Environmental Technologies Industries

Environmental Technologies Industries

Market Plans

China Environmental Export Market Plan

Chapter 10 - Positioning U.S. Exporters in the Market

Chapter 10- Positioning U.S. Exporters in the Market

China's environmental market is highly competitive, somewhat restricted, unwieldy, and not easily understood. Accurate data illustrating demand and market size is scarce, problems are large in scale, and the intricacies of how to address problems efficiently are not well understood by the domestic players, making it difficult for outsiders to determine where their services are needed and how access can be achieved. As a result, making sweeping strategic statements on market entry is unrealistic. Market potential exists for service and technology providers and for consultants with the capacity to gain a deep understanding of needs in specific localities and facilitate solutions that are both economically and logistically feasible.

Market access for foreign companies is further limited in that market demand remains largely aid driven. For U.S. companies, this poses further complications. The severe shortage of bilateral assistance from the U.S. eliminates possibilities for tied financial aid and leaves only the resources of multilateral agencies and the Trade and Development Agency (TDA). As indicated throughout this document, regulatory pressures, as well as the aims of increasing efficiency and positive corporate image, are increasingly contributing to market demand, but they do remain (to varying degrees) limited instigators. At the same time, the bulk of domestically-sourced spending on environmental protection is aimed at domestic suppliers. This, too, is changing (albeit on a small scale), as Chinese buyers realize the long-term benefits of spending more money up front on better equipment as opposed to covering the maintenance costs needed to keep mediocre, locally-produced equipment up and running. Nonetheless, price remains a strong determinant factor for many purchasers.

U.S. exporters also must consider in which sectors they can be most competitive vis-.-vis the strengths of third-country and local competitors. U.S. versus third-country competitor advantages are discussed in some detail in each of the sector analysis chapters; however, it should be restated that, although U.S. technology in a number of sectors is considered superior or of high caliber, prices may remain prohibitive. One sector in which the United States does excel is monitoring equipment, and the inabilities of local producers coupled with increasing mandates for stricter monitoring may play out to the advantage of exporters in this sector. Generally speaking, certain sector strengths (such as the French domination of the water sector) and tied assistance programs constitute advantages for third-country competitors. Various benefits associated with local production account for a large part of local competitor advantage. Entering the Chinese market requires due diligence and feasibility analyses. Even more important, it requires a willingness to take risks and determined perseverance. This approach of informed risk taking combined with a strategy of starting modestly and allowing natural business growth has been proven in the Chinese market. Many large companies have entered the market with a reasonable budget and, as a result of engaging the government at the wrong level (usually too high), positioning a high-cost expatriate, or hiring an inexperienced Chinese national, have failed and pulled out. Personnel issues also account for the failure of many overseas businesses in China.

The formula for success could in fact be quite simple. A midlevel Western manager with a proven business sense and a desire to prove himself or herself is often the best solution for in-country management in the startup phase. Contrary to conventional wisdom, overseas Chinese and experienced managers from other Asian countries (even Hong Kong and Taiwan) are rarely a better option. Although they may know the language, cultural differences between Hong Kong and the mainland and between Taiwan and the mainland can be as significant as those between the U.S. and the mainland, and while Western-looking American managers are allotted a margin of error by Chinese business partners, non-Chinese Asians and overseas Chinese who purport to have a flawless cultural sense are not. Chinese nationals who were trained in the U.S. and lived abroad for extended periods fall into the same category, while Chinese nationals who were trained in American institutions of higher education but have not worked in the U.S. lack the necessary business experience. While Western-educated Chinese constitute the best of the overseas hiring options, care should be taken to train and immerse them fully in corporate culture, and when transferred to China they should remain under the management of a midlevel corporate manager until they are fully trained. In sum, the best option is typically a foreign, mid-level team player who knows the business well and hungers to prove his or her capabilities. High-level corporate executives demanding large salaries and first-class living accommodations are not ideal. Startup managers need a couple of years' time to fully enter the market before achieving financial viability.

To assist in this process, or if local representation is required, a variety of private consulting and law firms are available for consultation, and a growing number of environmentally-specialized firms exist. If a long-term entry plan is not feasible for a U.S. company, then a local representative with a proven track record, which may be a Chinese or a Western company, may be engaged to market on behalf of the U.S. firm. Alternatively, a general representative office serving the interests of environmental industries toward a particular state business or sector may be established to promote the interests of its constituents in-country. Again, the management of such an office should follow a pattern similar to that described above. In all cases, broad-based consultations with the U.S. Embassy, the American Chamber of Commerce's environment, health, and safety forum, and other businesses should be undertaken to achieve the broadest possible perspective before decisions are made.

A number of countries offer bilateral aid and assistance programs to guide environmental protection development while generating investment opportunities for their nation's industries. Although the United States offers very little along these lines, monitoring other programs may help in pinpointing market opportunities that are tangentially related.

The U.S. and Foreign Commercial Service in China provides environmentally specific market analysis services, works to bring potential Chinese and U.S. partners together, and maintains an informative Web site (www.usembassy-china.org.cn/english/commercial/index.html) that contains links to a number of periodical briefs, resources, and statistics and to an introductory pamphlet guide to the Chinese market. The China Country Commercial Guide is available online at www.usatrade.gov, and further useful information can be found online at www.buyusa.com.

Monitoring the Market

Market Potential Versus Market Demand

Environmental conditions in China often lead investors to believe that opportunities in the environmental market are manifold and that increased legal and governmental pressures to improve the situation are causing even faster growth of market size. While these assessments are theoretically true, it is important to consider them in the context of market potential as opposed to market demand. A number of factors continue to prevent the market's potential from developing into demand. Several of these have been alluded to in other sections of this document; however, their importance cannot be overstated.

Market-Based Incentives. Fees and tariffs levied on services and resources in China still do not reflect their actual costs or values, making it difficult for service and resource providers to generate profits. Authorities have started to implement fees based on the costs of construction, operation, and maintenance of environmental infrastructure facilities and to establish new policies encouraging private investment. Yet, in many cases, these efforts do not constitute a real market approach and remain inefficient.

Enforcement of Legislation. China's environmental legislation has become quite complex and continues to grow more comprehensive. However, the ability to enforce this legislation and affect environmental protection in the localities varies considerably, primarily as a result of conflicts of interest, inadequate capacity and financial resources, and difficulties in locally interpreting and implementing national decrees.

