A structural view of MNCs’ operation in China

1. A structural view of MNCs’operation in China Simon. F. Huang Dept. of Project Approval Shanghai Foreign Investment Commission

2. Content • Three stages of Foreign Investment • Present “One Face ” in stage two • How to present “One Face” • Conclusions

3. Three stages of Foreign Investment • Entry establish a presence, begin to build a brand, and learn about the operating environment • Country Development involving more than one operating division, establishing brands, developing markets and following a geographic expansion strategy. coordination problems with the home office begin to occur • Global Integration becomes a “normal” location with particular resources, rather than a place that requires a specialized country effort

4. Each stage and its corresponding structure • Entry: business divisions dominate • Country Development: regional headquarter dominates • Global Integration: business divisions dominate again

5. Why structural change is desperately called for? • Most MNCs’ investment in China has moved into Stage Two • Coordination of different business units calls for a more sophisticated and centralized structure • Most global corporations currently downplay country management, putting more power in the hands of business units and product line managers

6. Shift to One face Structure • Business unit autonomy does not work well there because the Chinese government views corporations as single entities and largely treats them as such • Instead, it pays to show “one face to China”- that is, to establish a corporate identity that highlights the compatibility between the company’s goals and the country’s goal --- Quote from “the great transition” , Harvard Business Review, October, 2003 Kenneth Lieberthal and Geoffrey Lieberthal

7. How to present “One Face”? Viable legal vehicles for one face structure • China Holding Company (CHC)/ Regional Headquarter • Company Limited by Shares (CLS) • Foreign-invested Commercial Enterprise (FICE)

8. What is a holding company? Holding company, or umbrella company, is defined by Ministry of Commerce as a foreign-invested company that specializes in investment and management of investing companies exclusively.

9. CHC structure CHC WOFE/JV WOFE/JV WOFE/JV Branch Branch Branch Branch Branch

10. Requirements to set up holding companies • Parent companies total asset over 400 million USD, and have at least 10 million USD paid-in register capital in China • Or, Parent companies have at least ten invested companies in China and have at least 30 million register capital been paid in • Minimum register capital for holding company is 30 million USD • If register capital of holding company exceeds 100 million USD, the holding company will be granted RHQ status by MOC and will be granted an expanded business scope

11. Advantages of Holding companies • Held shares in subsidiary FIEs • Consolidate procurement and sales function • Provide centralized services such as HR, finance • Leverage financing ability • Cash pooling • Image building and commitment to Chinese market。 • Incentive from Local government

12. Drawbacks of Holding companies • High fresh capital requirement • Liabilities to undertake investment projects in due time • High income tax rate and lack of tax holiday • Business tax in shared service • Adding another layer in the current structure and may induce more management cost • Cash trap

13. Holding companies in China Among 273 holding companies Shanghai 105 Beijing 118 Guangdong 20 Tianjing 5 Fujian 6 Jiangsu 5 Zhejiang 3 Other provinces 6 As of Dec. 2004

14. 25 19 19 12 12 10 9 7 6 6 5 96 97 98 99 00 01 02 03 04 05 before 95 Holding companies in Shanghai Shanghai hosts 130 holding companies, more than any other cities. 13 holding companies relocated in Shanghai, among them are: BASF, Bayer, Philips, Robert Bosch, Ford, Baxter

15. What is a company limited by share (CLS) A foreign-invested company limited by share (CLS), refers to a business legal entity whose capital is made up of equal value shares contributed by both domestic and foreign shareholders, with total value of the shares purchased and held by the foreign shareholders exceeding 25% of the company’s total registered capital .

16. Methods set up a CLS • Promotional methods Transition Model New Co. Model • Share Float methods

17. Requirements to set up a CLS • Minimum registered capital (or the minimum share value at the inception of the CLS) RMB 30 million • At least 2 promoters (shareholders), more than half of them should be companies register in China • The foreign shareholders should hold at least 25%share • If the CLS is to be established in Transition Model, the existing FIE to be converted to a CLS should have been profitable for the previous three years consecutively • If the CLS is to be established in Share Float Method, at least one promoter should have been profitable for three consecutive years

18. Branch Branch Branch Branch Branch Use CLS structure for corporate restructuring CLS Note: Branches are transformed from previous independent legal entities

19. Advantages of use CLS for restructuring • Have a broad business scope to manufacture different types of products • Provide comprehensive services, including channel cash and balance the financial needs among branch operations • Enjoy low income tax rate and tax holiday • Enjoy tax savings by utilizing the tax losses of loss-making branches to offset the profits of profit-making branches • Have an indefinite life term and eligible for public listing

20. Drawbacks of use CLS for restructuring • Potential conflict with local Chinese promoters (shareholders) in the future • A painful negotiation process with partners and governments corporate income tax • Hidden cost bar code, tax-free equipments

21. Example: Unilever • Set up in 1999, First CLS for restructuring in China • Four FIEs merged into one CLS, Unilever owned 77% shares and Shanghai Light Industry Holding owned 23% shares • Change back into a Unilever wholly-owned limited company in 2002 after Unilever bought Chinese partner’s shares

22. Example: Alcatel • Set up in 2002 by transforming Shanghai Bell into a CLS • Alcatel owns 50%+1 shares, two Chinese partners owns 50% - 1 shares • Alcatel signed MOU with Ministry of Information Industry, put most of its Chinese and regional business into the new CLS

23. Example: Henkel • Set up in 2004 by transforming one Henkel-invested company into CLS • Henkel owns 86.29%, Henkel CHC owns 11.2%, a local company owns 2.33% and two trust companies own 0.09% each • Then use the new CLS to absorb the other four Henkel-invested companies as its branch companies

24. What is a FICE? A foreign-invested commercial enterprise (FICE) refers to a foreign-invested enterprise engaged in any of the following four business activities • Commission agency • Wholesale • Retail • Franchising FICEs are granted both import and export right and domestic distribution right, subject to the restrictions on certain goods such as medicine, agriculture chemicals

25. Requirements to set up a FICE • Minimum capital applied to new PRC Company Law, which is 30,000 RMB • Register capital should be in line with the business scope and volume

26. Advantages of FICE • Consolidate procurement and sales function • Establish own distribution network • Improve logistics efficiency • Exercise better credit control

27. Drawbacks of FICE • High income tax rate 33% compared to 15% of manufacturing companies • No tax holiday

28. FICE structure-operational center Local suppliers Overseas suppliers FICE Sister manufacturing companies Overseas customers Local customers

29. Overseas Parent company Vendor Vendor Vendor Flow of order Flow of payment Flow of finished goods FICE structure-operational center FICE Overseas customers Overseas customers Overseas customers

30. The milestones of FICE • From Jun.1 to Dec.31, 2004, 22 FICEs were approved, most of them were under CEPA • In 2005, 431 FICEs were approved, among which 92 are pure retail companies, 339 are wholesale companies or wholesale retail mixed companies • More than 110 non-commercial FIEs were approved to expand business scope to include distribution, including 24 Waigaoqiao bonded-zone trading companies which were converted into FICEs • From Mar.1, Shanghai Foreign Investment Commission has approved 50 new FICEs.

31. Challenges and our value • Structure is important to performance • Different stage, different structure • Current challenge: to find out a viable structure to consolidate Chinese operation • Our value: working with professionals to advise investors our practical and first-hand experience