Methods of entering the Chinese market

January 2018

Topics

1. Different methods of entering China

2. Due diligence

3. Distribution Agreements

4. Agency

5. Representative office

6. Establishing a presence in China

7. Online

2

Entering the Chinese market

Key methods of entering China

• You know you want Chinese consumers buying your

products, but what is the best method of selling your

product?

• No one correct answer

• Relevant factors:

• Cost

• Level of control

• Regulatory restriction

• Local knowledge

• Skill set

• Networks

4

Options include

• Sales to a distributor

• Sales via an agent

• Sell through a presence in China

• Direct to customers online

Comparison of methods

Distributor Agent In country Direct online

sale

Management

control

Low Medium High High

IP control Medium Low Medium Low

Cost of sales Medium Low High Medium/low

Inventory risk Low Medium High Medium/low

Regulatory

risk

Low Low Medium Low

Due diligence

Due diligence

• Proper due diligence could not be more crucial

• Areas of due diligence

• Commercial

• Financial

• Legal

• Sub-distributors/sub-agents

8

Commercial due diligence

• Experience with other similar companies/products

• References from its other suppliers

• Strategy to develop the product in China

• Evidence of distribution networks

• How well do they understand the market for your product

• Knowledge of local business customs and environment

• After sales service

• Banker’s reference

• Australian China Business Council/Chambers of Commerce

Financial due diligence

• Distributor - Unless supplying on credit the direct financial

risks are low

• However – you want a distributor who has the resources to

carry out their distribution strategy

• Financial stability leads to a more stable workforce – crucial

• Facilities for storing goods

• Third party review of financial records

Legal due diligence

• Ability to sell your goods

• Knowledge of Chinese marketing laws

• Anti-corruption policies

• Right to use key assets (such as warehouses)

• Legal proceedings

• Right to import

• Compliance with employment laws

Due diligence – Key message

• Face to face meetings are crucial

• It will also help build the relationship

• Due diligence is ongoing

Distributors

The distributor relationship

14

• Your distributor will be one of the biggest factors

contributing to the success or failure of your product in

China

• It will be a long term relationship and can be hard to undo if

the relationship does not work

• The relationship will only work if you are both successful

• Without a good distribution network you are invisible

Negotiations

• Confidentiality agreement?

• Fully disclose your expectations – volumes/marketing

• Cultural and language barriers may mean that negotiations

are more protracted

• Chinese negotiating team may be large

• Deferring a contentious point may just mean approval from

a superior is required

• You should try to control document preparation

• An MOU can be binding

Distribution Agreement - General

• Have in both English and Chinese

• Government bodies will read the Chinese version only

• Chinese are used to short contracts

• Contracts are enforceable

• Notions of fairness are important

Specific issues

• What are you granting:

• Any existing customers you would like to keep

• Is the grant exclusive

• Length of the grant – depends on experience and strategy

• Renewal – who has the right, what criteria must be met

• What is the territory:

• How is it defined

• Can the distributor service the territory

• Which products are covered

• How are new products added

Distributor responsibilities

• Right to import and sell the product

• Compliance of the goods with Chinese laws – labelling,

product safety

• Promotion of products

• Compliance with supplier directives

• Provision of market intelligence to the supplier (new

competitors, market conditions, customer complaints/trends)

• Confidentiality – How to maintain

• Acting for competitors of the supplier – good/bad

• After sales service / product returns

Intellectual Property

• What rights will you grant

• Monitoring IP use

• Actions if there is IP infringement

• Return of IP on termination

• Grey imports

• Separate contract dealing with IP?

