Can the West breach China's great walls?

It's all too easy to come a cropper in a culture that operates by very different rules. Mark Leftly reports

In China, big business is rarely independent of the government. So many Chinese state officials move into prominent private-sector positions that there is even a phrase for it: xia hai, roughly translated as "descending into the open sea".

For foreigners, those waters are choppy. Last week, internet giant Google shut down its main search engine in China, angered by censorship, while the state corruption case against four employees at FTSE 100 miner Rio Tinto drew to a close. In recent years there have also been high-profile difficulties with such diverse Western companies as eBay, Levi Strauss and Time Warner (see box).

Clearly there are huge obstacles to cracking the Chinese market, but it is becoming increasingly important that Western companies succeed there, as it has overtaken the US as the world's biggest consumer.

The UK has been particularly keen to establish operations, with the China-Britain Business Council (CBBC) last year receiving 6,900 inquiries from industry about the country. "I contend that it is difficult to set up in China," argues Stephen Phillips, the CBBC chief executive, before admitting: "But there are a number of high profile instances of problems and it is no doubt a challenging market."

Phillips points to the cultural differences between big European and US businesses and Chinese corporates, pointing out that government influence at national, municipal and local level is "a part of their DNA".

Certainly Rio's advisers have found this to be true, even away from the criminal lawsuit that accused Australian Stern Hu of accepting $900,000 in bribes as he negotiated the company's iron ore price with Chinese steel mills.

Last year, state miner Chinalco planned to invest $19.5bn in Rio, but was rebuffed in favour of a joint venture with London and Melbourne-based BHP Billiton. The Chinalco deal collapsed as the capital was no longer necessary, because commodities prices recovered from their recent dips.

An investment banker involved in the Chinalco proposal says that a deal would have gone through in the West, but the Chinese simply took too long. The source explains. "Decision-making is very much consensus driven, and this got stuck at a junior level. Lots of deals in the UK happen because two people get in a room together and sort it out, and that never happens in China."

Also, with so many officials in China involved – it is joked that the state is the public-sector wing of Chinalco – the proposals became too ambitious, scaring off Rio's investors. Those shareholders told Rio chief executive Tom Albanese to throw in his lot with BHP.

There have been successes. Tesco expects to open 19 hypermarkets in its current financial year. Growth in China helped boost sales across Asia to nearly £4.4bn in the six months to 29 August 2009, up 38 per cent on the same period the previous year.

The key is the type of businesses that succeed in China. Shaun Breslin, an international relations professor at Warwick University who specialises in Chinese politics, suggests protectionism is still rife. "It's very straightforward," he says. "If you go to China and produce goods that are exported overseas and bring in foreign currency, that's fine; if you go into sectors where China hasn't got existing business, that's fine; if you go over to compete, then that's a different kettle of fish."

For example, there was no real DIY market, so B&Q-owner Kingfisher was always going to be welcomed, and today has 43 stores across China. In contrast, China was not willing to change its practices to bow to the whims of Google, which earns between $250m and $500m in the country. China Unicom, the mobile operator, announced last week that it would remove the search engine from its latest handsets.

Breslin adds that there is an internal wrangle in which Western firms are getting entangled. Central authorities had slowly decentralised authorities so that municipalities had more control over the needs of domestic economies. But this has led to a situation that sees provinces duplicate each other's products, and the local government will protect its companies.

"If you build cars in Shanghai, then you're going to find it difficult to sell elsewhere in China as each province will have its own car producer," says Breslin. "Central government is trying to reassert itself as the regulator of the Chinese economy over and above local authorities."

One way central government has regained power is through the credit markets. Last year it announced 9.6 trillion yuan of bank loans, meaning it could finance struggling industries that state officials believed were integral to the development of the economy. This new form of central planning means that any Western groups that look to introduce unwanted competition will inevitably struggle.

Andrew Halper, head of the London-based China practice at lawyer CMS Cameron McKenna, agrees that the devolved nature of such a vast country creates problems, as no two provincial sets of rules can possibly be the same. And bribery is more prevalent in some areas than others.

"Corruption is endemic and affects not just locals but foreigners as well," he explains. "If a foreigner steps on the slippery slope he can find it difficult to grab a handhold."

Many Western firms hire or second executives of Chinese descent to lead operations in the country. Halper believes this is an error as these bosses have a perception, because of their heritage, of how the market works without accepting that they are still a foreigner. Hence, they might indulge in corruption as they believe that it is simply typical of Chinese deal-making. However, they would not have the same support mechanisms, such as a knowledge of the legal system, as indigenous Chinese.

Halper tells his clients that it is far better for them to support the municipality by helping fund PR-friendly public-works contracts, such as sports facilities, schools or clinics. "You make locals look good without engaging in corruption," he says.

Sound advice for working in an economy that Western companies simply struggle to comprehend.

Asian adventures

Time Warner was forced to withdraw from the lucrative Chinese TV market back in March 2003 after the channel it backed, CETV, captured a disappointing 2 per cent of viewers in the southern city of Guangzhou. Time sold its 64 per cent stake in the channel to the Tom Group, controlled by Asia's richest man, Li Ka-shing.

Levi Strauss, the jeans maker, withdrew from the Chinese market in 1993 over concerns about sweatshop labour and human rights abuses, only to announce it wanted to resume sales and manufacturing five years later. Today, the Levi brand is ubiquitous in prosperous, urban China – seen on TV, taxis and in shopping centres.

eBay, the auction website, like Google's main rival, Yahoo, chose to step back from the Chinese market when it folded its operations into those of a local company, Tom Online, back in 2006. Analysts pointed to pressure from Chinese authorities on Western companies to set up joint ventures, and stiff competition from Alibaba.com, known as "China's eBay".

Greg Walton