 billion US dollars. Export exceeded 183 billion and import surpassed 140 billion, with an annual trade surplus of 43.59 billion US dollars, ranking 11th place in total imports and exports among chief trading countries over the world, ranking 10th place in imports and 9th place in exports. Now a day, the implementation of exporting has been widely adopted by many foreign companies due to the low cost of investment in foreign production facilities and minimizes risks if the project fails.

The Chinese government imposed many restrictions on the import or export of goods and technologies in various circumstances to control, manage and protect the Chinese economy and environment. For example, the import or export in China shall be restricted in order to protect and defend the national security or public interests. Export shall be controlled on account of domestic shortage in supply or effective protection of exhaustible domestic resources. In addition, export shall be constrained due to the limited market capacity of the importing country or region. Import shall be restricted in order to launch or accelerate the establishment of a particular domestic industry, and import of

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particular industries such as agricultural, animal husbandry or fishery products in any form shall be restricted and controlled. Beside to that, the national international financial status and the balance of international payments must be ensured and maintained by the restriction on import, as the international treaties or agreements to which the peoples Republic of China is a contracting party or participating party require, the import or export shall be restricted. In addition, Chinese government also set many restrictions or prohibitions on import or export of goods or technologies in China, such as those goods or technologies will endanger national security or public interests and may disrupt or disturb the ecological environment. Therefore, for the import or export of such goods or technologies must be forbidden or banned in order to protect human life and health, and in accordance with the provisions of international treaties or agreements to which the People's Republic of China is a contracting party or a participating party (China Trade Global Trade Directory Import and Export Companies Service Organizations Administrative Organizations Policies & Regulations Exhibitions & Fairs 2000 and Regulations Foreign Trade Law of the People's Republic of China Adopted at the Seventh Session of the Standing Committee of the Eighth National People's Congress on May 12, 1994).

It is important for foreign investors to know the current situation for the Chinese government and the trend for the changes on regulations for exporting in the future. Different company should choose different modes in different fields according to the governments unstable regulations and policies. In addition, the decision making is also dependent with time. A suitable entry mode for a particular industry in China may vary from exporting to licensing or Joint venture for different period of time according to the Chinese governments direction.

Since China jointed with WTO, it has reduced the import tariff and quantity, and cancelled certain economic restrictions. There are thousands of laws and regulations have been drafted and revised to ensure the Chinese law and organizational structure is corresponding to international standard. After five years of transition period with WTO, in the end of 2006, China will complete the administration adjustment and set up

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comprehensive laws for foreign trading companies. The reduction on import tariff has attracted many foreign investors to come and choose exporting as a form of entry mode in China. However, this is not permanent. Host country may vary its import tariff according any events that may affect its national security and economy. Import tariff is an excellent tool for the Chinese government to manage and control the import and export system in China.

Currency exchange rate is another important factor that foreign investors need to be considered when choose exporting or importing as an entry mode in China. The laws and regulations governing foreign exchange control in China were initially promulgated on January 26th, 1996, and Chinas most basic law on foreign exchange control is the Regulations of the peoples republic of China on foreign exchange control. Foreign companies prefer low currency exchange risks countries rather than high exchange rate risks and China has been adopting fix exchange rate system for many years. Therefore it is fairly reliable for foreign companies to choosing exporting or importing as a manner for international businesses. However, because of the tremendous development of the Chinese economy, the Chinese currency Yuan has been fluctuated recently against US dollars which affect the decision makings for foreign investors. It is comparatively unpredictable on the Chinese Yuan under this condition therefore foreign investors need to think carefully during this particular period.

China has tested its decentralizing foreign trading system and has wanted to integrate itself into the world trading system. In November 1991, China joined the Asian pacific economic cooperation (APEC) group, which encourages and promotes free trade and cooperation in economic, trade, investment, and technology issues in Asia. Ten years later, in 2001, China became the leader of APEC, and Shanghai hosted the annual APEC leaders meeting.

In 1999, Premier Zhu Rongji visits the United States and signed a bilateral Agricultural Cooperation Agreement. This resulted in the removing of the Chinese

