Thu - November 25, 2004

A Subsidy by Any Other Name


In the Silicon Hutong, looking out at First Ring Road

The highly articulate Jason Dean published an interesting article in the Wall Street Journal today describing the plan of the Chinese government to open a venture capital fund designed to "invest" in the local semiconductor industry. Initially the fund will have US$121 million at its disposal.

This would be a very interesting and possibly even positive development, if the fund were intended to give new firms with compelling technologies the seed capital to bring their tech to market. That is, after all, what venture capital funds do with their money.

Unfortunately, that's apparently not what's intended. Reading between the lines (Jason is the master of innuendo), the money will instead be used to offset the 17% subsidy the local firms will no longer be getting from the government under WTO rules.

While it's unclear whether $121 million (if that's how much it turns out to be) will actually offset the subsidy loss, the way it looks like the funds are going to be distributed is just a subsidy by another name.

Without getting into whether the government even belongs in the VC business (it reeks of an industrial policy), one would hope the WTO keeps a close eye on this, and indeed that once the program is announced there will be appropriate measures taken to ensure that a) the process of allocation is transparent, b) the process of allocation is in keeping with the behavior of a venture capitalist, not a government hand-out, and c) if it even begins to smell like a subsidy, that the WTO cries foul.

That said, waht is really sad about all of this is that there is a screaming need in China's semiconductor industry for real venture capitalists, because there are some incredibly bright engineers out there with very good ideas that need some cash and some hand-holding to turn their ideas into businesses.

The government would be better off creating the fund and putting it in the hands of some very smart, proven venture capitalists. The VCs, with their management expertise and their ability to choose companies with a fighting chance, could really help China's domestic tech sector a hand up, rather than another worthless handout.

Posted at 06:52 PM    

Sun - October 10, 2004

The Coming China AgTech Boom



The Silicon Hutong Suite, Intercontinental Hotel, Singapore

Whenever someone gets enough of an adult beverage into my system and starts talking about the fundamental challenges China faces, he discussion eventually turns to the plight of China's peasantry. All of the development in industry and services will be for naught unless some way can be found to bring prosperity to the 900-million or so peasant farmers that make up China's rural population.

That millions - perhaps hundreds of millions - of those farmers will migrate to China's cities is considered a given among "informed observers" of Chinese population trends - people like the Asian Development Bank, the World Bank, and similar government-organized super-national organizations (GOSNOs for short). The question that nobody can seem to agree on is how many of those farmers will be surplus to needs in Chinese agriculture (and thus will need to be absorbed in the urban workforce), and how quickly they will make that shift from rural subsistence farmer to urban migrant worker.

This question is no trifling matter. Setting aside completely the peasantry, there is a huge mass of urban industrial workers in state-owned enterprises that need to be shifted out of the inefficient state sector and into more efficient, globally competitive companies. Once they've made that shift, an entire system to provide for their social welfare has to be created, because the government and the SOE's have been carrying that up until now. Nobody expects this change to be fast - it will take years.

NOW, add onto this the challenge of absorbing a rural population in cities already crowded with unemployed or underemployed workers.

It's daunting. The clear answer is to drive rural prosperity. Quickly. Keep em down on the farm.

My soapbox, now as before, has always been to create an agricultural economy that is high value-added, labor-intensive, and resource (i.e, land, water, capital) efficient. Provide those high-value crops to the increasingly prosperous urban population in China, and leverage government investments in infrastructure and the growing foreign role in transportation and logistics to create a global export market for those crops.

Now it looks like China is starting to figure it out. In a recent article in the Far Eastern Economic Review, Andrew Browne and Lai Yang have demonstrated that despite policymakers preferences for agricultural self-sufficiency, local workarounds on land use and China's entry into the WTO is allowing local farmers to tap the demand for cash crops, and move up into the nations' middle class. They give stunning numbers. China now produces half of the world's vegetables and melons. China produces four times as many apples as the U.S., and the quality is improving rapidly.

And American producers of apples, broccoli, and similar crops are hurting...while producers of maize, wheat, soybeans, sugar, and cotton will likely celebrate. There's good reason for that: the U.S., with around 5-10% of its population engaged in agriculture, has consolidated farms and it excels at the mass production of grain, beef, and oilseeds. But even with migrant farm labor, American fruit is premium priced in Asia.

In the end, China's policymakers will undoubtedly see the wisdom of horticulture and comparative advantage over seed security. But that brings up another problem.

The steps being taken by the farmers that Andrew and Lai Yang talk about are basic and their scale is comparatively small. What happens when cash-crop combines like the Longda group mentioned in their article become the official model for Chinese farming? Demand grows for key inputs, and you face shortages in water, land, transportation, refrigeration, etc.

