European Union Chamber of Commerce in China All Rights reserved

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1 In partnership with

2 European Union Chamber of Commerce in China All Rights reserved

3 TABLE OF CONTENTS P3 P4 P4 P7 P7 P8 P8 P9 P11 P11 P12 P12 P13 P15 P18 P20 P21 P22 P22 P23 P23 P23 P25 P25 P26 P30 P32 Executive summary Chapter 1: Optimism about market growth China s growth is a bright spot on the global investment horizon Investing for the future More hiring, greater workforce localisation More domestic R&D activity Greater competition Expected profitability will continue to lag behind projected growth Improving profitability through expansion Conclusion on growth and investment strategies Chapter 2: Proceeding with caution amid regulatory uncertainty Top 5 risks to future business in China: growth-related market risks and regulatory risks Government policies and practices towards Foreign-Invested Enterprises (FIEs) Inconsistent government law enforcement Regulatory obstacles hindering growth Increasing doubts about China s willingness to implement WTO commitments Looking ahead About the survey Questionnaire motivation and design Panel summary Industry Revenue, size and time in China Legal entities Motivation for presence in China Findings by industry sector, size and time in China About Roland Berger Strategy Consultants About the European Chamber

4 LIST OF FIGURES 2 Chapter 1: Optimism about market growth Figure 1: Business sector outlook in Mainland China over the next two years Figure 2: Importance of Mainland China in companies global strategy since the financial crisis by industry sector Figure 3: Business Sector outlook in Mainland China over the next two years by industry sector Figure 4: Intended actions for realizing revenue goals Figure 5: Mainland China as destination for investment today vs. in five years Figure 6: Proportion of foreign managers in top management positions Figure 7: Presence of R&D centre in Mainland China P9 Figure 8: Top 5 perceived competitive advantages vs. Chinese companies ( ) P10 Figure 9: Net profit margin results P11 Figure 10: Intended steps to improve profitability P4 P4 P5 P6 P6 P7 P8 P8 P12 Chapter 2: Proceeding with caution amid regulatory uncertainty P13 Figure 11: Top 5 perceived risks for future business in Mainland China ( ) P14 Figure 12: Perception of how government policies have affected the business environment for FIEs over the past two years P15 Figure 13: Perception of how government policies will affect the business environment for FIEs over the next two years P15 Figure 14: Perceived effectiveness of enforcement of Mainland China s IPR laws and regulations P18 Figure 15: Perceived effectiveness of enforcement of Mainland China s environmental laws and regulations P19 Figure 16: Perceived benefits from stimulus policies by company size P19 Figure 17: Top 5 regulatory obstacles when doing business in Mainland China P21 Figure 18: Overall assessment on implementation of WTO agreement P23 P23 P24 P24 P24 P25 P25 Panel summary Figure 19: Industry breakdown Figure 20: Total revenue in Mainland China Figure 21: Number of employees in Mainland China Figure 22: Years of operational presence in Mainland China Figure 23: Legal entities under which companies are registered in Mainland China Figure 24: Most important criteria to decide on Mainland China headquarters location In partnership with

5 EXECUTIVE SUMMARY Unpredictability about the future of the regulatory environment undermines positive market growth outlook among European companies The European Union Chamber of Commerce Business Confidence Survey 2010 surveyed over 500 European companies based in China between March and April of The results the most comprehensive and wideranging set of data yet gathered for this annual publication show a European business community that remains optimistic about surging economic growth, but concerned about uncertainty in the business environment and unpredictability in the regulatory environment. Survey respondents are generally optimistic about growth in their business sector they have seen the Chinese market recover strongly and anticipate that this impressive performance will create opportunities for their own industries. As a result, they report that China has become an even more important element of their global business strategies. However, this expected optimism about growth does not automatically translate into confidence in China as a sustainable and predictable investment environment in the long term. Instead, what the survey results present is a more complex picture in which optimism in the overall economic climate has been dampened dramatically by concerns about regulatory interference and uncertainty in the business environment. 3 Across the country and right throughout industries, European business reports that, apart from concerns about natural market trends such as fluctuating profits and rising competition, the number one issue affecting their operations in China remains the perception that the regulatory environment for foreign enterprises in China has become more difficult and will worsen further in the coming years. Remarkably, some 40% of respondents expect the regulatory environment for foreign companies to actually worsen for FIEs over the next two years, and a further 22% anticipate that there will be no improvement. Just 10% anticipate any improvement in this regard over the next two years. When asked to identify specific issues affecting their businesses over the last year, respondents highlight the same key problems that they have highlighted for several years indeed, the list of top five issues has remained unchanged over the last three years. Prime amongst these is the problem of discretionary enforcement of laws and regulations, while registration processes, IPR issues and inconsistencies in the local implementation of national standards continue to frustrate. These unresolved frustrations are compounded by uncertainty in the business environment; combined, these concerns appear to be impacting investment decisions. Results suggest China might be losing some of its lustre as an investment location. 30% of respondents indicate that China is currently the top investment destination but when asked to predict the situation five years from now, just 21% list China as the number one investment location. Over the next several pages of this report, this diverse array of often conflicting views will be examined in further detail and broken down by industry sector and region. As will be shown, general sentiment among respondents is decidedly mixed, but the main message that can be gleaned from their responses is very clear: European companies' continued commitment to China as an investment location is not unconditional and would be further enhanced by a clearer and more predictable business environment.