Conflicts of Interest. Several conflicts of interest stymie environmental protection in China today. The primary conflict is between environmental protection and economic development. Officials and business leaders believe that environmental protection costs limit industrial profitability and development plans. A similar conflict of interest exists between various ministries and other administrative bodies within the central government, in which some of the more powerful ministries oriented toward economic and industry development trump the authority of SEPA in the overall implementation of development plans.

A third conflict of interest exists in the administrative structure that governs the local EPBs. EPBs receive their regulatory directives from SEPA at the national level. SEPA has little means to enforce the implementation of those directives. Meanwhile, local government administrations control the budget, personnel, and other administrative details of the EPBs, giving them a vested interest in following the policy objectives of the local government as opposed to those of SEPA. Thus, if national environmental initiatives inhibit local government initiatives, the local government has more leverage to impose its preferences.

Fourth, and most meaningful in terms of commercial interests, is the conflict within regulatory institutions, which usually have a "consulting" institute. Most EPBs are supported by a research institute that acts as both inspector and consultant. Because of this, the market for environmental services and technologies is distorted by the local monopolies of regulatory institutions. Where monopolies are seemingly neutralized, institutional corruption often fills the void.

National Decrees and Local Implementation. There is an old adage in China, "Here, where the heavens are high and the emperor is far away." That still rings true today. The EPB structure discussed above is only one of a number of issues that illustrate this. The ability to monitor local compliance with national standards effectively depends to a great degree on the local government's interest in complying. Similarly, the national government has trouble implementing local-level price, fee, and tax increases aimed at improving market-based incentives. Governments in some localities are apparently concerned that such increases affect industrial productivity and development and could stir social unrest.

Because of these factors, a regulation-driven market in China has yet to emerge, and the potential market remains more promising than actual market demand. In a number of instances, however, signs already exist that some of these factors are changing, particularly in the more progressive coastal areas. Optimistic speculation indicates that future changes will generally err toward the side of improved regulation, increased market demand, and increased liberalism. The timely establishment of a market presence is increasingly important. Nonetheless, it is critical to consider all factors and to assess the degree to which and the speed with which national policies are carried out within a given locality.

Regional Specificity

Because the factors addressed above vary considerably across the country and from locality to locality, it is critical that potential investors think not about the market as a whole but about the market climate of the particular region or locality in which they will be investing. Perhaps the most important aspect of regional specificity is overall development and the ability to finance environmental protection. As previously indicated, development in China has been skewed over the years, resulting in a tremendous gap. This gap continues to play out in the environmental sphere in two ways.

The more underdeveloped regions of the country suffer some of the most severe environmental degradation. Because production capacity, municipal and township infrastructure, and awareness regarding environmental protection all remain underdeveloped, degradation continues. Environmental needs in these areas are often basic but overwhelming in terms of scale. Additionally, these are often the areas that are most hard-pressed to finance their environmental protection.

More developed regions have more financial resources to invest in environmental protection. As a result of relatively rapid development, a higher profile, and a relatively high degree of public awareness and pressure, they have managed to build better environmental protection capacities in recent years. These areas are often more attractive for foreign investors and are able to sustain stronger environmental protection measures. As a result, China's gaps increase.

In researching the market and considering market-entry strategies, technology and service providers need to consider where their strengths most suitably fit local needs. An obvious initial conclusion could be that the more developed and wealthier regions offer the best market opportunities. However, it should be remembered that, as pressure increases upon local governments to improve fundamental environmental quality, they look to experienced and capable technology and service providers for efficient solutions needed to make improvements affordable. Technology and service providers with innovative products and management techniques, who can profitably exploit large market bases with relatively inexpensive solutions, find an increasingly warm market climate. In such cases, selling in quantity and offering money-saving or revenue-generating management techniques is the key to profitability.

Policies and Priorities

China clearly expounds its environmental development priorities through policy initiatives such as its Five Year Plans, Agenda 21, the Trans-century Green Engineering Program, and other programs intended to decree or urge action for environmental investment. These policy drivers are good indicators regarding central priorities and should be consulted by foreign investors while investigating the market; however, they should not be viewed as the only or the ideal path to market access.

Foreign exporters should remember that these central priority plans are just that: centralized policy regarding widespread and intricate local problems. As indicated earlier in this chapter, central government commitment does not presuppose local government commitment, and any government commitment does not necessarily indicate commercial viability. Government assurances or state priorities are not a satisfactory substitute for standard due diligence. Furthermore, targeting the correct level of government decision-makers for information or permits is critical in order to reduce bureaucratic red tape and the risk of investment losses.

The Tenth Five Year Plan refers to the central economic development plan for the years 2001-2006 and in part refers directly to the environmental protection agenda during that period. Agenda 21 and the Trans-century Green Engineering Program are ongoing environmental development initiatives under the auspices of different and competing government ministries. The structures of these as well as other policies and priorities are outlined in Chapter 3, and contact information provided in the China Contacts list in Appendix B indicates channels for monitoring the most up-to-date developments in regard to these initiatives.

As previously noted, laws and enforcement trends are also key indicators that should be considered by investors.

Environmental Protection Bureaus

It is often stated that the best way to learn about local environmental needs is to contact the local Environmental Protection Bureaus (EPBs). EPBs are a primary inroad for assessing environmental stresses and thereby understanding protection and abatement demands. In theory, EPBs should have up-to-date statistics and indicators categorized by industrial sector on hand and should be knowledgeable about the specific needs of polluting industries under their jurisdiction.

However, it is often the case that EPBs themselves, particularly those in the more backward and environmentally stressed regions, are as much in the dark about how to address local environmental problems effectively and efficiently as everyone else in China. Simply calling various EPBs and inquiring about local needs will yield few specifics of interest. The reply will often constitute an indication that all sectors are lacking and that there is a need to address all of the most basic pollutants. (Additionally, the EPBs often indicate that only affordable, even cheap, solutions are viable, as finances are tight and the scale of the issues quite large.)

This lack of clarity on the part of the EPBs opens yet another market opportunity to highly motivated and entrepreneurial environmental market analysts and consultants who can personally visit locales and gather firsthand insight into regional needs. By becoming well acquainted with the intricacies of issues within the jurisdictions of particular EPBs, such consultants can offer insights to the EPBs regarding efficient abatement schemes and can offer market-entry consulting for technology and service providers.