Some of the issues:

• Water is in critically short supply in China. Even the most optimistic estimates (government statistics) place China's per capita water reserves at the minimum level required for a healthy economy. Given that reserves are likely much below those numbers, water is clearly a critical limiting factor facing China's agricultural modernization.
• Farms are some of the worst creators of water pollution in China. Current farming practices must be changed if this is to stop.
• While logistics are making progress, the situation in China is still horrible. There is no supply chain less tolerant of mistakes than a cash-crop supply chain, and the country is just not there yet. Coastal provinces are addressing these problems, but until cash crops can be brought from the interior as well, the radical inequalities between the west and the east in China - a festering sore point with the non-coastal populace - will grow, defeating much of the purpose of agricultural modernization.
• The supply of land available for agriculture shrinking. Cities are growing to accommodate the influx of displaced rural peasants. City dwellers are demanding a growing amount of space per capita. Suburbs are sprouting. Everywhere you turn in China demand for land for non-agricultural use is growing so quickly that the government has to inflict draconian measures to stop it.

In short, the move to cash crops is a great trend. But the leap to making it sustainable is going to require significant changes to the way crops are grown in China, including:

<> Techniques for raising crops with a minimum of water need to be adopted, adapted, and developed further. First, crop selection needs to begin emphasizing varieties that can be grown (or are best grown) in arid conditions. Some fascinating work in this area is being done in India at ICRISAT, but China absolutely must add arid and semi-arid crop research to its significant studies in reforestation. Indeed, a powerful case could be made that the focus of reforestation in China should be on sustainable cash crops for semi-arid environmens. There are significant opportunities here for businesses in consulting, equipment, fertilizers, etc.

<> Second, techniques like aeroponics need to be developed further to allow their commercial utilization before it becomes economically essential to do so. More research, but a clear need for the world's leading developers of this technology to be here and be involved.

<> Wastewater processing for agricultural will eventually become a necessity. Yes, it's ugly, and as a longtime China resident I have a hard time dealing with the possibility that my fruit is being watered by something unmentionable, or indeed downright dangerous. But the realities are that China, like India and many other nations in the world, will have to turn to the use of wastewater in crops for part of the agricultural requirements. China could start by endorsing the Hyderabad Declaration on Wastewater Use in Agriculture and turning to reputable international firms to help. The problem here, of course, is that China has just destroyed any near-term opportunities in this area by publicly infuriating a major foreign investor in wastewater treatment and disallowing a 15% annual rate of return on a treatment project. With all respect to the Chinese government, it is unlikely that any facility solely operated by - or controlled by - a local utility will reliably deliver processed wastewater of the kind of quality that agriculture would demand. China needs foreign firms, their technology and their management in this field like nowhere else.

<> Logistics needs to be addressed in two ways. First, clearly there needs to be government-private partnership, including foreign firms, in the creation of an effective system for moving fresh fruits, vegatables, and the like from anywhere in China to anywhere on the planet in time to have them arrive fresh at supermarkets worldwide. That's a huge task and will require a lifetime of effort to accomplish.

Second, as in interim measure, processing infrastructure needs to be moved close to the point of harvest in order to be able to process the crops sufficiently to withstand (in some usable form) transportation to distant markets.

<> Postharvest physiology is another part of the solution, developing ways in the modification of plant breeds to help the crops maintain quality and prevent spoilage.

A premature focus on a potential solution that ignores the obstacles can create much larger problems than it solves in the context of a place like China. Anticipating the challenges - and addressing them - is a process that not only makes the solution viable, it also determines what areas China needs to focus on in developing technology.

Spending the national treasure on duplicating technologies that already exist is at worst an unconscionable waste, and at best an unsure bet on future returns simply for the sake of keeping the money onshore. Import substitution as a policy, however, has been out of favor for decades, particularly among countries with significant advantages to leverage.

Spending the national treasure, on the other hand, in green-field (no pun intended) areas of research and development that can propel the country beyond its greatest challenge is, on the other hand, a wise choice. And if it means that a few foreign companies need to make a healthy profit to get China there a few years sooner, where is the harm?

Posted at 09:32 PM    

Tue - September 28, 2004

Would you buy a used stock from this man?



Craig Karmin's Wall Street Journal piece about Barclays PLC's new China exchange traded fund is right on the money, if you will - without question Barclays just made buying a basked of Chinese stocks a lot easier. The question is, why would you want to? And why would you want to use this device?