6 CHAPTER 1: OPTIMISM ABOUT MARKET GROWTH European companies are optimistic that China will continue to grow and are overwhelmingly focused on increasing revenue rather than cutting costs. Recognising the potential of the Chinese market, European companies are making China a priority, especially as growth slows in domestic markets. According to the results of this year's survey, companies' optimism about China's growth potential and their commitment to the local market is displayed in their plans to increase investments, strengthen their local workforce and further establish R&D centres to expand their local value chain. For many companies, however, growth in their business sector does not necessarily equate with profitability, with 18% of respondents reporting negative results over the past year (see Figure 9). Some 50% of respondents are neutral about the prospects of profitability in their sector, with 16% outright pessimistic. Figure 1: BUSINESS SECTOR OUTLOOK IN CHINA OVER THE NEXT TWO YEARS GROWTH OUTLOOK PROFITABILITY OUTLOOK 4 Total N=450 N=233 N=207 Total N=449 N=233 N=207 Pessimistic Neutral 2% 8% 5% 20% 12% 27% Pessimistic 16% 23% 18% Neutral 50% 42% 35% Optimistic 78% 65% 83% Optimistic 34% 34% 47% Optimistic Neutral Pessimistic China s growth is a bright spot on the global investment horizon The financial crisis has amplified the importance of China in respondents global strategies. Some 40% have reported that China has become a more important market, while 39% claim it has not changed in importance. More specifically, companies from the industrial goods and services sector are emphasizing the importance of China more than those in other sectors, even though more companies in this sector report having lower sales targets in China compared with last year. In partnership with

7 Figure 2: IMPORTANCE OF MAINLAND CHINA IN COMPANIES GLOBAL STRATEGY SINCE THE FINANCIAL CRISIS BY INDUSTRY SECTOR Total N=165 N=160 N=12 Professional Services 28% 36% Industrial Goods/ Services 41% 29% Consumer goods/ Services N/A 27% 4% More Important 31% 4% As important Less important Note: 40% of total respondents reported that China has become a more important market, while 39% claim it has not changed in importance. 5 Almost a third of those operating in China for more than a decade said that China has become a more important market for them over the past year. Only 4% of companies operating in China for less than two years made this claim. Since these companies are new to the market, one can assume that in most cases their strategies have not changed since they began doing business in China. Why do our respondents view China as being such an important market? Open-ended responses indicative of the pool include: China offers favourable market growth opportunities and long-term economic outlook compared with other regions (United States and Europe). China is our biggest market worldwide. China is the most important market for many of our customers. We expect further international investments and infrastructure development in China. China recovered quickly from the economic crisis. Post-crisis surge in business sector optimism. Spurring this perception of China as an international bright spot is a surge in confidence in China s growth potential in the near future. European companies across all industry sectors display increased optimism about the prospects for growth in their sectors in China. They are putting more weight behind China in their global strategies. Overall optimism about business sector growth rebounded this year to 78%, up from 65% in the midst of the crisis in This means sentiment is just slightly lower than it was when the market peaked in 2008, at which time 83% of respondents were optimistic.

8 All major industry sectors are more optimistic about sector business growth this year compared to 2009: Industrial goods and services: 6 percentage point rise over last year. Consumer goods and services: 13 percentage point rise over last year. Professional services: 22 percentage point rise over last year, suggesting that the crisis affected the confidence of these firms more acutely than others. Figure 3: BUSINESS SECTOR OUTLOOK IN MAINLAND CHINA OVER THE NEXT TWO YEARS BY INDUSTRY SECTOR Industrial Goods & Services Consumer Goods & Services Professional Services N=162 N=131 N= Growth 74% 22% Profitability 26% 52% 22% 4% 80% 19% 1% 36% 49% 15% 80% 2% 18% 39% 50% 11% N=53 N=95 N= Growth 68% 25% Profitability 32% 45% 23% 8% 67% 27% 39% 36% 24% 5% 58% 12% 30% 32% 46% 22% N=86 N=45 N= Growth 79% 13% Profitability 36% 42% 22% 8% 80% 16% 49% 38% 13% 4% 88% 3% 9% 58% 26% 16% Optimistic Neutral Pessimistic Figure 4: INTENDED ACTIONS 1) FOR REALIZING REVENUE GOALS N=359 Increase sales activities 81% Acquire new customers 77% Increase marketing 54% Offer new services Fund new product development 33% Invest in other companies 12% None of the above 3% 43% Companies also reported that increasing revenue is drastically more important than cutting costs at this point in time: 84% stressed the importance of increasing revenue compared with a mere 16% who said cost cutting was a primary objective. Increasing sales activities is cited as being the strongest method to accomplish revenue goals, followed by acquiring new customers. Attitudes towards business growth have improved over the past year, even though companies have still to return to pre-financial crisis levels. This is unsurprising considering that the Chinese economy experienced 11.9% growth in the first quarter of ) Respondents could select more than one answer In partnership with