Many EPBs maintain Web sites (of varying quality and usefulness) and have departments specifically oriented to working with international contacts. The China Contacts list in Appendix B contains updated contact information for EPBs. Where possible, the names and contact information of those members of each EPB who focus specifically on business affairs dealing with international parties and who can speak English have been provided.

Other Government Agencies

EPBs represent the first line of inquiry regarding environmental conditions and needs in an area. Agencies such as local economic and trade bureaus, planning bureaus, and bureaus of foreign trade and economic cooperation are often more knowledgeable and focused on servicing business needs. In many cases, local-level branches of these agencies outside the more developed regions may be unable to respond to international inquiries. In such cases, the next level (possibly the provincial level) of government must be consulted. Unless an extremely large investment is being considered, contact with national-level agencies is unnecessary and often inefficient.

Special Zones and Industrial Parks

Special economic zones and industrial parks provide another channel for gaining insight into environmental protection needs. Administrators within the zones and parks may be interested in addressing the environmental needs of the zone as a whole (for example, through a common waste management facility), and many administrators have insights into the particular needs of the entities operating under their jurisdiction.

Additionally, there are parks specializing in environmental industries (such as the Yixing Environmental Industry Park), acid rain and SO2 emissions control zones, and priority regions, rivers, and lakes and "key" cities, all of which can offer insights into what technology and services are needed, and where.

Box 10 China's Bonded Zones

Business operations in China's 16 bonded zones operate under the most liberalized albeit least clearly delineated regulations in the country. Originally conceptualized as extraterritorial export reprocessing zones where foreign manufacturers could establish operations and employ Chinese labor without being subject to various taxes, the zones have developed into leniently regulated trading hubs facilitating various operations, some of unclear legality. Extraterritorially allows foreign investors to avoid certain regulations, quotas, foreign exchange issues, and taxes that hinder foreign investors operating elsewhere, and trends indicate that leniency in the zones is increasing.

As a result of regulatory leniency with regard to national policy enforcement, foreign investors operating in the zones can increasingly circumvent restrictions to facilitate their commercial operations in China. Among various creative arrangements, companies inside bonded zones have been established to administer sales and marketing outside of the zones (which is not intended under the preferential tax and incentive policies available only to operators within the zones), retailers have arranged to provide after-sales services (a sector currently reserved for Chinese operators and JVs), and foreign investors have even become involved in domestic trading. However, each bonded zone operates under its own set of rules, and what is possible in one zone may not be possible in another. Investors considering operating out of a bonded zone should fully understand the intricacies of each zone before determining which best suits their needs.

Service providers doing laboratory work for environmental analysis might consider establishing operations in a bonded zone. Customs and fixed asset investment taxes, which are normally levied on facilities and equipment brought into the PRC when establishing such an operation, are waived inside the zone. The service provider could then partner with a Chinese laboratory holding a Class A license (required to approve and validate samples tested) and offer services to clients throughout the mainland. A number of laboratories have already established such arrangements and are operating successfully.

The potential for foreign environmental industries to exploit the possibilities afforded by the bonded zones is broad; however, pushing the outer limits of the law runs risks. With the assistance of competent lawyers experienced in the operations of bonded zones, foreign investors can get quite creative and remain safely within the ambiguous bounds of the law. Those who wish to push those bounds should seek reliable counsel in determining the benefits and potential costs of doing so. As liberalizations associated with WTO entry increase market accessibility, the benefits of operating in bonded zones are dissipating, as the regulatory leniency currently governing the zones is reined in.

Market Entry

Market-Entry Vehicles

There are essentially three general methods by which to enter the Chinese market, each with its own positive and negative aspects. Potential vendors must assess which market-entry strategy is best suited to their needs based on what services or technologies they provide, who their potential customers are, their financial constraints, and their various strengths and weaknesses. Investors should also be certain to understand the inherent benefits and complications of each market-entry method. Choosing one over another often constitutes exchanging one set of complications for another (see Table 10.1).

Local Presence. Foreign investors hoping to provide equipment, component parts, consulting, contracting, or engineering services should consider establishing a presence in China. Establishing a local presence, either through a JV with a Chinese company or through a WFOE offers a number of advantages:

Due to high import tariffs and reduced labor and raw material costs in-country, local foreign-invested operations can provide goods at a lower cost than competitors that are importing foreign-produced goods into China.
Local foreign-invested operations can take advantage of the above-mentioned points and benefit from the local perception that American-made environmental protection products (including those produced in China under the supervision of a Western company) are of a consistently higher caliber than wholly Chinese-produced goods.
Companies with a local presence can accept payment in renminbi, important because foreign currency is tightly controlled and domestic companies and government organizations are often hard-pressed to pay in U.S. dollars.
A local presence facilitates the development of personal relationship networks, which are vital for successful business operations in China. Ideal local partners have a relatively strong, established network.
China's regulatory environment is lacking in transparency. Although this is changing since WTO entry, a reliable and capable local partner well versed in the daily procedures of Chinese business is invaluable.
Chinese customs procedures are notoriously opaque and troublesome. Local producers that can minimize reliance on imported goods are able to reduce those complications.

It is to be noted that, in addition to the above-mentioned advantages, establishing a local presence may generate difficulties:

Locating and partnering with competent, trustworthy, and commercially viable Chinese counterparts can be difficult. Protecting intellectual property is a very real challenge, financial disclosure regulations for enterprises are minimal, bookkeeping is often creative, and potential partners are known to present themselves deceptively.
Investors have reported complications as a result of conflicting interests between JV partners. Chinese counterparts have sometimes been described as unreliable in the long term and competitors in the short term. Furthermore, due to financial pressures, the local partner often views the overseas partner, not the success of the project, as the source of income.
Drafting the JV contract can be a trying experience, yet the frustrations may pale in comparison with the difficulties involved in seeing that the contract is honored in its entirety.
The opaque legal system previously discussed can also create difficulties for foreign JV partners. The lack of a rule of law makes contract disputes and other partner-related affairs difficult to manage, often leaving the foreign investor at a disadvantage.
Establishing a WFOE as opposed to a JV can alleviate some of the above issues, and with regulations easing, the establishment of a WFOE is becoming an increasingly popular option. However, WFOEs must make up for the relationship network gap that is not filled by a Chinese partner, making the recruiting of very capable and experienced local players requisite if the foreign players lack their own network.
In the past, foreign-invested companies have been urged to focus on producing for export unless they are bringing technologically-advanced production methods or products into the country. Priorities and policies are constantly changing, but it remains difficult to predict what might be expected of foreign-invested enterprises operating in various parts of the country.