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restriction on the import of beef, poultry, grain, and citrus. Following in November 1999, a historic bilateral market-access agreement between China and the US has been reached, which lead to the entering of China into the world trade organization (WTO). The major part of the liberalization agreement is to lower tariff and eliminate the market impediment in China after joining the WTO. For example, the Chinese will be able to import, export, and trade their product with the foreigner without the involvement of a government. In 2004, a tariff rates on the US agricultural export decrease from 31% to 14% and from 25% to 9% on the industrial product segment by 2005. Moreover, the agreement also gives the opportunities for the US service provider such as banking, telecommunications, and insurance. After China signing the bilateral WTO agreement with the EU and some others trading partner in 2000, China also consider the issue of the multilateral WTO accession. In order to increase the export, china has introduced the policies such as the development of foreign-invested factories. These also pull together the imported component into consumer goods for export. After 15 years of negotiations, china has become a member of the world trade organization on 11 December 2001. This can be called as the longest negotiation period of GATT records. China has adopted the so-called export promotion development strategy which was proven to be a remarkable success in the Asian NIEs. Together with export promotion policy, china has implemented economic reforms and open door policies and made efforts to promote trade by concluding several bilateral trade arrangements and adopted unilateral actions. There has been substantial progress in reducing tariff barriers in the 1990s: the average un-weighted tariff rate on imports declined from 43.9% in 1992 to 23.6% in1996 and to 17.6% in 1997. China has also formulated and implemented a series of preferential policies to encourage international trade. Duty exemptions for intermediate products used in the production of exports have been particularly important in boosting chinas foreign trade. It is obvious that Chinas regulations and policies on foreign exporting to China are toward internalization and there are fewer differences between exporting to China and exporting to other countries. After China jointed with WTO, Foreign investors adopting exporting may not suffer huge negative effects from the Chinese laws and regulations and

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the Chinese laws act as a tool to protect the foreign investors rights. However, the reduction of import tariff results severe competitions against international investors, and as time passed, the opportunities for adopting exporting as an entry mode in China is very little. There will be less and less foreign investors can choose exporting as an entry mode to China with the increasing difficulties from global competitions.

4.3 Licensing and franchising

Licensing and franchising are the two types of entry modes that typically with high risk and unreliability in the Chinese market. However, since China opened its door and joined WTO, the Chinese regulations and laws are fairly comprehensive for licensing and franchising. For example, the Shanghai economic commission issued a notice to implement the administrative measures on commercial franchising operations in Shanghai with respect to foreign invested franchising operations. Foreign invested enterprises that intend to engage in franchising operations must first obtain relevant licenses for commercial enterprises accordance with the administrative measures on foreign investment in commercial sector. The notice also underscores the disclosure obligations imposed by the measures, which requires those who have engaged in franchising operations before December 31st, 2004 to report the status of their franchising operations to the competent authority before May 30th, 2005 for record fill purpose. This announcement has confirmed that Chinese laws and regulations on licensing and franchising entry modes are moving toward with respect to globalization and internationalization. The Chinese laws aiming to protect foreign companys trade mark, brand name, and other rights. It can be declared that foreign investors adopting licensing and franchising in China will protected under the inclusive laws made by the Chinese government.

Because licensing and franchising involve smaller amount of foreign capital inflow to China compared to other FDI forms, the Chinese government pays less attention on licensing and franchising than FDI. In addition, it is more risky for foreign

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investors adopting licensing or franchising than FDI. However, Licensing and franchising help to explore intangible core competencies such as patents, inventions, formulas, processes, designs, copyrights, and trademark, and help to overcome tariff and non tariff trade barriers. Foreign investors implementing licensing or franchising as a type of entry mode may provide good technology and management transfer from outside China to local Chinese companies. Licensing and franchising both inject many positive variables to China such as technologies, business know-how, management systems, etc. those variables assist China to develop its economy efficiently and quickly. As a result, China has published various laws to support and protect Licensing and franchising as entry modes in China. However, the cultural variables make licensing and franchising in China untrustworthy and unreliable.

Foreign licensing and franchising are encountered by the domestic infringement of intellectual property rights. According to United State customers service, China ranked first in seized counterfeits in 2002. Chinese domestic companies have the superb skill of copying brand name products, and some fake products are even better than the proper one with the cheaper price. This is the nightmare for private companies, especially foreign international companies. For example, top class brand name company, Louis Vuitton chose franchising as an entry mode and opened a new branch in china selling expensive hand bags. A few months later, the local private companies have imitated Louis Vuitton products and selling the counterfeits all over China. The local private companies selected similar materials and was selling the same hand bag at a price 20 times cheaper than Louis Vuittons hand bags. People find Luis Vuitton hand bags every in the city, even low income female farmers were carrying duplicated Luis Vuitton hand bags. Nowadays, if someone holding an original Luis Vuitton hand bag on the street in china, the Chinese will think it is the fake one and cost only about 10 pound. Similarly, watch industry and DVD industry also suffered from the counterfeits in China. China has the largest number of fake watches and seized huge number duplicated watches all over the world, especially in Asia such as Thailand, Malaysia and Singapore. Then the counterfeits are redistributed and sold from those countries to Europe and America through various channels such as E-bay, etc. More over, the most shocking event for

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counterfeits in China is happened in the DVD industry. There are fake CDs and DVDs for movies and software everywhere in China and the Chinese seems get used to it and dont consider it as an illegal thing. Even now, people still can find fake CDs and DVDs outside their houses. As a result, foreign investors adopting licensing and franchising are affected by the infringement of intellectual property rights and the time for Chinese to duplicate the original products is very short, sometimes takes only a few days after a new product is launched on the market.