9 Investing for the future Respondents are confident about China s future growth and are planning to act now to harness that potential through new investments, expansions, new hires and increased R&D. Almost half of respondents planned to make major new investments over the next two years. This means that at present, market growth prospects appear to still outweigh the challenges presented by regulatory obstacles. Despite regulatory obstacles, China will remain a key investment destination on a global basis from the vantage point of European companies: 30% say that China is currently the top global destination for investments and 21% believe it will remain in the top position five years from now. 34% say that China is currently ranked as a Top 3 destination for additional investments and 47% feel that it will be so five years from now. Figure 5: MAINLAND CHINA AS DESTINATION FOR INVESTMENT TODAY VS. IN FIVE YEARS N=419 19% 17% N=415 13% 18% 34% 47% Top 10 destination Top 5 destination Top 3 destination This seems to suggest that now is the time to invest in China, especially as other emerging investment destinations will likely take over in the medium term. The urgency to invest in assets in China has a two-fold explanation. In the immediate wake of the rebound, China finds itself in an economic sweet spot. This will probably dissipate once the effects of 2009 s lending spree are felt. In the meantime, the rest of the world economy is recovering, but at a slower pace than in China. 7 30% 21% Top destination Today In five years More hiring, greater workforce localisation Unsurprisingly in such a growth context, the outlook for future employment in China is strong. More new hiring is taking place and higher numbers are expected to come. Some 23% of surveyed companies reported that the number of permanent employee positions increased this past year and 48% of respondents predict an increase over the next two years. However, in 2009, 46% expected an increase in permanent positions and only 23% have actually reported an increase thus far. Time will tell whether European companies meet their new hiring forecasts.

10 A trend towards hiring greater numbers of local managers has also continued in In 2008, 33% of respondents reported that over three-quarters of top management were foreign passport-holders. Today, that figure has dropped to just 20% of respondents, suggesting that local Chinese managers are participating more significantly in European companies operating in China. Figure 6: PROPORTION OF FOREIGN MANAGERS IN TOP MANAGEMENT POSITIONS 1) 2010 survey N= survey N=187 20% 13% 12% 55% 33% 11% 12% 44% < 25% 25%-50% 50%-75% >75% 1) Foreign = non-prc passport holder Note: Question not asked in More domestic R&D activity Figure 7: PRESENCE OF R&D CENTRE IN MAINLAND CHINA Existing R&D centre in Mainland China No R&D centre in Mainland China N=400 N=206 26% 74% % 83% 2009 N=188 27% 73% 2008 Commitment to China is also being shown in increased R&D investments. Nearly a third of companies (26%) reported having R&D centres, a remarkable increase from last year s 17%. The main reason listed for opening an R&D centre was to adapt products to the Chinese market. This has been the top reason since Government-related issues, including tax breaks or meeting government requirements, were not important drivers. Not surprisingly, R&D centres are most widespread in the industrial goods and services sector. In addition, the longer a company has been operating in China, the greater the likelihood they will have an R&D centre. Only 21% of companies doing business in China for less than two years have one, whereas 32% of companies that have been operating in China for over 20 years have established their own R&D centres. Greater competition The investments highlighted above are planned in the context of China s high-growth market. As the Chinese economy grows and matures, increased competition should be expected. In partnership with

11 Local and foreign competition were cited as top factors affecting net profit margins, with 41% reporting pressure from mainly Chinese companies and 37% from foreign ones. Competitive pressure concerns have risen again, growing from 36% in 2009 to 43% in European companies still enjoy competitive advantages over Chinese companies in several areas, especially in European strongholds like product quality, product innovation and design, technology development, process management and management efficiency, but Chinese companies are making inroads. Though still dominant in these areas overall, European companies seem to feel more vulnerable than last year in product quality (down 8 percentage points), technology development (down 6 percentage points) and process management and operations (down 6 percentage points). This suggests that they are feeling some pressure from China s increased domestic expertise, and represents a driver for respondents plans to invest in R&D and human resources. Figure 8: TOP 5 PERCEIVED COMPETITIVE ADVANTAGES VS. CHINESE COMPANIES ( ) Product quality N (2010) = 445; N (2009) =228; N (2008)= % % % Product innovation and design % % % 9 Technology development % % % Process management and operations % % % Management efficiency % % % Expected profitability will continue to lag behind projected growth While respondents are bullish about China s growth potential, they are decidedly more downbeat about their sector s prospects for profitability 1 in China. Please see Figure 3 on outlook by industry sector. Indeed, companies are no more optimistic about profitability now than they were during the crisis. 1 Profitability defined as having positive net profits, not breaking even.