Cross-Border Entry. Some investors considering the establishment of a local presence may be able to achieve their goals via cross-border entry. Others may want to enter the market initially through cross-border entry with the intention of establishing a local presence over time.

Technology and equipment providers can export directly to China, but they face high import tariffs, making it difficult to offer competitive pricing. Additionally, current industrial reform policies are aimed at developing domestic production capacities, placing exporters at a disadvantage. Such an approach does, however, open exporters up to certain preferential treatment by the Ex-Im and eliminates the necessity of establishing a corporate body in the country. Nonetheless, a local representative office, local partner, or hired representative remains necessary to maintain a market presence. For those uninterested in establishing an office or partnership in China, an increasing number of market analysts and representatives are available. The well-established players in this field have a strong understanding of the China business climate, the ins and outs of day-to-day business, and pre-established relationship networks.

An option that is increasingly being considered by overseas investors is the establishment of a base in one of the coastal bonded zones in China. These areas are designed for importation of parts for assembly and re-export without the encumbrance of duties and taxes. The benefits provided by this mechanism are that while a physical presence is established in China, in effect all activities are technically "cross-border." If the legal mechanisms for such a presence are properly understood (with the assistance of an experienced law firm) and properly utilized, significant operational flexibility and access can be achieved.

Chinese procurement agencies work to bring buyers and suppliers together. Traditionally these agencies, particularly those carrying out government procurement, have targeted domestic producers or unscrupulous agents of foreign companies (a strategy that may create difficulties for U.S. companies with regard to the Corrupt Foreign Practices Act). Although this entry method is still somewhat tight, insiders have noted that, as a slowly increasing number of domestic contracts are being opened to unrestricted bidding, opportunities are increasing for foreign producers offering unique products at competitive prices.

Foreign providers are also allowed to offer consulting services via cross-border delivery. All other service providers must operate in China or through a local partner. Any foreign service provider requiring official approval at any stage of project execution needs a local partner. Some areas of activity, such as undertaking EIAs or providing engineering services, are severely restricted and require collaboration with a properly licensed local agency. To carry out baseline studies, EIAs, sample analysis, or other services in which final reports or designs require official approval, a foreign provider must establish either a permanent local presence or a contractual JV. Contractual JVs may be established for a prescribed period of time or may be project specific.

Foreign investors might also consider the direct needs of multinational and other large foreign enterprises operating in China. Such enterprises generally seek to outsource procedures that are not considered profit generating; however, they often have difficulty finding local service providers that can manage these procedures in accordance with their relatively strict internal standards.

Multilateral and Untied Bilateral Projects. Entering the Chinese market via multilaterally funded and untied bilaterally funded projects remains one of the most secure methods. These projects have available hard currency, undergo lengthy feasibility assessments, and are subject to the internal policies and standards of the implementing agency. Although bidding for some Chinese government-funded projects is opening up to foreign contractors, multilateral and untied bilateral projects have the further advantage of employing reasonably transparent and competitive bidding procedures.

Bidding for multilateral projects, however, is highly competitive and remains a difficult task for inexperienced vendors. Potential bidders that have no experience in tendering a multilateral project are best advised to work cooperatively with one that does. It is also necessary to monitor the development of projects from the earliest possible stage. Most competitors are usually quite well positioned for the bidding process long before the call for bids is issued.

The barriers to untied bilateral projects are similar to those mentioned above, but they are compounded by the scarcity of such projects. Essentially, the only consistent untied bilateral aid donor to China that has significant operations in this sector is Japan's JBIC. However, the country's overall aid to China may yet decrease, as pressure in Japan to review its China aid program has been mounting.

Most other bilateral aid programs of significance are tied to contractors within the country from which the aid stems. Tied bilateral aid has in fact helped many companies establish a very strong presence in China. U.S. companies complain they are at a decided disadvantage resulting from a lack of tied bilateral aid from the U.S. government.

Table 10.1 Advantages and Disadvantages of Various Market-Entry Vehicles

*Vehicle*	*Advantages*	*Disadvantages*
Local Production	Can accept payment in renminbi. Can (possibly) compete better on cost. Proximity to end user allows faster delivery time and other such benefits. Offers many options for manufacturing.	Requires investment. Could require higher operating costs. Presents potential dangers in technology transfer.
JV	Partner may provide some benefits. May make it easier to get investment approval.	Loss of technology is possible. Must run business with partner. Involves more difficult exit strategy.
WFOE	Lack of partner allows a free hand in the market.	No partner is available for assistance.
Direct imports	Technology is easier to protect. Costs lower all around. Poses less risk and exit strategy is easier.	Cannot accept payment in renminbi. May face import restrictions. Products will likely cost more
Representative office	Offers cost-effective market entry. Can understand market better before setting up production.	Unlike other direct import options, involves operating costs for China presence.
Agents/distributor	Can be very useful for broad footprint of end users. Can provide service.	Poses dangers of losing control of marketing. Does not cover all products.
Franchise	In-country presence is not needed.	Poses risk of technology theft. Monitoring and controlling are very difficult. Little recourse is available in disputes.
Direct sales (no distributor or representative)	In-country presence is not needed.	Presents operational difficulties. Covers only products with small end user footprint.

Source: U.S. Department of Commerce, International Trade Administration, Partnering in China's Environmental Sector.

Public Private Partnerships and Build-Operate-Transfer Projects

Several large foreign companies have entered the Chinese environmental infrastructure market via models known as public private partnerships (PPPs) and build-operate-transfer (BOT) projects. Currently, most of these projects take the form of BOT and are water-management oriented. Although PPPs are less commonly seen in China, the possibilities for them also exist, and at least one clear example of a successfully initiated PPP is known. Official press coverage of infrastructure projects being developed through these models has been positive and outspoken, and insiders have indicated that the official sphere looks on them with increasing favor. As other infrastructure markets open up in China, these models, while challenging to implement, may grow in importance.