Okay, first, the ETF is a misnomer - it's not a fund. It's an exchange traded security, just like a stock. But instead of the underlying value of that security being a share in a business - the value of which doesn't change radically on a day to day basis - the underlying value is the value being the underlying value of a company, the basis is a basket of stocks. This by itself is, to someone who has rejected as so much oat bran the Efficient Markets Theories, is pretty scary.

What is worse, the underlying stocks are shares traded in Shanghai and in Hong Kong. To the extent that these are Shanghai shares, one's queasiness at least extends no further. But shares in Shanghai? Shares that are traded and that are priced on an ongoing basis based on technical criteria or superstition? Shares for whom the opacity of their underlying companies is so great that it is impossible to get a bead on value?

Wiser people than I have unfavorably compared China's bourses to casinos with 45 million gamblers. Amen. If you want a piece of a Casino, try Harrahs, or MGM Mirage, or even Wynn Resorts. At least you know you're on the winning side of the gamble.

Posted at 07:23 PM    

Wed - July 14, 2004

Beyond Intellectual Property: The Counterfeit Dilemna


Covering a major issue, The Washington Post once again only manages to cover a single dimension.

In a story written by special correspondent Wang Ting in Shanghai, the Washington Post noted today that the Chinese public has a growing taste for brand-name luxury items, but that many of China's consumers - even relatively prosperous ones - were choosing fakes over the real thing.

Counterfeiting is a severe problem in China, and while fake Dior, Cartier, and LV make really good press, an equally and arguably more serious problem lies in the faking of fast-moving consumer goods. A fake Cartier watch making it to New York may deprive maison Cartier of a sale (and it might not, since anyone in New York who could afford the real thing would probably buy it), a fake watch probably never killed anyone. But counterfeit edibles certainly could, as has happened in the case of one international beer manufacturer and reportedly in other cases as well. Worse, some firms are even starting to knock-off complete cars. For the technology industry, the problem is at least a $10 billion a year issue just in the case of electronics, and China is perceived as the key.

A far better piece on the problem - and one that, quite politically incorrectly does not leave the unspoken impression that China is the center for all such evil - was written up in The Economist last year, and you get a broader perspective on the issue in China from Ed Young's outstanding feature on Brandchannel from a few years back.

The standard approach to these issues has been to hire investigators and attorneys, and in many cases they can be quite effective. Probably one of the best counterfeit investigators in China, Peter Humphrey, did a presentation (pdf here) not to long ago to the Swiss Chamber of Commerce in Beijing that gave a good explanation of the micro-issues surrounding counterfeiting.

But counterfeiting is not a simple problem to solve, and indeed part of the challenge for the wide range of institutions, companies, and individuals seeking to fight it is that counterfeiting is actually several problems.

First, counterfeiting is to some extent a legal problem. China's laws on protecting intellectual property rights have long lagged the rest of the world. But in recent years, and in particular in the wake of China's accession to the WTO, legislators and policymakers have stepped up to the plate and an international-standard legal framework is emerging with fairly respectable rapidity.

This leads us to the second problem, which is enforcement. Enforcing intellectual property rights requires well trained investigators, good intelligence, solid security, sharp tactics, and a legal bench prepared to do more than slap the wrists of offenders. This requires a highly professional law enforcement community (China is getting there, but it will be a long haul, especially in the provinces), and one that is divorced from the self-interests of local government. You see, the funny thing about counterfeiters is that through employment, use of services, taxes, and outright payoffs, these enterprises actually do much to support economies in areas that have not yet enjoyed the full benefits of development. Shutting down a counterfeiters factory is a pretty straightforward process. Replacing the jobs, the income, and the local political stability that factory brought is far more tasking. It is this prospect as much as anything else that hobbles enforcement.

In recent years Beijing has turned to its domestic paramilitary police arm, the People's Armed Police, or the Wujing, (founded in 1990 to ensure that protests are never again handled by an inappropriately trained and armed force) to engage in enforcement. But this carries with it an implicit danger by compelling local groups (counterfeiters, government, police, and, God forbid, the general populace) to band together in defiance of a team from Beijing. Apart from the tactical damage that such defiance brings (lets the bad guys get away), it also foments about a situation when a local government is facing down Beijing. In the context of the center-periphery strains implicit in Chinese politics, that is an extremely dangerous scenario. All of the above combine to make tactical enforcement highly problematic. The issues surrounding judicial performance in this area could be (and might be) the subject of another feature, but suffice to say that the best tactical execution of a counterfeit bust can all be for naught when an adjudicator sees matters in a different way.