12 Optimism about profitability has weakened noticeably in the consumer goods and services sector and in the industrial goods and services sectors. However, outright pessimism has dropped by 9% in the consumer goods and services sector, owing perhaps to the prospect of rising domestic household consumption in China. Optimism about profitability has strengthened in the professional services sector, which might expect to benefit from the growing sophistication and ambition of China s top companies. Although the majority of respondents reported positive net profits this year, the percentage doing so has declined slightly over previous years. For 18% of respondents, the crisis was still not over in the spring of They reported negative net profit margins for the previous year. Some 57% of companies with a negative profit margin believe they will resume or reach profitability by the end of this year or Figure 9: NET PROFIT MARGIN RESULTS 2010 survey N= survey N= survey N= survey N=128 Positive Break-even Negative Even though many respondents cited China as being the bright spot in the global economy in 2009, only one-third of respondents actually experienced better margins in China than in other parts of the globe. This is remarkable given that the financial crisis in 2009 was global in scale. This further underscores that China is not a highly profitable market for many businesses, but rather a high-growth market where investments are being made with longer-term profitability expectations. Specifically: 37% reported that China s net profit margins were higher than their company s worldwide average. 29% reported China s net profit margins to be the same as worldwide average. 34% reported China s net profit margins to be lower than worldwide average. It is interesting to note that over half of larger-sized companies managed to garner higher margins in China than worldwide. This is not true for their smaller-sized peers. This confirms the 2009 Business Confidence Survey findings showing that larger companies who are more exposed to fluctuations in both U.S. and European markets saw greater disparities between profit margins in China and the rest of the world. SMEs have more difficulties to make their businesses profitable in China, or have not yet had sufficient time. In partnership with

13 Improving profitability through expansion Expanding the market is viewed as the number one step to increase profitability by 55% of participants and as an important step by another 21%. Such a strategic choice is consistent with the high level of confidence in the growth of China s markets. Improving productivity and strengthening relationships with customers were also moderately important as options, but these pale in comparison to expanding the market. Companies that are new to China and have been operating here for less than two years place a higher emphasis on expanding the market as an initial step in order to improve profitability compared to companies with longer operating times in China. Figure 10: INTENDED STEPS TO IMPROVE PROFITABILITY N=359 Expand market 75% Improve relations with customers 51% Improve productivity 38% Innovate in product and service Expand distribution network 22% Improve internal process management 22% Improve relations with local government 18% Improve relations with suppliers 11% Re-focus range of products/ services 9% Reduce headcount 6% Reduce employee turnover 4% Close facilities 3% 38% 11 Note: Respondents could select more than one answer Conclusion on growth and investment strategies China is ranked high on the list of companies global investment locations due to its continued growth prospects. It is well positioned to receive further investment: companies across sectors are forging ahead to expand and increase revenue. Companies are hiring employees and building more R&D centres, thus confirming and contributing to this market s importance for the foreseeable future. Companies are optimistic about growth, but are more reserved about their profitability prospects.

14 CHAPTER 2: PROCEEDING WITH CAUTION AMID REGULATORY UNCERTAINTY In tandem with the increased optimism on business growth in China, but in marked contrast to this positive sentiment, the 2010 Business Confidence Survey shows a mood of rising concern and uncertainty among the European business community about certain key factors in the China market most significantly the regulatory environment for foreign invested companies. Remarkably, some 40% of European businesses surveyed expect the regulatory environment for Foreign Invested Enterprises (FIEs) to worsen over the next two years. And some are responding to this by reducing or suspending investments. Top 5 risks to future business in China: growth-related market risks and regulatory risks 12 Respondents identified several risks for future business in Mainland China: 63% listed the global economic slowdown as the top risk factor, down 11 percentage points from 2009 when the crisis was peaking. Risk of a Chinese economic slowdown closely trailed the global one, but again shows a significant decrease from With the rapid post-crisis recovery in China, a Chinese economic slowdown is seen as less of a risk this year. Last year, 54% of respondents identified competition as a significant concern. This year, we asked respondents about domestic competition, rather than asking about overall competition. This distinction provides a more nuanced picture: 58% of companies responded that they perceive rising domestic competition as a risk. Increasing labour costs in many respects the price to pay for China s extremely strong economic recovery has returned to prominence as a top concern after a dip in It is telling that the first four of the top five risks relate to growth and its corollaries (rising competition, labour costs). Local protectionism/anti-foreign sentiment completes the top five concerns on the list, illustrating that despite confidence in strong market growth, there are also concerns regarding the ability of all companies domestic and foreign to participate fairly in China s growth story. The constant level of concern regarding Local Protectionism over the past three years illustrates that little progress that has been made in strengthening the regulatory environment to prevent discrimination and that this issue continues to plague the business climate for FIEs in China. In partnership with

15 Figure 11: TOP 5 PERCEIVED RISKS FOR FUTURE BUSINESS IN MAINLAND CHINA Global economic slowdown N (2010) = 380; N (2009) =232; N (2008)= % % % Chinese economic slowdown Competition from domestic firms % % % % % % Market / Growthrelated risks % Rising labour costs % 65% Local protectionism / anti-foreign sentiment % 50% 50% Non-market risk 13 Government policies and practices towards Foreign-Invested Enterprises (FIEs) Questions regarding the regulatory landscape and the Chinese government s policies and attitudes towards FIEs were introduced this year in response to concerns among Chamber member companies in 2009 about inconsistent treatment from the Chinese government towards FIEs. Thirty years after the start of China s opening and reform, there are still perceptions that FIEs are not treated equally. Last year, some 43% of respondents expected a rise in policies favouring local companies. This alarmingly high percentage called for additional attention. Questions aimed at gaining deeper insights into how the regulatory environment for FIE is perceived by Chamber member companies were introduced this year. For example: 36% consider government policies to have become less fair towards FIEs to at least some degree over the past two years. 24% say that policies are as fair towards FIEs now as they were two years ago. Only 8% feel that they are more fair. No company said that policies are increasingly favouring FIEs.

