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BUSINESS & TECH

Doing Business in China: Small Towns Stretch Made-in-China Label, Snuggle Up to Imports

By Doug Young

(Beijing) — Anyone who has lived in China for a year or more is almost certainly familiar with the local concept of tiered cities, even though few of us know what actually defines such tiers. Regardless of the math, one universal truth is that doing business in these smaller cities is far different from big ones.

Imagine the Western equivalent: A big-city businesswoman opens a slick new convenience store in Smalltown, USA, only to quickly discover her car is frequently ticketed, goods often get lost in the mail, and employees always call in sick. Then she discovers the sheriff’s nephew just happens to own the local general-goods store just a few blocks away.

Such small-town practices disappeared more than a decade ago in major cities like Beijing and Shanghai, and even most provincial capitals are now largely free of such backroom dealings. But the same isn’t true for smaller Chinese towns, where “guanxi,” or deeply embedded relationships, often create hidden connections and conflicts that could easily sabotage an outsider’s big business plans.

A good local friend in the drug sector opined that foreigners should probably avoid manufacturing in these smaller towns, or at least find a very good local go-between before making any such move. But he was quick to add that selling into these smaller markets is quite a different matter, and foreigners might even have advantages in such cases.

Before we go any further, let’s step back and take a quick look at just what exactly it means to be a small city in China. Although I’ve lived here for more than a decade, the only thing I knew with certainty about the frequently quoted tiered system is that Beijing and Shanghai are first-tier cities. I had a vague impression that big provincial capitals like Chengdu in Sichuan might be second-tier cities, but wasn’t quite sure.

A little web browsing led me to a very nice graphic tool developed by Hong Kong’s South China Morning Post, which explains that cities are rated in three ways: by population, gross domestic product (GDP) and politics. For example, tier-one cities must have more than 15 million people, GDPs of more than $300 billion and generally report directly to the central government. There are just four possible tiers in the system, and only Beijing, Shanghai, Tianjin, Chongqing and Guangzhou meet the qualifications for first-tier cities in all three classifications.

A look at the national map nicely shows that the vast majority of China falls into the lowest tier-three and tier-four categories, meaning this is perhaps one of the biggest business opportunities out there. Indeed, big companies frequently talk of the huge potential of selling to these smaller markets, and anyone from Alibaba down to Coca-Cola has its own strategy for marketing to these smaller cities.

My pharmaceutical friend was quite positive on the potential for selling into these markets, saying both Chinese and foreigners are generally welcomed due to their ability to create jobs, rent local offices and create other economic activity. He added that foreigners may even enjoy a slight advantage over Chinese businesses since they are often automatically more trusted.

But he and others say the situation quickly changes when it comes to manufacturing, which brings us back to my U.S. Smalltown scenario. He cited a specific case in which a peer agreed to buy a factory making traditional Chinese medicines in small-town Sichuan only to discover the factory hadn’t ever formally transferred its land from agricultural to industrial use. Without making such a transfer, it couldn’t get an official permit to actually operate a factory on the land, meaning it had been operating illegally for its entire existence.

Of course, none of that mattered, since the factory had close connections with the local government, which was happy to allow things to proceed without all the official permits. But the buyer needed to complete those processes before it felt comfortable closing the deal, and the local government was quite happy to help out. As a result, everything got done in just about the same amount of time as it would have in a big city like Beijing, and even cost a little less because local officials helped the buyer tap various government incentives and other preferential policies.

In some cases, the local angle can also become outright dangerous, as was conveyed in another tale told by an acquaintance who advises investors from his boutique firm, Grapevine Asia, in Shanghai. That case saw a client win control of some assets from a former business partner in Fujian province after some litigation. But when he went to take possession of those assets, he met with some “resistance” from local police, who also happened to be close to the Fujian businessman. In the end, everything worked out, though the foreigner quickly learned a new lesson in small-town business dealings.

The bottom line is that doing business in China’s third- and fourth-tier cities can be quite lucrative for foreigners looking to sell their wares into these markets, but can be more problematic for those looking to tap lower costs and preferential policies often attached to such locations. That’s likely to change over time as these smaller towns gradually get pulled into the 21st century. But in the meantime, it’s worth remembering that these markets deserve their own separate sales and manufacturing strategies.

Doug Young has lived in Greater China for two decades, including a 10-year stint at Reuters, where he led China corporate news coverage. Send your questions or comments to DougYoung@caixin.com.

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