Licensing products are facing obstacles from the Chinese government. New foreign properties may find it not easy to enter the Chinese market and in touch with the local customers, as the Chinese government released certain restrictions on broadcasting foreign TV programs and foreign participation in publishing to protect the national security. However, due to the Chinese special policies, adopting Hong Kongs media as a channel to promote their products to local customers is a lot easier and faster. Foreign licensors can also use channels such as internet and short messages system to build recognition of new properties.

4.4 FDI- Joint Venture

Since china launched the economic reforms and called for foreign capital participation in its economy in 1979, China has received a large part of foreign direct investment inflows. China has been the second largest FDI inflow recipient after United States and the largest host country amount developing countries. For twenty years from 1979 to 1999, the total foreign direct investment inflow in China has reached 306 billion US dollars which is equal to 10% of the world total FDI flows.

The Chinese FDI trends can be distinguished according to the changes in the regulations and laws in China. From 1979 to 1983, the Chinese government established four Special economic zones in Guangdong and Fujian provinces and offered special incentive polices for foreign companies who invest in those areas. This resulted limited

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amount of FDI capital inflows and the main FDI inflow are located at those four special zones. The total inflow of FDI during this five year was only 1.8 billion US dollars and approximately 360 million US dollars annually. Since 1984, Hainan Island and other fourteen coastal cities across ten provinces were continuously opened which further more stimulated the FDI inflow in China. From 1984 to 1988, the total FDI inflow reached 10.3 billion US dollars. However, the remarkable upward trend of FDI inflow was impacted and started to decline due to the Tiananmen incidents. Until 1992, after Den Xiaoping circulated Chinas southern coastal areas and special economic zones, the Chinas policies on opening its door to the world and applying economic reform were pushed forward evidently. Since then, China adopted a new approach, which turned away from special regimes toward more nation-wide implementation of open policies for FDI. The Chinese government has issued many new policies, regulations and laws to encourage and support FDI. The result of this were remarkable, the total FDI inflow in 1998 reached 45.4 billion US dollars.

China has some unique policies that other countries dot not or can not have. Those kinds of policies were created under the communism theory of the republic of china. For instance, in china, the land is belonging to the country, to the people, not to any single person himself. This is very different compared to capitalistic countries. Companies need to define the nature of the land with the local government before implement on businesses. In other words, the government has to lend the land to private companies and consider the types of the business and necessary period of time for lending the land. Sometimes the lending is free of charge, but sometimes, it costs huge amount of money. For example, if a foreign company is willing to build a hotel in a rural area, the land for building the hotel has to be agreed by the government for lending to the company. If the government is enthusiastic on the development of that area and interested in building a new hotel, then it may be easily agreed with free of charge, on the other hand, the government may collect some fees for the lending of the land proportional to the period of time the company is willing to borrow. In addition, if the nature of the land is for farming and not for building a hotel, then it has to be changed by the government before the land is lent to the private company. Unfortunately it may take years for only

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changing the nature of the land. The result is, that private company eventually running out of funds as they couldnt get started for the construction of the hotel. Running business in China is more complicated than developed countries.

Since china opened its door to the world, more and more multinational enterprises paid massive attentions on Chinese market as the Chinese government provided numerous attractive policies and regulations for joint venture companies. For example, foreign direct investing private companies have the advantages of paying no car tax fees. Chinese government also provides special economic zones for private companies. In those zones, private companies enjoyed extra offers than other companies such as less tax rate or low tariff, better government support, and etc. In the past 20 years, China has mainly opened its economic market alone the coast line on the east. However, a few years ago, China paid large attention on the west which further enlarges the opportunities for private companies, especially multinational enterprises. The reason for China to provide thus advantages for private companies is obvious, in return, china will create more employment opportunities and the Chinese will learn capital, technology, and management know how from other countries. This type of development strategy is very popular in developing countries, especially in East Asia. For instance, Thailand has created BOI zones for industrious enterprises with free tax for five years. FDI may results some negative impacts on developing countries, such as dependency and instability, china has adopted certain special policies that not only attract FDI, but also control the inflow of FDI to avoid those negative impacts. Joint venture became the most influential form of entry mode for foreign investors in China and China has paid its most attention on protecting and attracting more and more foreign joint venture firms into the Chinese market. The Chinese realized the benefits of having joint venture enterprises as it benefits both the country and the people in the country. Therefore Joint venture entry mode enjoys plentiful supporting policies from the Chinese government. However, recently China pays more attention to foreign wholly owned enterprises and the number of Joint venture in China is decreasing. This is because of the globalization and Chinese government opened most of its industries to foreign investors and they are willing to take full control and become the owner of thus businesses. In return, huge amount of capitals and assets

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are installed to the Chinese market. The trend of Chinese laws will be moving towards foreign wholly owned enterprises positively. However, certain industries such as Banking and media businesses are still protected and restricted by the Chinese government in China. Foreign investors dont have the opportunities for adopt foreign wholly owned as an entry mode and only choose joint venture as an entry mode for foreign direct investment in those industries.

The Tiananmen protest in late 1989 has stalled foreign investment in China. As a result, the Chinese government then introduced numerous laws and regulations regarding to encourage and attract foreign investors to invest in high priority sectors and regions. An example for this is the encouraged industry catalogue which sets out the degree of foreign involvement allowed in various industries sectors.