16 Figure 12: HOW DO YOU PERCEIVE GOVERNMENT POLICIES TO HAVE AFFECTED THE BUSINESS ENVIRONMENT FOR FIEs? No opinion N=454 Less fair More fair As fair 14 Such figures are concerning and could seriously dent China s image as a business and investment destination. What is more worrying is the perception that the regulatory environment for FIEs will further deteriorate in the future. As markets mature, it is natural for initial surges in investment to taper off, but persistent concerns about the regulatory environment in China will likely hasten that trend in this case. Where do members see improvement or deterioration of the regulations regarding FIEs? Open-ended responses indicative of the pool include: Improvements: Banking Consumer Finance Private Equity Deterioration: The linkage of indigenous innovation policies to government contracts Representative office regulations Media content Taxation Looking two years ahead, the responses do not suggest that companies see the government becoming more fair in its policies: 39% believe that policies will continue to discriminate against FIEs in some capacity. 22% say policies will be as fair in two years as they are now. 10% are hopeful and report that policies will be more fair. In partnership with

17 Figure 13: HOW DO YOU PERCEIVE GOVERNMENT POLICIES AFFECTING THE BUSINESS ENVIRONMENT FOR FIEs? No opinion More fair N=453 As fair Less fair Furthermore, government policies regarding FIEs have led 20% of our respondents to either suspend new investments, reduce or slow investments or have discussions about reducing investments. This is a troubling development, and one that the Chamber has tried to convey to the Chinese government. The Chamber welcomes recent moves by top Chinese leaders such as Premier Wen Jiabao s meeting with European business leaders and his assurances that FIEs will be treated fairly. Inconsistent government law enforcement Although government laws per se are not deemed overly problematic, the discretionary enforcement of broadly drafted laws and regulations is the regulatory obstacle cited most often when conducting business in China. This has been a top concern for three consecutive years and shows no sign of waning. 15 Figure 14: PERCEIVED EFFECTIVENESS OF ENFORCEMENT OF CHINA S IPR LAWS AND REGULATIONS Adequate N=104 28% N=136 N=111 19% 21% Regarding the important issue of intellectual property rights (IPR), there is a large discrepancy in satisfaction levels between the written laws and regulations and their actual implementation: 66% believe written IPR laws are adequate or excellent. Only 22% feel that the enforcement of laws and regulations are adequate. Inadequate 48% 46% 56% Despite the severity of this discrepancy, it is important to stress that companies perception of enforcement levels has improved, albeit slightly, from 15% feeling enforcement was adequate in 2008 to 22% today. Very inadequate 22% Consumer Goods/Services 35% Industrial Goods / Services 23% Professional Services From an industry standpoint, companies in the consumer goods and services sector consider laws to be more adequately enforced than the other sector.

18 Optimism about sector growth is high... OVER Uncertainty about future undermines positive market growth GROWTH OUTLOOK Neutral 20% N=450 Pessimistic 2% 78% Optimistic TOP 5 RISKS TO BUSINESS 1. Global Economic Slowdow 2. Chinese Economic Slowdo 3. Competition from Domestic 4. Rising Labour Costs 5. Local Protectionism / Anti-f While the first four are driven b direct impact of government in Outlook on the regulatory How do you anticipate government policies will affect the business environment for FIEs? No opinion 29% 10% N=453 22% 39% Less fair More fair As fair

19 VIEW regulatory environment outlook among European Companies...But recurrent regulatory concerns persist TOP 5 REGULATORY OBSTACLES WHEN DOING BUSINESS IN MAINLAND CHINA N = 381 IN MAINLAND CHINA: n Discretionary enforcement of laws and regulations 39% wn Firms Market / Growthrelated risks Registration processes 33% oreign Sentiment Non-market risk IPR protection 29% y market forces, the fifth is a terference. Visa and work permit practices Local implementation of national standards 26% 26% environment is uncertain For European companies, China remains an attractive investment location, but their continued commitment to the country does not come without reservations and is not unconditional.