A BOT project differs from a PPP project in that, although it does constitute a relationship between the client (the public entity) and the supplier (the private entity), it is not a partnership in which the players cooperatively invest in and operate a facility. Rather, the building and operation of a facility in a BOT project is 100 percent funded and owned by the private investor prior to its transfer to the public entity at a pre-determined time. In contrast, a PPP project is a partnership in which both the public and private entities make equity investments in a facility, each maintaining a percentage of ownership. It is possible for a BOT facility to be included as part of a larger PPP project in which part of the private entity's agreement is to build a facility that is to be transferred at a pre-determined time in the future.

The current number of BOT and PPP projects in China amounts to little more than a handful.

BOT Projects in China. Currently, BOT projects in China are limited to the building, operation, and transfer of facilities whose specifications are defined by government planners prior to contracting the foreign investors. This approach limits the capacity of the contractor to develop a comprehensive service infrastructure and fails to take advantage of foreign expertise and know-how, thus affecting overall efficiency. Concession agreements, in which a firm is contracted to develop a comprehensive system to service a given geographical area in its entirety, are preferred by foreign investors because such agreements afford them the flexibility to develop an efficient system suited to the greater needs of the locality. Currently, contractors are rarely consulted in the planning of such projects, and product distribution, pricing, and billing remain under the control of the local government. Industry insiders have indicated that local governments are beginning to recognize the decreased efficiency resulting from these constraints, and they appear optimistic regarding the potential for more comprehensive BOT agreements in the future.

Many of the foreign BOT operations in China have been funded through official aid programs, helping the involved firms to develop a strong market presence. Tied bilateral aid has been a significant contributor, but the ADB is also a strong proponent of the BOT model. The tied bilateral aid option is not available to U.S. companies; however, the potential markets are far from saturated in China. Companies seeking to enter them are well advised to establish a market presence sooner rather than later.

A number of domestically-generated BOTs were announced in the first half of 2001, indicating further acceptance of the model by both Chinese authorities and Chinese enterprises. Several proposed projects are quite large in scale; however, it is not at all clear what opportunities they might hold for foreign vendors.

PPPs in China. PPPs are less commonly seen in China than BOTs. They have considerable potential to become important. In one instance of a true PPP in China, a subsidiary of a large multinational entered into what is essentially a JV with a state-owned municipal facility. The public entity contributed its previous facility for a lesser stake in the company, while the multinational subsidiary agreed to build, operate, and transfer additional facilities, establish sound management, and train local hires. Contract negotiations included agreements with the local government regarding pricing structures that the private entity deemed sufficient. The public entity viewed the training (including training modules based in the U.S.) and positioning of locally hired high-level managers as beneficial to the socioeconomic development of the locality.

The managing director of the private entity conceded that this operation has been fortunate in that the public sector partner is progressively oriented and willing to compromise. Additionally, the project is located in a relatively affluent region, thereby facilitating pricing structures that are sustainable. The director also explained that such a project would not have been possible at this time without funding from the parent multinational. The project is expected, however, to function as an influential pilot program that will attract other local government leaders in search of similar arrangements, and it has afforded the foreign investor a market presence without the assistance of any outside funding. As is the case in any partnering scheme in China, the compatibility of PPP partners and their goals is critical to success.

Box 11 Protecting Intellectual Property Rights in China

Intellectual property rights violations are a fact of life in the Chinese marketplace. Foreign investors of all types and sizes,
from single-person operations to multinational conglomerates, are subject to the possibility of IPR infringement.
Unfortunately, breakdowns in the rule of law, the pervasiveness of the issue, and the ingenuity of the perpetrators make it difficult for companies to protect themselves completely. Some enterprises accept IPR infringements as a cost of doing business in China; however, those that cannot afford that cost should seriously consider whether potential successes in the Chinese market justify the risks.

Environmental equipment providers producing technologically unsophisticated yet innovative equipment must be cautious.
Enterprising Chinese can easily reverse-engineer such products and flood the market with cheap copies. One market consultant with years of experience in the China marketplace insists that the best method to prevent such a scenario is to network an awareness of a particular product heavily, making clear to end users, local officials, and other producers its origin and rightful owner, and then to establish the necessary relationships to ensure its protection. Other companies invest large sums in contracting firms to manage IPR issues, some becoming deeply involved in local politics. Ongoing efforts to dismantle vast production and distribution networks of pirated goods, upon which entire local economies are based, continue in China today and will likely continue for some time.

Potential Complications and Requisite Precautions

Whether foreign investors choose to enter the market via JV, WFOE, cross-border entry, or any of the various other methods, a number of potential complications exist. China remains a country with an underdeveloped rule of law, and investors have been victims of robbery, embezzlement, IPR infractions, and similar issues with little or no recourse to the law. Nearly all entry methods require some degree of partnering or interaction with local entities. Each method should be carefully screened and well understood.

Below is a list of some of the most commonly encountered complications to watch for. It is not, however, exhaustive, and investors considering entering the Chinese market are strongly urged to consult experts in the field.

Partnering in China can be confusing. Expectations must be very clearly communicated and understood. The most common issue that arises is that overseas investors do not understand their partners well and do not nurture a trusting relationship over time. The agreements reached need to be simply stated and put in writing regardless of the goodwill that may exist in early negotiations. Seeking out progressively-oriented partners that have worked with foreign investors before or that have worked overseas is ideal.
Delinquent payment for goods and services is a serious problem faced by both exporters without an in-country presence and locally operating firms. It is advisable to seek out creative means by which to ensure delivery of payment.
Regulations governing business practices in-country can be restrictive and can vary from place to place. As an example, companies operating in the Suzhou Industrial Zone are required to hire only local Suzhou residents unless the employee is a university graduate. Some firms operating in the zone have expressed dissatisfaction with the restricted labor pool while competitors operating in a nearby zone are not hindered by such restrictions. Investors establishing operations in-country are advised to understand not only the intricacies of local policies where they will invest but the likelihood that those policies will remain consistent in the future.
Intellectual property rights are constantly infringed upon in China, resulting from a weak rule of law, enforcement difficulties, and a local failure to understand the importance of personal property rights as they apply to intellectual property. This problem continues to frustrate even the most seasoned investors in China. Those without creative means to protect themselves are advised to consider the costs of potential IPR infringements seriously and to determine whether the benefits of market entry justify the risk.
Corruption in China is an unavoidable fact. Many investors have encountered situations in which progress cannot be made without delivery of "gifts," "favors," or expensive dinners. Some operations have been held up due to the absence of "suitable transportation," such as four-wheel-drive vehicles or new sedans. Few investors in China can honestly claim never to have encountered one type of corruption or another. Some try to fight or avoid it, while others accept varying degrees of it as a cost of doing business.

