Cost vs Risk

China has always been a challenging place to do business, but it is now also an expensive one. Costs are increasing across the board, from raw materials and minimum wages to services and office space…and compliance. The competition for qualified management and staff has also intensified, and rising costs are a top concern for international businesses operating in, and buying from, China.

Unfortunately rising costs are not balanced by falling levels of risk. The key risk themes reported by international companies in China, as reported in surveys by some of the big US and EU chambers of commerce and membership organisations include:

Higher costs
Slower growth
Increased competition
Human Resources
Protectionism
Legal issues (including IPR and corruption)

These risks are not conducive to predictability or profitability…but they are the perfect materials for making a rock and a hard place between which to sit! To add to the corporate challenge is the spectre of white-collar crime, which is another rising expense item. China Daily reported there were around 1.5 million money-related crimes investigated by Chinese police in 2013 (i.e. just the tip of the iceberg), with the major ones involving:

Fraud
Counterfeiting
Bribery
Embezzlement
Insider trading

Kroll’s 2013-2014 Global Fraud Report noted that 67 percent of respondent companies were affected by fraud in China, and that risks are increasing. Anecdotal evidence suggests that despite the official anti-corruption campaign, plenty of commercial bribery and fraud continues to take place. In the current environment businesses cannot afford either the monetary losses or the reputational and regulatory costs. The ongoing bribery scandal involving GSK is a case in point, and today’s news that charges are being brought against the company’s former country head, Mark Reilly, and two other local executives shows clearly that foreign businesses and their managers (whatever their nationality) can experience serious consequences when rules are broken.

A range of common business risks (which I will cover in a later post) require attention, but need not to be a barrier to success. Where processes are adapted and assessments made with the benefit of some local knowledge (and due diligence), relevant protections can be put in place. The challenge is then to ensure they stay in place, and continue to adapt at least as fast as the market which, contrary to some mainstream thinking, can be very innovative!

China has potential for sustainable economic growth, but also for unsustainable corporate losses that result not only from difficult trading conditions, but also from white-collar crime and regulatory fines. The budget for risk management can be managed, and may help achieve efficiencies and avoid disaster. The budget for a post-loss recovery is harder to quantify, but could be painfully high.

Senior management – in China and HQ - need to take a lead and ensure that their houses are in order, and that incentives and budgets for local management do not encourage inappropriate risk-taking or corner-cutting.

In the next post I will look at some tricky risks “with Chinese characteristics”.

For more news and discussion on risk issues in China, join the Risky Business In China LinkedIn Group, and follow the @RiskyBizChina feed on Twitter. The issues are also covered in detail in my upcoming book, “Risky Business In China. A Guide To Due Diligence”, which will be published by Palgrave Macmillan in September 2014.

Photo: West Hill, Kunming, 2013. © Jeremy Gordon