20 Environmental regulations are perceived to be more strongly enforced on foreign companies in China than they are on local ones. Only 7% reported strong enforcement on local companies, compared to 47% on foreign companies. This illustrates one of the many reasons why European businesses feel discriminated against in contrast to their local competitors. Figure 15: PERCEIVED EFFECTIVENESS OF ENFORCEMENT OF MAINLAND CHINA S ENVIRONMENTAL LAWS AND REGULATIONS ON COMPANIES N=376 N=376 N=146 N=148 N=96 N=99 Do not know 32% 30% 54% 23% 25% 28% 54% 18% 22% 25% 21% 18 Weak Strong 60% 47% 25% 28% 7% Chinese firms Foreign firms % 70% 54% 53% 25% 28% 7% 4% Chinese firms Foreign firms Chinese firms Foreign firms Regulatory obstacles hindering growth European companies are recovering from the financial crisis and 73% feel that their company is being allowed to participate in the recovery. However, of that percentage, 33% feel that they are not benefiting as much as they could due to regulatory challenges affecting FIEs. Businesses are rebounding, but not necessarily because of China s 2009 stimulus policies. The stimulus policies fell short of company expectations: In 2009, 44% predicted they would benefit from the stimulus package, but in 2010, only 37% reported an overall benefit. 7% felt direct benefit from the stimulus package and 30% stated that their company benefited indirectly through increased customer demand. 40% predicted no benefit would come in 2009 and a much higher 63% lacked support altogether in How well companies benefited from stimulus policies varies widely depending on size, time in China and industry. Large companies reported receiving more overall assistance than small companies. Large companies also believed the stimulus plan to be more advantageous than did small companies. Some 44% of respondents from the industrial goods and services sector reported an overall benefit, compared to 40% from companies in the consumer goods and services sector and 26% from professional services. In partnership with

21 Figure 16: PERCEIVED BENEFITS FROM STIMULUS POLICIES BY COMPANY SIZE N=191 N=106 N=75 N=50 N=42 2% Direct benefit Indirect benefit (customer demands) 21% 29% 32% 48% 52% < > 5000 No. of employees Other regulatory obstacles hinder European businesses too. The increasing diffuseness of concerns is interesting to note. Over the past three years, a growing number of different regulatory concerns have been identified as being significant. The difference between the top five obstacles and the rest is narrowing. Such a phenomenon might be due to the increasing number of regulatory variables faced by companies in China, as well as the growing diversity of FIEs in China. 19 Figure 17: TOP 5 REGULATORY OBSTACLES WHEN DOING BUSINESS IN MAINLAND CHINA N = % Significant Discretionary enforcement of laws and regulations Neutral Insignificant Not applicable 35% 10% 16% 33% Registration processes 34% 15% 19% 29% IPR protection 34% 14% 24% 26% Visa and work permit practices 32% 29% 13% 26% Local implementation of national standards 36% 14% 24%

22 The top 5 obstacles differ in ranking and degree by industry: Industrial goods and services N= Discretionary enforcement of broadly drafted laws and regulations 41% 2. Registration processes for companies / products 35% 3. Local implementation of Chinese standards (national and industrial) in conformity assessment procedures 29% 4. IPR protection 29% 5. Customs procedures 27% Consumer goods and services N= Discretionary enforcement of broadly drafted laws and regulations 42% 2. Registration processes for companies / products 29% 3. IPR protection 24% 4. Discrimination against FIEs in public procurement 23% 5. Ownership restrictions (e.g. JV requirements) 22% 20 Professional services N= Discretionary enforcement of broadly drafted laws and regulations 35% 2. Registration processes for companies / products 33% 3. IPR protection 31% 4. Visa and work permit practices 27% 5. Customs procedures 25% 6. Local implementation of Chinese standards (national and industrial) in conformity assessment procedures 25% Increasing doubts about China s willingness to implement WTO commitments Dissatisfaction towards WTO implementation continues this year, with companies perceptions growing slightly more negative than in last year s survey: Only about one-fifth of respondents (both in 2009 and 2010) share the stance that China is implementing changes in the spirit of the WTO agreement. Fewer respondents this year feel that while China is in fact willing to implement changes, it is not succeeding. The percentage of respondents who feel that China is actively seeking loopholes to avoid or delay implementation has risen 4 points to 26% this year. Taken together, these figures paint a troubling picture. It appears that Chamber members increasingly perceive lapses in China s enforcement of WTO commitments to be deliberate attempts to circumvent trade rules rather than owing to a lack of resources. In partnership with

23 Figure 18: OVERALL ASSESSMENT ON IMPLEMENTATION OF WTO AGREEMENT 2010 survey N=377 28% 21% 26% 25% 33% 2009 survey N=235 22% 22% 23% 2008 survey N=210 24% 32% 26% 18% 2007 survey N=110 34% 30% 26% 10% Implementing changes in the spirit of the WTO agreement Actively seeking loopholes in the requirements to avoid to delay implementation Willing, but failing to implement changes Unsure Looking ahead 21 The 2009 Business Confidence Survey encouraged China s economic planners to promote more fair competition to even out the playing field for domestic and foreign firms alike and to help usher in greater prosperity for China. This year, the percentage of respondents calling for better rule of law and more transparent policymaking dropped just four points from 43% to 39%, suggesting little perceived or real improvement from the government. For many European companies, the question remains, Are we being treated fairly or are we being taken for granted by China s policymakers? Although this survey does not answer that question directly, we see foreign companies continuing to invest in China and emphasizing it in their global strategies. With that said, however, companies still have reservations about the discretionary enforcement of laws and some have decided against investing in China based on this perceived capriciousness. Some foreign companies also see their domestic competitors being given favourable treatment, thus ratcheting up the pressure on them. Some companies are sceptical and some are hopeful that government laws, regulations and attitudes towards FIEs will improve. These differences in perception reflect the rich diversity of European business in China in terms of sector, size and time operating in China. In short, European businesses are moving forward in China, but with caution. Their continued presence is not unconditional, and their optimism largely contingent upon the return of strong market growth prospects. It is therefore important for the Chinese government to foster conditions that encourage European companies to continue to support China s development, even when GDP growth inevitably dips as the economy matures.