During 1993, Chinese total output was accelerated due to the fast economic development and the foreign investment capital inflow to China was elevated. The Chinese economic further expansion was pushed by the governments introduction of Special Economic Zones that provide special policies and conditions for foreign investors. At that time, there are more than 2000 Special economic zones in China. Beijing, the capital of China was approved by the Chinese government for additional long term reforms in order to meet the international standardization and to participate more on market oriented institutions, moreover, to gain total control from the central government. The Chinese government published a policy named socialist market economy, in this statement, the public owned enterprises or state enterprises would continue take control for the main industries in China. Therefore foreign wholly owned enterprises were not allowed in those industries. The fast growing economy has pushed China with high growth rate with lower inflation rate. However, the Asian financial crisis occurred in 1998 and influenced the economic development in Asia, including China. The economy in China was slowed in the late 1990s. After the Asian financial crisis, Chinese economys growth has then accelerated again early in the new century, reaching 9.1% in 2003, 9.5% in 2004 and 9.8% in 2005.

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Opening up to the world remains vital to China's development. Foreign-invested enterprises create about 45% of China's exports, and China continues to attract large investment inflows. Foreign exchange reserves exceeded 800 billion US dollar in 2005, more than doubled from 2003. China then became the world's biggest holder of reserves in 2006. However, there remain several barriers to free trade including administrative enforcement and non-tariff measures. The local content requirement and the export proportion requirement may inversely act to promote FDI. The import substitution policy may function to promote FDI in the short term but further competition, which can be created from the increase in import, may positively act to promote new additive investment in current investors for introducing high-technology production. Also, Chinese further acceptance of multilateral investment arrangement is necessary to promote FDI into China. For example, china still does not allow wholly foreign-owned companies to trade in many areas even though it has started to liberalize it. Chinas entry into the WTO will be conductive to the settlement of the problems. If foreign invested companies are permitted to establish their own retail trade that would help them to expand the scope of their investment and increase their market portion.

Up to now, the Chinese government has created world standardized laws and regulations to support Joint venture in China and in order to attract more and more foreign investors to China, the Chinese government has released abundant policies to provide advantages for foreign direct investment. Even through China put high attention in attracting foreign wholly owned enterprises to China. The main and major industries in China are still under controlled by the Chinese government, and the unique situation in China makes it hard to changes. Therefore foreign wholly owned companies still facing many obstacles compared to Joint venture. Foreign Joint venture is the most appropriate entry mode for foreign investors that willing to choose foreign direct investment in China. However, as China moves toward globalization, foreign wholly owned companies may surpass Joint venture and become the core entry mode for FDI in China.

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Chapter 5

Case Study of KFC in China

5.1 Introduction
A case study on KFC is investigated during the writing of this dissertation. Kentucky Fried Chicken (KFC) is one of the most well known fast food chains in the world started in the early 1930's by Kernel Sanders in the Southern USA as a small franchise operation. Colonel Sanders has become a well known personality throughout thousands of KFC restaurants World wide. Quality, service and cleanliness (QSC) represents the most critical success factors to KFC's global success.

Throughout its 35-year history, the company has gone through several stages and has answered to a legion of corporate parents from Heublein to R.J. Reynolds. The most significant stage was when the enterprise was sold to the American giant, Hubelin International in 1974. Rapid growth throughout the use of franchising together with increased competition from primarily MacDonald's reduced the consistency of the standard of both food and service on the individual franchise level leading to massive decreases in profitability. Together with low Research and Development funding from Hubelin, the division found it difficult to match the expansion plans of its main competitors. KFC responded to these problems by improving staff training; employ a new manager- Michael Miles capable of managing an effective turnaround strategy. The

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QSC motto was emphasized on a global level together with slogans such as "We do Chicken Right". In 1982, Hubelin International was acquired by R.J. Reynolds and Richard Mayer succeeded Miles.

5.2 INTERNATIONALIZATION OF KFC

Opposite to Hubelin International, R.J. Reynolds was willing to fund KFC's overseas expansion plans. In order to reduce risk, KFC encouraged franchising in complicated markets. This reduced financial risk, but also increased problems of operational control, as local franchisees often were more interested in maximizing profits in the short term rather than to adhere to corporate standards and strategic plans. To find the balance between corporate control and cultural sensitivity has been the main point of concern at KFC.

5.3 CHOOSING THE CHINESE MARKET

The China expansion plans first came-up in the early 1980's after several successful expansions in the South East Asian (SEA) region including Japan. Tony Wang who was born in China, educated in Taiwan and in the USA, and now living in Singapore was appointed manager for KFC's SEA region. He was given the autonomous responsibility to further investigate the feasibility to further expanding KFC's operations in Asia to the world's most populous nation and the largest market for consumer goodsChina. On the other side of the scale, expanding into China would certainly be KFC's most risky international business strategy so far. Moreover, a "go-ahead" signal would make KFC the first western fast-food chain in China.