• IP created by the distributor

Sale of goods

• Distribution agreement is also a sales contract

• Will your standard conditions of sale apply

• Retention of title

• Consider competition laws:

• Dominant position – identification of the market

• Resale price maintenance

• Exclusive dealings

Indemnities – exclusions of liability

• Generally the supplier indemnifies the distributor for product

defects – how should this be limited

• What information should accompany a claim for indemnity

• Who is responsible for ensuring the product complies with

Chinese law

• Not all exclusions of liability are permitted

Managing the relationship

• Transparency is crucial

• What delegations have occurred

• Right to inspect records

• Does this extend to sub-distributors

• Support:

• On-going training and support is critical

• But – do not cross the line and start providing services in China

without being registered

End of the relationship

• When can the contract be terminated:

• Act by a party

• Time

• Sales targets

• Without cause

• What procedure must be followed

• Which clauses survive termination

• Return of IP

• Sale of stock on hand

23

Restraint

• Non-compete clause:

• Does it comply with Chinese competition law

• Does it extend to sub-delegates

• Does it apply to territories, clients, products

Dispute resolution

• Negotiation/arbitration/litigation

• Ad hoc arbitration not recognised in China

• Foreign judgments not enforced

• Crucial that dispute resolution be specified in the contract

• Governing law

• Arbitration:

– Seat of arbitration – HK, Singapore

– Language

– Arbitral rules

25

Distributor issues arising from FTAs

• Are you required to provide a CoO

• Do you warrant that the goods are of Australian origin

• Who is liable for duty if Chinese Customs denies Australian

origin status

• Declaration of origin:

– Easier for supplier

– Requires the importer to obtain an origin ruling from

Chinese Customs

• Sharing the duty savings?

26

Distributor trade compliance

• General position is that the importer is liable for trade

compliance

• Main risks are avoiding customs duty or incorrectly

describing goods

• Chinese Customs prefers to target an international brand

• Your representatives in China may be targeted

• May impact future imports (even by different distributor)

• Review import declarations – the information is not

confidential between the supplier and the importer

27

Agency

Sales via an agent

• Third party in country seeking to secure orders

• Not your employee

• Can complete sales or introduce you to customers

• Most Chinese agents are not true agents and generally

cannot bind the supplier

• Crucial to understand and document the agent’s authority

• You maintain control over terms of sale to the customer

• You carry all of the risk

Sales via an agent

• The agent may not work exclusively for you

• Does not enter into sales contracts on their own behalf

• Does not take title to, or import, the goods

• Usually paid on commission

• Reimbursement of expenses

Due diligence

• Even more important than with distributors

• Will they prioritise your product

• Do they understand your product

• Do they understand the market

• What are their networks

Authority of the agent

• Agents must act within the terms of their authority

• Actual authority

• Implied authority

• Apparent authority

• Authority can be restricted by good, territory, contract value,

customer

Agency agreement

• Crucial that there be a written agreement setting out authority

• Exclusive/non-exclusive

• Duration

• Sub-agents

• Aftersales service

• Territory

• Products

• Pricing – who sets the price

• Commission

Obligations of the agent

• Duty of good faith – act in your interests, not the customer’s

interest

• Promote the product

• Compliance with directions

• Communication of market intelligence/complaints

• Maintain confidential information

• When will payments be remitted to the Principal

• Insurance of products held by the agent

• Allow access to records

Your responsibilities

• What support will you provide

• Provision of promotional material/samples

• Compliance of the goods with Chinese requirements

• Payment of commission:

• Is it offset against customer payments received

• What do you require before commission is paid (proof of sales)

• What is the commission liability trigger (introduction, order, payment)