24 ABOUT THE SURVEY Questionnaire motivation and design The 2010 Business Confidence Survey was conducted in March 2010 and published in June Out of 1,177 eligible entities, 514 responded to at least part of the questionnaire and 374 completed it. In order to identify evolving trends among businesses in China, most questions asked this year were consistent with those posed in To follow up on concerns about fair treatment towards foreign invested enterprises raised in last year s survey, and to determine how businesses are currently faring in the aftermath of the financial crisis, questions relating to these issues were added and a new section entitled Crisis Impact and Business Confidence was introduced. This year s survey was specifically interested in the current strength of respondents business confidence and how that relates to business decision-making. Questions that were considered no longer relevant or of little importance given current business conditions were removed. To attract a high response rate, the survey was condensed as much as possible while still maintaining the appropriate depth and scope to enable a thorough analysis of the business environment. 22 The core questions included in this year s survey centred upon the following themes: Company Profile and Statistics Crisis Impact and Business Confidence Company Strategy Financial Performance Regulatory Environment Human Resources In partnership with

25 PANEL SUMMARY Industry This year s Business Confidence Survey respondents represent the three primary sectors of industrial goods and services (35%), consumer goods and services (28%) and professional services (33%). The remaining respondents (4%) were unspecified. The classification of industry categories this year is consistent with 2009 with one exception: Last year s survey contained a financial services sub-category in order to identify how this sector was impacted by the economic crisis. This sub-category was omitted this year. The 2009 breakdown was as follows: industrial goods & services at (36%), consumer goods & services (25%) and professional services (39%). Figure 19: INDUSTRY BREAKDOWN Industrial goods & services Automotive Chemicals & petroleum Machinery Utilities, primary energies & other commodities Civil engineering and construction Transportation, logistics, and distribution Others Renewable energy equipment Paper processing & manufacturing Distribution & Retailing Mining and metallurgy Trade services & Supplies Instrumentation Aeronautics Construction materials Biotech Telco equipment Industrial IT software (incl. Development) Medical equipment Electronic systems Engineering products manufacturing Steel manufacturing Industrial Manufacturing & Sales Testing and Certification Packaging Furniture Glass Factory Automation 35% N=514 28% 33% 4% Other (unspecified) Professional services Media and publishing IT and telecommunications (services, infrastructure) Other professional services (incl. Legal, consulting services) Human Resources Education (incl. Management) Sciences (incl. Life, Material and environmental) Standardization service Real estate investments Advertising and branding Public relations & Communications Management & HR consulting Airline catering Others 23 Fashion and textiles Food and beverage Pharmaceuticals & healthcare Financial services (incl. insurance) Consumer goods & services Retail & hospitality Cable industry Consumer electronics & appliances Cosmetics & toiletries Tourism & travel Other consumer goods Others Revenue, size and time in China Companies with revenues over EUR 250 million were less strongly represented this year than in Only 10% of respondents reported revenues of this amount compared with 19% in the previous year. A dip in revenue was to be expected given the economic crisis. However, this figure might also be skewed due to the addition of the don t know/ can t disclose option this year. One-third of respondents marked this answer. It is unclear which slice of the pie this large demographic would fall into with full disclosure.

26 Figure 20: 2009 TOTAL REVENUE IN MAINLAND CHINA N=501 Don't know/ Cannot disclose 31% < EUR 1 M EUR 1 M EUR 10 M > EUR 1 B EUR 251 M EUR 1 B EUR 51 M EUR 250 M EUR 11 M EUR 50 M The increase of SMEs in the survey pool continued this year, with 63% representation compared with 61% last year. A company is designated as an SME if it has fewer than 250 employees. Figure 21: NUMBER OF EMPLOYEES IN MAINLAND CHINA N= employees employees > 5000 employees < 50 employees employees Some 73% of companies have been operating in China for at least six years, which is consistent with 2009 findings. Figure 22: YEARS OF OPERATIONAL PRESENCE IN MAINLAND CHINA N=507 > 20 years < 2 years 2-5 years years 6-10 years A correlation exists between size and time spent in China. The longer a company has been operating in China, the greater the number of its employees. Some 78% of respondents from companies operating in China for less than two years reported a company size of less than 50 employees. In partnership with