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5.4 RECOMMENDATIONS
An expansion into China is recommended. The potential size and growth of the market in association with improving political stability makes the Chinese market very attractive. As KFC has been able to successfully expand into the Pacific Basin, and its popularity in the region (large portion of the population is Chinese), the people in China will most certainly find KFC's products attractive. In addition, the ready access of quality poultry in the major metropolitan areas and host government emphasis on modernization of this industry can ensure a reliable supply of supplies. Opposite to this, potential competitors such as MacDonald's face major barriers to enter the market due to poor beef supply. Moreover, the Chinese government has opened-up access to its markets.

5.5 MARKET ENTRY OPTIONS

There are three market entry strategies that can be employed by KFC: Franchising and Licensing, Wholly owned subsidiary and Joint venture.

First, KFC's traditional franchising strategy, which is emphasizing standardization and reducing financial risk, on the expense of cultural sensitivity and control. Due to China's strict foreign investment laws such a strategy is not feasible. In addition, KFC will be pioneering in the fast-food field and thus needs to be highly sensitive to cultural demands. In the past, KFC encountered problems with aligning corporate planning with franchisee's short-term focus on profitability.

A wholly owned subsidiary represents the second option. Such a strategy relies upon total control over competitive advantages and ensures complete operational and strategic control. It also involves high investment expenses with no financial risk sharing. With high levels of resource commitment and little country-level flexibility and responsiveness, this option is not recommended.

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5.6 RECOMMENDED ENTRY MODE: JOINT VENTURE

When KFC first went into the Japanese market in the early 1970's, the company chose to form a joint venture with a large scale poultry producer with excess capacity. This 50/50 joint venture served the two partners very well, as KFC was able to ensure a stable supply of quality supplies to its operations, and the local corporation was able increase efficiencies in production by selling its excess supply. Furthermore, KFC was able to utilize existing distribution networks serviced by the partner and at the same time, adhere to exiting rules and regulations imposed by the Japanese government on foreign direct investment.

Despite of the many differences between the Chinese and the Japanese market, a similar joint venture agreement is highly recommended in China. The essence of a joint venture is the synergy effect of two different entities merging. Such an international business strategy will attempt to; solve many logistic problems such as access to good quality chicken and other supplies, solve many logistic problems such as access to good quality chicken and other supplies, ease the access to the Chinese market, share risk with a local entity, and finally serve as a sign of commitment to the host government increasing goodwill. In addition, due to the complexity of many barriers to entry into China, a potential partner with sufficient contacts/networks with government agency officials may smooth the process of setting-up operations in the nation.

The potential joint-venture partner should be large, well established, provide excellent distribution channels and have personal network access to government officials. It should also have modern equipment and a good management record. It is recommended that a partner is found by backwards integration. In other words, a good domestic poultry supplier should be discovered. In order to ensure total commitment and balance of power between the two partners, a 55/45 joint venture, with KFC as the dominant partner should be set-up.

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By building on each partner's core competencies, knowledge, and efficiencies, a mutually beneficial synergy effect could be achieved as a result of joint venture activities. For instance, the local partner can learn from KFC how to produce a better product at a lower cost and further expand on its new competitive positioning. KFC, on the other hand, can maintain quality supply which is detrimental to its success.

A joint venture will also significantly ease the entry to the virgin Chinese market. A new entrant would find it very difficulty to form local and personal networks between businesses and government agencies, which are crucial to success and provide access to the local market and domestic suppliers. In addition, local business customs and laws can be quicker understood and established ways to cut bureaucratic red-tape can be further utilized. Also, the local knowledge of culture, language and geography is beneficial for any foreign entrant into a relatively unknown market.

In order to cope with the significant political risk of investing in China, a local joint venture partner will share this risk. There is always a risk of domestication measures imposed by the host government, often leading to major financial losses for the foreign investor. By having a 55/45 joint venture agreement, this risk is potential eliminated, since only 55 percent of operations are domesticated. If such an unfavorable situation would arise, KFC has clearly less to loose in such an agreement. In addition, by being the dominant partner, KFC will be able to ensure cost, quality and strategic control measures.

The Chinese government may very well find KFC beneficial to the nation, as it is the pioneering western fast-food outlet. Training the joint venture partner, personnel and other institutions in the value chain can reduce learning and experience curves. KFC's operations may also inspire local competitors to increase service and quality of food. It can also help to create a competitive fast-food industry in China as new competitors respond to KFC's ideas. Moreover, a joint venture agreement commonly produces goodwill and commitment between the host government and the foreign investor. In such a relationship, the foreign investor is not seen as trying to take advantage of the nation for profit purposes, but rather show willingness to share. Maintaining good relations with the

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host government is a critical success factor as government policy impacts intensely upon business activities.

5.7 RECOMMENDED LOCATION

Even if KFC had developed "excellent contacts" with the government of Tianjin, further expansion should not be made here. The poor supply of good quality poultry and the geographic location does not attract too many westerners that are able to bring-in foreign currency, which is crucially needed to ensure profitability.