• General obligation to indemnify the agent

• Are expenses covered by the commission rate

Terms of supply

• If the agent can bind you, make sure they are contracting

according to your standard terms of supply

• Can the agent negotiate your terms of supply

• Incoterm of supply

• Currency of supply

Agency termination

• Same issues as distribution

• Termination rights

• Dispute resolution

• Non-compete

Representative office

Representative office

• A permanent establishment in China

• Purpose is to represent foreign companies

• It is not a separate company

• It cannot engage in direct business activities

• It does not have a legal status – so cannot enter

contracts

What you can and can’t do

Permitted Restricted

Business liaison Direct business activities

Product introduction Buying and selling goods

Market research Set up multiple offices in one city

Information exchange Directly employ staff

Leasing Warehousing goods

Coordinating work permits

Maintaining a bank account

Distribute promotional material

Liabilities

• The foreign company is liable for the acts of the

representative office

• Engaging in direct business activities may subject the

foreign company to fines and confiscation of profits

• Representatives based in the representative office are

subject to Chinese income tax

Benefits of an RO

• No minimum capital requirements

• Easy way to gain presence in China

• Complete control

Conduct business in China

China is ranked 93 out of

190 economies for ease of

setting up a business

Australia is ranked 7th

Conducting business in China

• To carry on business in China you must be registered

• A variety of types of companies can be set up by foreign

investors

• Most common is a wholly foreign-owned enterprise (WFOE)

• Others:

• Equity joint venture – both foreign and Chinese investors

• Cooperative joint venture – both foreign and Chinese investors, does

not have to be a company

• Partnership

• Special entities – wholesale and retail

WFOE

• Separate legal entity

• 100% management control

• Limited liability

• Can engage in a wide range of activities – but must be

within its business scope

• Cannot issue shares

Less red tape

• Previously there was a strict approval process for foreign

investment

• New - Online filing process if you are not on the negative list

• Industries subject to restriction down from 57 to 35

• Special NDRC approval no longer required for most

manufacturing

• Company up in running in 2-3 months

• Five in one business Licence application

Business scope

• The activity of the WFOE must be within its business scope

• Business scope is set out in the articles of association

• Acts outside the business scope may be invalid or result in

fines

• There is a balance between drafting a wide business scope

and having the business scope accepted by the regulators

• Can discuss it with the approving authority

• Can be amended after the WFOE is established

• Need to get it right – risk is contracting to do something

which you are prohibited to do

Funding

• Appropriate amounts of total investment and registered

capital must be determined before applying to set up a

WFOE

• Balance between realistic (may be harder to increase later)

and not too high (avoid trapping capital)

• Capital increases must be approved by the relevant

authorities

• It can vary from city to city

• Reductions can also be approved – must generally be a

change in activities

Free trade zones

Life is easier in the free trade zones and these represent the

future for China

• more flexile investment rules

• more flexible financing regulations

• less red tape

• expedited customs clearance

• 7 new Free Trade Zones across the country

Hong Kong holding company

• Generally no foreign investment restrictions

• International funds can be easily accessed

• Low corporate tax rate

• Less restrictive corporate environment

• Preferential mainland treatment under the FTA between

Hong Kong and China – can access restricted areas

Online sales

Methods

• Your own website – if not in Chinese, it is invisible

• Chinese e-commerce website – Tmall Global, JD.com

• Could consider smaller specialist sites – cosmetics,

electronics, fashion

• Ship from Australia

• Import into China and ship from a Chinese warehouse

Tmall Global

• China’s largest B2C platform

• No need for a physical presence in China

• Goods can be shipped from international destinations and

distributed by Tmall Global within China

• Registration - $25,000 security deposit, annual fee of

$5,000, commission 0.5% – 5%

• Will need an Alipay account – 1% service fee

• Must be the brand owner or authorized agent

Online sales – Individual goods sold from AU

• Regulation of ecommerce is uncertain

• Stricter registration requirements were proposed, then

implementation has been delayed – end of 2018

• Currently treated as personal parcels - no registration

requirement

• China is reportedly drawing up new rules on cross border

ecommerce

• 15 cities currently have delayed implementation of laws

requiring registration of CBEC products

• Likely to be stricter enforcement of health and safety laws

Questions

CONTACT Russell Wiese

T: 03 8602 9231

E: rwiese@huntvic.com.au

Lynne Grant

T: 03 8602 9246

E: lgrant@huntvic.com.au