Market-Entry Procedures

Contracting in the Chinese market is best facilitated through a "bottom-up" approach, meaning that U.S. investors and suppliers should establish preliminary contact with local purchasers, partners, or government bodies as opposed to national-level ministries. Provincial- or municipal-level government offices directly or indirectly involved in potential projects are ideal places to begin. If possibilities for a project materialize, such partners are instrumental in facilitating various permitting processes and obtaining necessary authorization; foreign investors should take advantage of local partners' capacities to do so.

For industrial pollution control projects, local EPBs are the primary contact point (generally via a well-established consultant or market representative). Despite the lack of overall clarity alluded to earlier, EPBs are well situated to report on the state of affairs for individual point sources of pollution within their jurisdictions, and interaction with them is almost always requisite in one manner or another. SEPA is not involved in the implementation of such upgrade projects; however, national level approval from SEPA, SETC and SDPC is needed if overall expenditure exceeds a certain amount. The dollar level at which national-level authorization is needed varies among provinces and municipalities.
For municipal water, wastewater, and solid waste management projects, the Ministry of Construction and local construction bureaus are the primary contact points. The ministry may be useful in directing investors to local construction bureaus, through which project implementation is conducted. The Ministry of Construction should also be consulted as project plans materialize to verify that all national requirements are met throughout implementation.
For facilitation of partnerships with equipment producers, investors should seek advice from private consulting firms, the U.S. and Foreign Commercial Service in Beijing, and EPBs at various levels.
For facilitation of the sale of equipment, whether it consists of cross-border sales or sales of domestically produced JV or WFOE equipment, providers should proactively monitor the interactions of potential buyers with the Ministry of Finance, various-level development and planning commissions, and various-level economic and trade commissions. Projects that are preparing to procure equipment go through a series of approvals with each of these government bodies, and may apply for financing, before publicly announcing a call for bids. In reality, however, arrangements for procurement are likely to be firm before the call for bids is made. The best way to secure a contract is to interact cooperatively with project facilitators as they move through the bureaucratic processes and establish a solid working relationship. Those equipment providers lacking the capacity to do this should hire a consulting firm or market representative to do it for them.

The Approval Process

The approval process for environmental and infrastructure projects in China is confusing and relatively opaque. All projects require approval at some level (state, provincial, or municipal) by SDPC, SETC or MOFTEC, as well as EIA approvals from SEPA. The required administrative level of approval is based upon the investment size of the project:

Investment of less than RMB 30 million ($3.6 million) requires approval at the municipal level.
Investment of RMB 30 million to RMB 200 million ($24.1 million) requires approval at the provincial level.
Investment of over RMB 200 million requires approval by SDPC or SETC and the State Council.

In some cases, coastal special economic zones and some municipalities have increased discretion when approving projects with investments of up to RMB 200 million. Ministries or bureaus that are directly sponsoring a particular project also have a considerable say in approval processes regarding that project. EPB approval is necessary for all projects, and national-level SEPA approval is required for projects with investments of more than RMB 200 million, transprovincial projects, projects with potential for causing transprovincial pollution, nuclear facility projects, and projects that involve a degree of state secrecy or state security concerns.

The approval process - which can take from 12 to 24 months, contingent upon project complexity, financial sourcing, and requisite approvals - generally proceeds as follows:
1. Project proposal and pre-feasibility study
2. Review meeting of all associated local officials
3. Initial approval by the appropriate-level planning commission, trade commission, or finance bureau
4. Completion of feasibility study and EIA
5. Second review meeting of all associated local officials
6. Feasibility study approval
7. Project implementation

For a detailed discussion of the approval process, as well as of project financing, see the U.S. and Foreign Commercial Service's Environmental Project Approval and Financing in China: A Perspective for U.S. Companies.

For up-to-date information on customs regulations and procedures, import documentation, finance regulations, economic and market information, laws and procedures for licensing and investment, and U.S. government regulations and restrictions, see the China - Country Information section of the U.S. Department of Commerce's International Trade Administration Web site (www.trade.gov/td/tic/) and consult the U.S. Embassy's Country Commercial Guide available online at www.usatrade.gov.

The following three documents published by the General Customs Administration of the PRC provide comprehensive information on Chinese customs regulations:
1. The Practical Handbook for Custom Clearance (March 2002; price: RMB 240; includes CD; Chinese only)
2. Customs Import and Export Tariff of the People's Republic of China (December 2001; price: RMB 220; Chinese and English)
3. Administrative Measures for Tariff and Import/Export Trade (February 2002; price: RMB 240; Chinese only)

All three books are issued yearly. They can be purchased from the General Customs Administration Bookshop, No. 6 Jiannei Dajie, Dongcheng District, Beijing 100730; tel. +86 (10) 6519-4173.

Facilitating Market Entry

U.S. Government Programs Facilitating Environmental Exports to China

There are several U.S. government programs that specifically support environmental exports to China. The U.S. Ex-Im offers several applicable programs. In addition, the U.S. and Foreign Commercial Service in Beijing assists exporters and facilitates adhoc arrangements with other federal- and state-level government agencies.

The Export-Import Bank of the United States. The Ex-Im has a number of non-environmentally specific short-, medium-, and long-term programs to support U.S. exports to China. Spare parts, raw materials, quasi-capital goods, consumer goods, and bulk agricultural commodities can be supported by the bank's short-term credit insurance policies, while capital goods and related services can be supported by medium- and long-term loan and guarantee programs.

Operational agreements between the Ex-Im and both the Bank of China and the CDB are in place. Several other banks can and do work with Ex-Im, and loans to other entities are considered provided they meet all necessary standards to the satisfaction of the Ex-Im and PRC law. Prior to October 2000, Ex-Im lending and finance relationships were mainly restricted to government entities. The bank now allows U.S. exporters and Chinese buyers of U.S. goods to apply for financing of private sector transactions.