Instead, the Chinese capital city, Beijing is recommended as the preferred location for KFC's entry into the Chinese market. Beijing is the center for most political activity and provides the necessary access to government agencies and business regulatory bodies. Furthermore, it has a large population of nearly 9 million inhabitants. The numerous universities located in the city further educates people that may make them more open to foreign ideas perhaps including western fast-food. More importantly, plenty of western tourists are attracted to Beijing's many tourist attractions, increasing the potential for generating foreign currency sales. Also, suppliers of poultry are available. Beijing can serve as the initial platform of KFC's operations and later expand into other potential areas such as Shanghai and Guangzhou.

One or two initial outlets should be set up in order to get a "taste" of how KFC will be perceived in the Chinese Capital. Both dine-in and take-out facilities, much in line with most of KFC's international operations ought to be offered in large, clean and well serviced company owned outlets to cater for the customers with above average disposable incomes. In order to ensure the right cultural fit of the business, restaurants must be highly functional and effective in order to serve large numbers of customers due to the cheer size of the population. Special menu-substitutions may also have to be facilitated, such as substituting rice for French-fries.

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5.8 CENTRAL CONTROL VERSUS LOCAL RESPONSIVENESS

In a foreign market with high political risk and low cultural knowledge, a high degree of cultural sensitivity is crucial. Centralized control cannot be maintained since it is impossible to effectively manage an overseas operation from the headquarters without the information and knowledge needed to make sound strategic decisions.

China operations surely need to be able to quickly respond to political and/or market changes. The joint venture will facilitate some of this responsiveness, but a KFC or a R.J. Reynolds head office in the region with a high level of autonomy is needed. Perhaps, such a regional office could be set-up in Hong Kong to oversee overall corporate objectives of further expanding R.J. Reynolds products and KFC into the Chinese market.

5.9 CONCLUSION
The Chinese market represents a great opportunity for KFC, but also significant risk. KFC should begin operations in Beijing and later expand into other metropolitan areas. By finding an appropriate domestic business partner via backwards integration, it is possible to further build on opportunities and significantly reduce risk throughout financial sharing, cultural sensitivity, and favorably treatment from the host government. Choosing the right form of entry mode is the most crucial part for KFC to enter the Chinese market. KFC needs to consider on cultural, political, and environmental

perspectives with respect to the Chinese local market conditions before making the decision.

From the case study, it can be concluded that Joint venture is the most suitable form of entry mode for KFC to invest in the Chinese market. Joint venture with Chinese partner helps KFC to solve many logistic problems and create good relationships or

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Guanxi with local government and people. In addition, provide positive benefits to the country, simultaneously obtaining enormous profits from the Chinese market.

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Chapter 6

INTERVIEW OF A FOREIGN INVESTOR IN CHINA

6.1 Introduction
An interview was done with Mr. Cai Rongzhuang, chairman of Lvbang international company Co., LTD, who is an oversea Chinese lived in Thailand for more than 20 years. In 1997, Mr. Cai Rongzhuang after success in his business in Thailand came up with a thought to invest in China. After 2 years, in 1999, Mr. Cai Rongzhuang decided to go back to his homeland and invested in Daxing town, Beijing for some agricultural businesses. He invested 10 million Yuan in Daxing for a green food project. The concept for this project is to set up a chain system between local farmers and Lvbang international company to produce and sale high quality vegetables and fruits in Chinese supermarkets and convenient shops. Because he is an oversea Chinese, he knows the Chinese culture and market conditions very well. When asking on the types of entry mode he decided to select for entering the Chinese market, the answer is clear and straight forward: FDI. The details of the interview are shown below:

6.2 Interview
Question (By me): Why do you choose China as the place to invest?

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Answer (By Mr. Cai Rongzhuang): I am a Chinese and I would like to donate my personal experience and finance to help my hometown- Daxing. I would like to help the local farmers to produce cheaper and better quality products and services and gain more profits. In addition, to provide employment and improve local citizens standard of living. I have signed hundreds of contracts with more than 200 farmers in Daxing to collect, clean and pack their vegetables and fruits by using high tech machineries. In addition, several groups of skilled agricultural technicians were send to every farmer to help and teach them on planting, fertilizing, protecting insects, and harvesting with technology and experience to generate better quality vegetables and fruits with minimum lost. All the vegetables and fruits will then be sent to the selecting section, cleaning section, sterilization section, packing section, and distribution section. At last, the products will be distributed to every supermarkets and convenient shops in Daxing, Hebei, and Beijing. Moreover, I have constructed two green food restaurants in Daxing. The meaning of green food restaurant is that all the food in the menu is made from vegetables and fruits. There are more than 60 types of dishes made from only vegetables and the concept for the restaurant is to let people know that we can cook vegetables in many ways that are delicious, beautiful, and good for health. I also built a large exhibition hall in Daxing and planned to set up various types of exhibitions and shows relating to green food to provide a media for Daxing people to communicate and discuss with each other in order to help to improve the quality, standard and costs of the products and services.