27 Figure 23: LEGAL ENTITIES UNDER WHICH YOUR COMPANY IS REGISTERED IN MAINLAND CHINA N=497 WFOE 50% Representative office 32% Joint venture 23% Regional branch / office 14% Holding 9% Regional headquarters 7% R&D centre 5% FICE 2% Legal entities Wholly Foreign-Owned Enterprises (WFOEs) are again the most common legal entity registered in Mainland China, with half of all respondents reporting a WFOE in Representative Offices (32%) are the second most common entity followed by Joint Ventures (23%). Companies registered under an R&D Centre (5%) or FICE (2%) yielded the fewest responses. The WFOE legal entity registration is most commonly found in companies that have been operating in China for years. More WFOEs exist in the industrial goods and services sector than in the two other industry sectors. Motivation for presence in China 25 Some 52% of respondents have their Asia-Pacific headquarters located in Mainland China, followed by Hong Kong with 20%. Being close to the market/better market access was the most important reason for choosing Mainland China as the headquarters location, as it was in Respondents continue to prioritise Shanghai, Beijing and other coastal areas for their headquarters and other functional locations. Only 3% of companies are headquartered in the West (Chengdu, Chongqing and Western China). Figure 24: MOST IMPORTANT CRITERIA TO DECIDE ON MAINLAND CHINA HEADQUARTERS LOCATION N=268 Close to the market / Better market access 76% Infrastructure, distribution and logistics 7% Degree of internationalization Proximity to talent 6% 3% Support from local government 5% Proximity to raw materials/extractive industries 2% Relatively more transparent legal environment 0%

28 FINDINGS BY INDUSTRY SECTOR, SIZE AND TIME IN CHINA The following groups are analyzed below: Industrial goods and services Consumer goods and services Professional services SMEs Large companies Companies operating in China for more than 10 years vs. less than 5 years 26 Findings by industry sector Industrial goods and services No. of industrial goods and services companies = % of respondents from this sector said they had benefited from stimulus policies, which was higher than consumer goods and services with 31% and lower than professional services with 47% Respondents in this sector are less optimistic about profitability over the next two years (28% reporting optimism) than consumer goods and services and professional services (both 37%) 73% of respondents are optimistic about the business outlook in terms of growth, which is the lowest percentage among the three sectors, indicating that all sectors are very confident of growth 18% reported having higher sales targets in China; 11% reported having lower sales targets With 28% this sector was the least optimistic about the business outlook in terms of profitability (38% and 36% for professional and consumer services), indicating that industry sectors overall do not have a strong outlook regarding profitability Industrial goods and services companies are more likely to have an R&D centre than other industry sectors in China at 28% 43% are optimistic about productivity over the next two years compared with 38% from consumer and 40% from professional services In partnership with

29 Findings by industry sector Consumer goods and service No. of consumer goods and services companies = % of respondents reported a positive net profit margin compared with industrial goods and services at 49% and professional services at 68% 53% from this sector are concerned with labour costs and express a pessimistic viewpoint towards it over the next two years, which is a slightly higher percentage than industrial at 51% and professional services at 51% 45% are pessimistic about competitive pressure over the next two years versus 40% for industrial and 44% for professional services 85% stress increasing revenue, compared with 87% for professional services and 81% for industrial services 80% of respondents from this sector are optimistic about growth in their sector, compared with 73% from industrial and 80% from professional services At only 7% this sector is the most seriously concerned about Indigenous Innovation policies and have already begun to be affected by them. This demonstrates that sectors overall do not have this high on company radar 27 Findings by industry sector Professional services No. of professional services firms = % of respondents from this sector currently rank China as the top country for additional investments on a global scale (industrial at 28%, consumer at 20%) In five years, 28% from the professional services industry continue to see China as the top destination for investments (20% for consumer and 15% for industrial) In five years, 50% from the professional services industry feel that China will be one of the top three destinations for investments compared with 38% for consumer and 54% for industrial The top three most significant obstacles for professional services firms in China are: Discretionary enforcement of broadly drafted laws and regulations (35%), Registration processes for companies / products (33%) and IPR protection (31%)

30 Findings for SMEs (<250 employees in China) No. of SMEs = The majority of the 2010 survey respondents are SMEs: 63% this year compared with 60% in % of SMEs have been operating in China for less than 10 years 55% generated less than 10 million Euros in revenue and only 4% generated more than 50 million Euros from their China operations in % of SMEs had a positive net profit margin in 2009 compared with 50% of larger companies 50% of SMEs had less than 25% foreign staff in their top management functions in China compared with around one-third of large companies 83% of SMEs do not have an R&D centre and are not planning on opening one Only 5% of SMEs reported direct benefit from stimulus policies and an additional 22% reported indirect benefit through customer demands Around one-third of SMEs feel that government policies have increasingly discriminated against/less fair in some capacity towards FIEs over the past two years. Over the next two years, they anticipate government policies to increasingly discriminate/become less fair 84% of SMEs prioritise increasing revenue over reducing costs 31% of SMEs reported net profits from their China operations to be better than their worldwide figures in % of SMEs reported that the current number of permanent positions increased relative to the total number of employees in China last year. 50% expect the number of permanent positions to increase over the next 2 years, relative to the current number of employees. Only 15% of SMEs are planning to suspend new investments or reduce/slow existing investments in Mainland China due to recent and expected government regulations 56% of SMEs indicated that the economic downturn in their domestic market was a significant factor affecting net profits in 2009 (56%) Companies with negative net profit margins in 2009 are predominantly SMEs (87%) One-third of SMEs are optimistic about profitability in their business sector over the next two years compared with 21% of larger companies In partnership with