The Ex-Im's Environmental Exports Program supports exporters of applicable goods and services as well as exporters involved in foreign environmental projects. The program includes the following elements:

A short-term environmental export insurance policy for small businesses, which offers as much as 95 percent commercial coverage and 100 percent political coverage with no deductible.
Enhanced medium- and long-term support for environmental projects, products, and services, including local cost coverage equaling 15 percent of U.S. contract price, capitalization of interest during construction, and maximum repayment terms allowed under OECD guidelines.

Foreign currency-denominated debt through the Ex-Im's medium- and long-term programs requires Chinese government approval, and final Ex-Im approval is contingent upon proper documentation indicating that this approval has been granted. The Ex-Im Web site (www.exim.gov) contains all pertinent details, as well as standards for environmental qualifications.

In March 1999, the Ex-Im, the U.S. Department of Energy, and the CDB signed a memorandum of understanding to initiate a $100 million clean energy program. Under the memorandum, the Department of Energy and Ex-Im encourage U.S. private industry to work cooperatively with Chinese planners in identifying, assessing, and implementing projects by which to showcase cost-effective and environmentally sound energy technologies. The terms associated with this fund are the most favorable that Ex-Im offers; however, it remains unused because local purchasers believe that the interest rates are too high.

Environmental Technologies Industries Office. The U.S. Department of Commerce's Environmental Technologies Industries (ETI) Office provides U.S. environmental technology enterprises with valuable resources and contact information pertinent to environmental markets around the world. ETI works collaboratively with the U.S. and Foreign Commercial Service in Beijing and other public and private organizations to monitor the market and to assist U.S. enterprises in market entry.

The ETI Office's China-specific resources are available online at www.environment.ita.doc.gov. The U.S. Department of Commerce's International Trade Administration offers assistance on more general aspects of trade. Information is available online at www.trade.gov/td/tic/.

U.S. Trade and Development Agency. In mid-January 2001, President Clinton lifted the suspension of TDA activities in China. TDA programs had been suspended in 1990 in line with the legislative reaction to the Tiananmen incident of 1989. The legislation permits the president to terminate the suspension if doing so is determined to be in the interests of the United States.

The TDA is an independent government agency charged with promoting U.S. private sector participation in projects based in developing and middle-income countries. The agency supports market development with pre-feasibility studies, orientation visits, training programs, and technical symposia focused on helping U.S. firms enter new markets. Prior to its suspension in 1990, the TDA committed approximately $24 million to projects in China. Over $1.4 billion in U.S. exports have been associated with those projects. Environmental protection is a focus for TDA in China. Information about TDA projects and activities is available at www.tda.gov.

Monitoring and Consulting for Market Entry

Several consulting firms in China monitor market-entry potential and specialize in bringing technology and service providers together with clients. However, the consulting sector is not saturated, and given the potential for growth, an increasing number of knowledgeable, experienced, and innovative specialists are needed. Consulting firms can select from several specialized approaches as follows.

Monitoring Multilateral Opportunities for Small Manufacturers. As noted earlier, bidding for multilateral projects can be difficult, particularly for small manufacturers and companies with little experience in tendering for such projects. Part of the difficulty stems from the necessity to monitor projects and prepare to bid from the very earliest assessment stages of project development. Keeping close watch over all the opportunities can be difficult, particularly for small operations watching for opportunities in more than one country. Another difficulty stems from the logistical challenge of bidding successfully, something not easily overcome by small companies with no experience tendering for multilateral projects.

Small foreign manufacturers could benefit from the presence of a small manufacturers' association or private consultants that would simultaneously monitor multilateral project development and the capabilities of small manufacturers bidding for such projects. The consultants might not only work to match potential clients with business opportunities but also assist in the bidding process for those manufacturers lacking the experience to manage the bid on their own successfully.

Local Assessments and Partner Facilitation. Given many EPBs' lack of clarity in assessing overall local environmental needs and efficient strategies to address them, ambitious and savvy consultants may find success by proactively approaching EPBs, comprehensively assessing the regional situation, and facilitating the implementation of environmental protection plans that can deliver the greatest impact possible, based on budgetary and social constraints. Such players would have the dual function of consulting for EPBs on the best overall abatement strategies and bringing appropriate technology and service providers into contact with the appropriate EPBs.

Consultants interested in such a scenario should look to various BOT and PPP projects currently existing in China as operational models, draw lessons from successful and unsuccessful implementation schemes, and consider undertaking pilot projects to illustrate their potential to local officials. Consideration should be given to which environmental issues in the region can be most effectively addressed for the lowest possible abatement costs. Efforts should be made to draw funding from diverse sources while simultaneously working to exploit opportunities presented by various programs (such as UNIDO's program to address the issues of town and village enterprises).

Consortium Development. Foreign investors might want to consider addressing potential projects through a consortium scenario. A consortium would ideally bring together planners, designers, engineers, managers, and financial support. Some European groups are currently experimenting with this model, with some degree of success. In effect, a consortium able to address issues within smaller cities travels to the cities (in the form of a traveling exhibition) and - through consultations and demonstrations - provides cost effective modular solutions, which include technology inputs as well as management tools.

Box 12 Market Development and Bilateral Assistance

Of all officially assisted environmental exports to China, approximately 60 percent are from Japan, 35 percent from Germany,
and less than 1 percent from the United States. Industries from countries with strong bilateral aid programs to China are quickly establishing significant market presence by capitalizing on opportunities generated by publicly funded development assistance programs.

Most end users of environmental technology and services in China have a tremendous need for guidance and consulting
regarding equipment manufacture and procurement, as well as general planning and management. Bilateral assistance programs providing this guidance often lead to opportunities for numerous types of contracts.

The U.S. Agency for International Development (USAID) remains inoperative in China. Economic support funds cannot be
used in China without specific legislation waiving sanctions imposed after the Tiananmen incident of 1989. Occasional sums
of money from the Department of Energy or the EPA are available to facilitate bilateral assistance. The recent reintroduction of the U.S. Trade Development Agency into China is a positive first step in addressing this issue.

Creating and Maintaining a Market Presence

Many foreign-invested environmental industries in China currently operate with small profit margins. Their initial purpose is to establish market presence and name recognition that facilitates future market expansion rather than to reap immediate profits. Creating and maintaining a market presence in China now could be vital to future success; however, it requires more than innovative products and a solid marketing plan. Firms without reasonable budgets, innovative personnel, patience, and solid relationships are unlikely to succeed.