The third problem is internal. Many companies (as Peter Humphreys alludes to in his presentation) find that the primary source of counterfeiting is coming from a cabal operating within its own ranks. Peter likes to explain how one fast-moving consumer goods company discovered a group of employees that was over-ordering packaging, sending it on to factories that were making fake product, and fulfilling orders from the counterfeit factory - orders that never showed up on the FMCG company's books and that ensured that counterfeit product in legitimate packaging went to the legitimate outlet.

Another challenge comes from the factory. A wholly-owned or contract factory for a luxury handbag manufacturer takes an order from Milan (or an ASICs order from Tokyo) for, say, 10,000 pieces. The manufacturer makes 10,500 to prepare for production or quality problems. Inspectors clear 10,000 pieces in the shipment. To recoup the cost of the extra product, the factory manager dumps 500 pieces (including the quality problems) onto the domestic black market. Result? The real thing, but companies loose money. The infusion of "off the back of the truck" merchandise like this continues to grow, but it is not a problem that is being tracked.

Finally is the matter of the consumer. Most consumers don't understand the difference - indeed the value - of buying the real thing over the fakes. As important as it is to have an external environment and internal systems that discourage counterfeiting, in the long run consumer education will be the critical tipping point. If a company can make a better bag than a counterfeiter, that value needs to be made clear, as does the critical social statement someone makes by buying from a legitimate businessperson rather than a supply-chain owned and managed by organized crime. Certainly the idea of handing a growing amount of power and control to criminals in China would give anyone here pause if the prospect of the nation evolving into a Russian-style kleptocracy were made clear.

Posted at 01:10 PM    

Thu - July 8, 2004

Protectile Dysfunction



The coming showdown over the State Intellectual Property Office's decision to void Pfizer's Viagra patent will likely be long and ugly. If the past is any guide, the heavy media focus on the IPR protection problems around Viagra will lead many to conclude that the IPR issue is the primary cause of Viagra's commercial failure in China.

The full blame cannot be laid on China's failure to protect Pfizer's intellectual property. Distribution issues caused by the government's determination that Viagra is a controlled substance certainly were a contributing factor.

But if one were to dig deep enough into the Wall Street Journal story covering the government's decision, one would find that Pfizer itself suggests the problem was caused by inadequate information filed with the original patent application. While the information was not required by the government at the time, the government is apparently requiring the data retroactively. Pfizer has 3 months to file an appeal along with the data. Given the saber-rattling going on today, smart money in Beijing has SIPO granting the patent again once the information is filed.

One also discovers that Pfizer never tried to patent the compound. There could have been a range of reasons for this.

Finally, the story notes that a coalition of Chinese pharmaceutical companies are the proximate cause for the voiding.

This entire case makes a few important points:

1. Chinese intellectual property law continues to evolve. Even if you have patents, copyrights, and trademarks in China, you are likely to have to keep watching the law, because today's protection is tomorrow's loophole.

2. Don't count on intellectual property protection to create a market position for you in China. Market position needs to be built the old-fashioned way - branding, distribution, positioning.

3. The locals are a powerful force if allied against you. Don't let those alliances grow by being aloof - find strong local partners (either in manufacturing, the channel, or among key advocates) and make them your shield against this kind of ambush.

Posted at 10:44 PM    

Why Government Relations in China is Not About Lobbying...Or Guanxi


The second step requires that at least those officials with a direct interest in the company's business are assessed for their specific opinions and stances on a variety of issues from the role of foreign companies in the PRC economy/specific sectors to their take on a specific project - all without mentioning names and all without inadvertently affecting the process in a Heisenberg-style nightmare.

One day not too long ago I was in Singapore addressing a large room full of local executives all eager to hear about what was in store for China in the coming year. After I had stepped down from the dais, an executive from a major Japanese electronics multinational buttonholed me to ask me about hiring a lobbyist who will address their government relations in China. I demurred, but he really pressed me - I need a good lobbyist, he said. Who should I hire? Unfortunately, while I have no lack of names of individuals who could lobby on his behalf, all of whom have wonderful ties to the government, I had to send the gentleman away disappointed.

One reason I had to demur was that he was unwilling to give me enough of an idea of what the problem was to even allow me to suggest the right person to reach out to. Which indicated another problem - somehow he had convinced himself that all he needed was a really good fixer. And, coming from a very, very large company who should know much better, this was more than a tad disturbing.

This Ain't Washington

American companies have long understood the importance of hiring a lobbyist in Washington in an effort to inform (or, less charitably, to influence) the legislative process in their own favor. European, Japanese, and Korean firms learned quickly about how this process could show genuine results, and indeed to take the greatest possible advantage of the situation (see Agents of Influence, Pat Choate's alarmist but indeed fact-based polemic about the influence of Japanese lobbyists in the US.)