Question: What type of entry mode did you choose when invest in Daxing?

Answer: I know the Chinese market and culture quit well. Therefore I decided to choose foreign direct investment. After visiting Daxing many times, I have found an experienced partner who has the ability and capability to help me for the achievement. I chose equity joint venture, and I am holding 51% shares. Exporting is simply an international trade, not really an investment. I am not interested in this type of entry mode because exporting can not enter the Chinese market essentially. The input and output for exporting are low and considering the Chinese market, with the current speed of economic development,

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exporting can not lasting for a long time due to the high competitions and rapid changing of customers tastes resulted from globalization. I also dont like licensing and franchising. Because I feel that there is less responsibility for me to choose licensing and franchising as the types of entry modes and it is harder for control and manages the company. Joint venture is the most suitable form of entry mode for Lvbang I think. Chinese culture is quit unique compared to other countries and only local companies understand their customers well. With the help of local partner, Lvbang can enter the Chinese market speedily through good Guanxi with the locals. By building on each partner's core competencies, knowledge, and efficiencies, a mutually beneficial synergy effect could be achieved as a result of joint venture activities. For instance, the local partner can learn from Lvbang how to adopt the chain system and high standard management skills, further expand on its new competitive positioning. Lvbang, on the other hand, can learn and know the local customers, suppliers, and government officials to help it for further development.

Question: what are the obstacles you have faced? How did you overcome those obstacles?

Answer: Well, doing business in China is not that easy as I thought. The most severe obstacle I faced when registering Lvbang in China is communicating with the government. The power of government is superb for company, especially foreign invested company in China. A good Guanxi with local government officials can bring enormous benefits to the company; on the other hand, a bad Guanxi will drive the company to death. For example, when Lvbang ask the government to change to property of the land for construction of exhibition hall, it was told by the government officials that it may take one year to do so. But the local partner has very good Guanxi with the local government officials, therefore it takes only two months to change the property of the land and the construction was implemented right afterward. The Chinese culture is also important. Without knowing the customers tastes can result negative effects to the company. When Lvbang first named its products in English, it was not very welcomed

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and accepted, after receiving advices from the local partner, Lvbang changed its product name in Chinese, and soon caught the attention of the local customers. In brief, there are 3 things that foreign investors need to understand and solve before making implementation: Cultural, Governmental, and environmental factors in China.

Question: what will you expect the future of Lvbang?

Answer: I think the future of Lvbang is bright with perspective. Even through the Chinese economy is growing dramatically, the cheap labor costs and sufficient labor sources provide core advantages companies run their businesses in the Chinese market; the quality and standardization of products and services in China are still poorer than other developed countries, and foreign companies can produce competitively lower prices of products and services with a better efficiency and quality. There are still many things can be improved and enhanced in the Chinese market. Foreign investing companies may bring new technology and management systems to help China to expand toward developed countries.

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Chapter 7

Conclusion
7.1 Chinese market environment
In 1978, with the open door policy, China began a deep economic reform which is call as Jingji gaige in Chinese, which brought about modernization and growth: fast development, together with structural changes and lifestyle improvements have made the country one of the main players in East Asia.

Since the opening up, china applying foreign capital has resulted positive feedbacks which drives it towards globalization and internalization. There are basically three stages for china to absorb foreign capitals. The first stage occurred from 1979 to 1991, since the reform of the Chinese government. The government mainly relies on foreign loaning and foreign investments have only occupied a small part of the total foreign capitals. In this stage, the total foreign capital entered China was nearly 80 billion US dollars, 52 billion from foreign loaning and 28 billion are from foreign investments. The second stage was from 1992 to 1997, in this stage, the situation has turned over, foreign investment became to main part of total foreign capital and foreign loaning became a subsidiary part. Foreign direct investments started to exist in the Chinese market and the Chinese market became more attractive for foreign investors. In 1992, the FDI projects in China exceeded 58 billion US dollars. The third stage began after 1998; foreign investors realized the importance and draw high attention on the high potential

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Chinese market. Large scale of foreign capital from foreign companies has injected into all types of markets.

China has the largest population in the world, more than 1.4 billion. The market in China is enormous and extraordinary. It is necessary for foreign investors to identify the market and divide this huge market in to segmentations. Samsungs sale manager in Beijing stated that marketing in China is like dealing with all Europe. The Chinese market can be segmented in many ways depending on what criteria are used, such as geographic, demographic and social cultural. Geographic means to divide the market by areas, such as east, central and west regions which is also adopted by the Chinese government; demographic segmentation is to divide the Chinese market according to the demographic factors such as age, gender, race and education level; further more, the social cultural segmentation involves social class, religion and life style choices. Foreign investors need to choose the right and suitable entry modes for different kinds of companies at different circumstances. One of the strengths of the Chinese business model is the business market is large and transparent. The number of population is each segment is more than the whole population of some countries. For example, the number of children in china is more than the population of Thai citizens in Thailand. The huge number of population in China becomes the biggest advantage for attracting foreign private business enterprises. The meaning of transparent can be defined by the easy understanding of the Chinese market after segmentation.