Timing Market Entry

Establishing a market presence sooner rather than later is important for several reasons:

Many large firms already maintain strong market presence in several sectors. Some claim to hold as much as 50 percent of market share in their respective sectors. Name recognition is important in the Chinese market, and a select few are well established. Few markets are saturated, and opportunities arise for those well positioned to exploit them.
Those hoping to introduce relatively innovative methodologies and technologies need to prove their feasibility to convince local planners and enterprises of their worth. Pilot projects can be useful in doing this; however, it takes considerable time and effort to establish a sound operation. Having a strong pilot program in operation may be invaluable as the market continues to open and planners begin looking for the most effective and efficient methodologies to address particular issues. However, attempts to introduce unproven technologies into China are not usually welcome.
Understanding the market and key relationships is critical to success in China. As in most business climates, personal relationships and networks can open doors that otherwise would remain closed. However, in China, relationships are arguably more important than in other markets. It takes time to develop the connections and trust that good relationships are based on. As market opportunities increase in the near- to medium-term future, those most able to capitalize on the opportunities will be companies that have established a presence and have the proper connections to exploit them. It must be clearly understood, however, that relationships do not necessarily need to be with powerful national figures or those who claim to be such figures. Rather, through proper research, government functionaries who are reliable decision-makers can be found. Such relationships need to be nurtured and used gently.
Chinese guanxi (relationships) can be stronger than foreign guanxi, regardless of the quality of particular operations and products. Chinese companies with little or no experience or name recognition have won contracts over foreign competitors, seemingly based on guanxi. Therefore, the role of reliable Chinese personnel in local operations is critical in order to understand the politics of such relationships, which appear totally mysterious to most U.S. business people regardless of their experience or business acumen. A longer-term in-country presence provides ample time to bring such local players into an enterprise and fully train them in its intentions and operations.

Box 13 Seeking Market Representation and Entry Facilitation

Exporters and foreign investors entering China's environmental protection market are often directed toward one or more of a variety of Chinese environmental protection foundations or societies, or governmental research and policy institutions. These institutions, such as the China Environmental Science Society, the China Environmental Protection Foundation, and even Agenda 21 and the CRAES, are not ideally positioned to assist foreign investors in entering the market. Some are research institutions with no commercial capacities, some are bureaucratic gateways designed to attract and absorb inordinate amounts of foreign capital, and almost all of them lack a sound understanding of commercial viability and the savvy to facilitate market entry successfully.

In contrast, an increasing number of Chinese industries and Chinese and international private consultants are available to
provide market analysis, partner facilitation, legal consultation, and numerous other commercially-oriented services. The best suited of these entities are usually companies that were founded in China by experienced expatriates or Chinese nationals with substantial international experience. They have an in-depth understanding of China's public and private marketplaces, extensive partnership networks with industry and government leaders at all levels, and well-tuned communication skills. Additionally, such entities benefit from a privatized commercial business orientation and a definitive separation from centralized planning and bureaucracy. Investors are advised to forgo, as much as is possible, any dependence on cumbersome bureaucratic obstacles and to seek out private entities with the capacity to streamline bureaucratic interactions and facilitate market entry by commercially-oriented means.

Investors should not, however, be misguided into believing that analysts and consultants based in Hong Kong or Taiwan
are tantamount to such entities based on the Chinese mainland. The Taiwanese and Hong Kong marketplaces are separate entities from China. Operators based there are also, in essence, foreign investors. Enough capable and experienced facilitators operate with extreme dexterity within the mainland; little logistical or financial incentive exists to seek consultation from outside sources.

Opening Doors

Those having difficulty breaking into the market or establishing a pilot program might consider donating a piece of equipment or services to a wholly Chinese-initiated project. Many Chinese environmental initiatives are hard-pressed for financing and equipment and could benefit greatly from financial and technical support. The Chinese partner's successes may in time open doors and help establish valuable connections for the foreign partner, particularly if the Chinese entity is contracted to implement its scheme on a larger scale and subcontracts the foreign entity as a supplier.

This approach, however, requires extreme caution. As a single example, one French company attempted the strategy by donating a piece of equipment to a Chinese firm establishing a pilot program. The expectation was that the French company would be contracted to provide the equipment if the Chinese firm developed a commercial project. Instead, the Chinese firm simply reverse-engineered the equipment and facilitated its delivery through other means.

Dispelling "Neocolonialism"

Chinese planners are wary of anything resembling "neocolonialism," fearing that foreign investors will profit while not contributing to the overall advancement of the locality. Investors working with local planners may find that offering training and high-level positions with good wages to local hires, as well as various tangential initiatives such as the renewal of public space, supporting local education, and furthering overall social advancement, will ease such concerns.

Selected References and Web Sites

References

Cao Dong and Sun Rongqing. Environmental Financing in China: A Review. Beijing: CRAES, SEPA, November 2000.

U.S. Department of Commerce International Trade Administration, Environmental Technologies Industries Office. Partnering in China's Environmental Sector. Washington, D.C.: U.S. Department of Commerce, 2001.

General Customs Administration. The Practical Handbook for Custom Clearance. Beijing: General Customs Administration, March 2002.

General Customs Administration. Customs Import and Export Tariff of the People's Republic of China. Beijing: General Customs Administration, December 2001.

General Customs Administration. Administrative Measures for Tariff and Import/Export Trade. Beijing: General Customs Administration, February 2002.

Stover, Jim, Justin Harris, and Christopher Adams. Hard Currency Financing for Environmental Projects in China, International Market Insight. Beijing: U.S. and Foreign Commercial Service, August 1999.

Wang Jinnan, Wu Shunze, and Luo Hong. Integrating Economic Development and Environmental Protection in China During the 10th Five-Year Plan Period. Beijing: CRAES; November 2000.

U.S. and Foreign Commercial Service, Beijing. Environmental Project Approval and Financing in China: A Perspective for US Companies. Beijing: November 2000

Web Sites

BuyUSA: www.buyusa.com

China Economic Information: www.cei.gov.cn

China Online: www.chinaonline.com

State Statistics Bureau: www.chinastatistics.com

U.S. Department of Commerce: www.doc.gov

U.S. Department of Commerce, International Trade Administration, Office of Environmental Technologies Industries:
www.environment.ita.doc.gov

U.S. Embassy, Beijing: www.usembassy-china.org.cn

U.S. Embassy, Beijing. Country Commercial Guide: China: www.usatrade.gov

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