It is natural, therefore, for American, European and Japanese firms to consider their policy, regulatory, administrative, and political issues in China and to wonder whether or not they need to hire a lobbyist -- or, to cut to the chase, a well-connected political fixer. Without doubt, all are encouraged by a growing number of individuals and firms who suggest (if not promise outright) that they have sufficient leverage or guanxi in the PRC government to help mitigate these issues.

A vast range of players exist in this market who will promise to solve all of a company's problems for a payment. Former PRC government officials, family members of government officials and senior academics on the Chinese side, former U.S. Presidents, Cabinet Members, Senators, Congressmen, former U.S. ambassadors to China and a similar number of former officials of other governments on the other make for a formidable array of consultants, not to mention U.S. lobbying firms who ply a somewhat different version of their trade in China.

In many cases, these individuals and firms offer genuine assistance, usually because of the specific and limited scope of their mandate. When the issue is about using association with a distinguished person to raise a company's profile in Zhongnanhai or to get a meeting with one of China's top leaders for a chief executive, few can deliver on such a requirement as well as a Henry Kissenger, a George H.W. Bush, a Lee Sands, or indeed a James Sasser.

And many former officials of the PRC government - retired, downsized, or entrepreneurial - make a good living arranging for meetings with working level officials ranging from a department head to a full minister, and occasionally even higher.

Each of these can occasionally deliver a message, and even provide some insights or advice on one or several government entities.

But such efforts alone are by nature incomplete at best and, at worst, can be counterproductive, particularly if pursued before a company understands the full range of issues it faces in the Chinese government. The common perception that the Chinese government is a monolith leaves executives, directors, and shareholders with a critical blind side. What is worse for U.S. firms, the Damoclean threat of the Foreign Corrupt Practices Act hangs above any efforts in China -- with most intermediaries, you can never be entirely certain that the influence is not being in some way purchased on your behalf.

The far less publicized truth is that there are a range of interests operating inside the Chinese government, and indeed different viewpoints and factions contend for power inside ministries, departments, and administrations that form the real rocks and shoals of business in China. To venture forth without as complete a chart as possible invites disaster.

Rather than depend on some unqualified "guanxi", a mapping exercise is in order as a first step. A company (and in some cases, divisions and even products and services) needs to spell out its goals in China, and go methodically through the Chinese government and list the entities and individuals who by their position would have a direct or an indirect influence on the interests of a company in China. As a second step, individuals and entities who have a personal (rather than a professional ) interest in one's company, business, or industry need to be assessed both individually and, once the motivations that like them are understood, collectively as well.

The second step requires that at least those officials with a direct interest in the company's business are assessed for their specific opinions and stances on a variety of issues from the role of foreign companies in the PRC economy/specific sectors to their take on a specific project - all without mentioning names and all without inadvertently affecting the process in a Heisenberg-style nightmare.

Once these assessments have been made, it becomes clear that a company's interests are not just affected by a small group of government officials or ministries, but that in most cases there are a broad range of entities and individuals who might take a piece of a company or, equally important, see some part of a policy decision that affect the company as falling under their jurisdiction. This is the point at which the company uses its map to navigate those shoals, and to select the appropriate device to win friends and influence China's governmental processes. In short, this exercise needs to be undertaken before hiring a former president or ambassador, or an influence peddler in China.

Regardless of the company or industry, it is a truism that government relations reaches beyond mere lobbying or guanxi. It presumes a complete understanding of the regulatory, policy, and administrative environment, and the appropriate, coordinated use of internal and external resources. While not as simple as hiring a name or a face, it is the only real way to guarantee continued success in navigating the trecherous waters of Chinese business.

Posted at 05:39 PM    

Tue - July 6, 2004

SMS Law: FUD by Another Name



To its credit, the Wall Street Journal has refused to succumb to the mass hysteria generated by reports that the Chinese government will be mining SMS messages for counterrevolutionary content. The consensus among thinkers is that first, such a mass monitoring is not practical. This suggests that either a) the monitoring will be selectively applied to those the government already suspects of subversive activity; or b) the entire announcement is a propaganda move to try to get said suspects to stop using SMSs because the government knows it cannot monitor them. Either way, the government wins because SMS is no longer considered a safe means of sub-rosa communications. Sometimes, the FUD is better than the reality.

Posted at 09:59 PM    

Thu - March 4, 2004

Waiting for the Telecoms Law: Godot Will Get Here First


Still waiting for the China Telecommunications Law? Waiting Is.


Posted at 11:36 AM    

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