Entering Chinese market is complicated and challenging. Foreign companies need to carefully investigate the Chinese culture, government regulations, policies, laws, and Chinese market environment. It is easier for companies that enter Chinese market to follow the examples of both local and foreign companies that have already achieved success there.

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7.2 Comparing different forms of entry modes in China

Exporting is the simplest form of trade that allows foreign companies to enter Chinese market. Since exporting does not require the goods to be produced in the target country, no investment in foreign production facilities is required, which reduces risk if the project fails. In addition, exporting is usually seen as a low key method of entering a foreign market as it avoids the often substantial cost of establishing manufacturing operations in the host country such as, factories, machineries and employees. However, since China opened its door to the world, the reduction of import tariff results severe competitions against international investors and as time passed on, the opportunities for adopting exporting as an entry mode in China is very little. There will be less and less foreign investors can choose exporting as an entry mode to China with the increasing difficulties from global competitions. In addition, foreign companies adopting exporting as an entry mode in China face severe obstacles against counterfeits in China. Another disadvantage for foreign exporting of particular types of products to China is the poor after sale service.

Licensing and Franchising are the two convenient forms of entry mode that foreign investors can choose to enter the Chinese market. Recently the Chinese regulations and policies against Licensing and franchising are getting more comprehensive and inclusive. Foreign companies will receive total protections from the government which ensure stability and reduce the risks. However, comparing to FDIJoint venture, licensing and franchising are still lack of control and management. Licensing and franchising are often chosen by foreign investors when a multinational company has strong core competencies in technology and design, or intellectual property rights are well protected in a host country, or tariff and non tariff trade barriers are high in a host country, or political risks are too high to invest indirectly in a host country. There are many negative effects for Licensing and franchising such as Dianqiao in cultural aspect and media restrictions in political aspect.

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Joint venture is the most popular form of entry mode presently. Even through there are many disadvantages to foreign Joint venture, such as high risk compared to other modes of entering foreign markets, require higher amounts of resources and commitment as appose to other modes. Joint venture has abundant advantages: the first being that the company has direct ownership (unlike licensing) which provides a high degree of control in the operations and the ability to better know the consumers and competitive environment. Secondly, since china opened its door to the world, more and more multinational enterprises paid massive attentions on Chinese market as the Chinese government provided numerous attractive policies and regulations for private companies. In the cultural aspect, Joint venture provides plentiful employment and higher wedges and salaries to local labors. Technology and information transfer also benefits China significantly. Comparing Joint venture with other forms of entry modes in the cultural aspects, it requires the highest level of Guanxi and negotiation with the local peoples. However, Joint venture enjoys the advantages in the competitive production factors and the cheap and plentiful labor forces and resources. In addition, there are less influences on cultural dangerous such as Duanqiao or Counterfeits for Joint venture compared with exporting, licensing, and franchising. Joint venture also benefits from the Chinese government support in various aspects, such as special car tax rate, special economic zones, etc. more over, Joint venture has many advantages for investors; it spreads the costs and risks to two parties and improves access to financial resources. Joint venture has the ability for companies to access to new technologies and customers, access to innovative managerial practices easily and quickly. The adoption of joint venture as an entry mode may lead to economic of scale and advantages of size. In addition, joint venture can influences the structural evolution of the industry, pre-empting competition, create of stronger competitive units, Speed up to meet the market demand, and improved agility.

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7.3 Best choice- Joint venture

As stated above in section 7.2, Joint venture is the most suitable form of entry mode to entry the Chinese market in the current economy condition. There are abundant advantages for Joint venture both culturally and politically compared to exporting, licensing and franchising.

So far, the Chinese government has created world standardized laws and regulations to support Joint venture in China and in order to attract more and more foreign investors to China, the Chinese government has released abundant policies to provide advantages for foreign direct investment. Even through China put high attention in attracting foreign wholly owned enterprises to China due to the globalization, and Chinese government opened most of its industries to foreign investors and they are willing to take full control and become the owner of thus businesses. In return, huge amount of capitals and assets are installed to the Chinese market. The trend of Chinese laws will be moving towards foreign wholly owned enterprises positively. However, the main and major industries such as Banking and media businesses are still protected and restricted by the Chinese government in China, and the unique situation in China makes it hard to changes. Therefore foreign wholly owned companies still facing many obstacles compared to Joint venture. Foreign Joint venture is the most appropriate entry mode for foreign investors that willing to choose foreign direct investment in China. However, as China moves toward globalization, foreign wholly owned companies may surpass Joint venture and become the core entry mode for FDI in China.

As China moves toward internationalization and globalization, FDI will be come the most supported and encouraged form of entry mode in China from the aspect of the Chinese government. Moreover, foreign investors adopting FDI in China will receive more and more benefits for themselves.

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