Free Business Essays - An analysis of the impact of entry of China into the WTO on the strategies of Chinese Small and Medium sized Enterprises (SMEs)
Executive Summary
China's market reforms and accession to the WTO has led to its economy growing rapidly, to the point where it is now the fourth largest on earth, and is expected to be in the top two within the next decade (Business Monitor International, 2006). As a result, China's SMEs are now facing an economy flooded with foreign capital, and with a more open economic climate than in previous years, but also a much more competitive economy, where many of their previous practices are no longer relevant. This piece aims to examine the effect of these changes on the strategies of Chinese SMEs by first examining the role of the SME in the economy, then analysing the strengths and weaknesses of the Chinese SMEs, and the opportunities and threats that have arisen from China's WTO membership. The piece will then examine Chinese SMEs from a strategic perspective, and the impact the the WTO membership has had on said strategies. Finally, the piece will give strategic recommendations for Chinese SMEs that wish to take advantage of the opportunities that WTO membership offers, and also for those SMEs that wish to avoid the challenges it poses.
The Role of SMEs in both the International Perspective and the Chinese Perspective
Academics have long realised that small and medium enterprises grow to become the major corporations and businesses of the future (Davis et al., 1985). As a result of this view, greater attention has been given to the role of small and medium sized enterprises (SMEs) in contributing to the economic growth of countries over the past twenty years in countries all over the world. Due to the importance of the role that SMEs play, for the last 15 years governments have urged by academics, economists and policy experts to take strong and deliberate actions to accelerate small business development (Hung and Rondinelli, 1993, p. 20). Indeed, for rapidly growing emerging economies, SMEs can play a pivotal role in a country's economic development, making the difference between the economy surging forwards or stagnating (Hill, 1995).
This is particularly true in Asian nations, such as China, where the more developed and newly industrialised nations are seeing the rate of economic growth start to drop off, and are increasingly counting on the SMEs to maintain steady economic growth. Also, many of the 'tiger' economies of East Asia are looking to their SMEs to prevent their economies being over reliant on foreign direct investment and the activities of multinational corporations, as these factors are often outside the control of the government. However, at the same time, as the developing economies become more open to the global markets and economy, they face increased competition of foreign investment, and will often look to SMEs to help attract and channel this investment (Siu, 2005).
Separately, regardless of the state of a country's economy or its reliance on international trade and investment, research by Acs (1996) has shown that the strength of the SME sector is a major factor in economic development in its own right. This factor has been observed and analysed in China (Department of Small and Medium-sized Enterprises of State Economic & Trade Commission 1999; cited in Siu, 2005), and is reflected in the fact that SMEs in China not only dominate and help determine the strength of the Chinese economy in general, but also contribute significantly to increased levels of affluence, business activity, and employment in their respective region within China (Siu, 2005).
Indeed, such is the importance of the role of SMEs in the Chinese economy that the government passed the SME Promotion Law in 2003; which provides support, and defines the Chinese government's rationale for providing support for small and medium enterprises One major change resulting from this law is the creation of support systems and networks and enabling institutions for the small and medium enterprises at the municipal level of government (Atherton and Fairbanks, 2006). This law was the latest in a series of developments aimed to promote the role of SMEs in the Chinese economy since the turn of the century, and shows that the government appreciates the role SMEs will play in China's economy, and the implications of providing government support for these companies.
Potential Challenges and Opportunities Chinese SMEs face after WTO entry
Following entry to the WTO, the Chinese government increased the level of protection and support it provided to the private sector and SMEs; this has led to many growth opportunities for SMEs, and made the private sector the most dynamic in the Chinese economy. Indeed, WTO membership has helped increase the speed at which the Chinese government has adopted a series of reform measures aimed at changing the country from a highly-centralized planned state to a socialist market economy. This has thus given SMEs an increased role: one that is socio-political as well as economic (Anderson et al. 2003). This has led to increased opportunities due to the large number of national and local newspapers and publishers that are arising from China's growing economy and importance on the world stage. Indeed, news reports, stories and articles about successful Chinese entrepreneurs and SMEs are frequently headline news in many local newspapers (Siu, 2005), which not only encourages further entrepreneurship, but also encourages Chinese citizens to use their local SME, ahead of foreign competitors.
Indeed, one of the greatest opportunities available to SMEs following China's WTO reforms is that the Chinese state now only controls the macro economy, and the micro economy is controlled by the private sector, which is dominated by the SMEs. Indeed, Tan (2001) commented that the reforms required by China to secure WTO entry meant that Chinese SMEs managed to better target niche sectors, thus they gained the opportunity to develop specific strategies which give them much more opportunities than the large state owned enterprises. However, government planning still affects the micro economy, due to interference in some market activities, the activities and aims of the political and economic institutions set up by the government, and the government ability to control the SME incentive systems, which in turn can control its behaviour and performance. These can provide challenges to SMEs, as can the government policies that continue distort the market by using subsidies and directives to guide production based on what is good for the state, not the firm. As a result, Chinese SMEs are operating in a market where their performance is not just determined by their actions and the health of the market economy, but also by government intervention and other institutional factors (Li 1998). As a result, government intervention is still a major force among Chinese SMEs, and is a major challenge facing them when they attempt to benefit from China's WTO membership.
A further challenge may arise from the expiry of the Multi Fibre Arrangement (MFA), the system that restricts imports on clothing and textiles. Control of the textile trade was brought under the WTO when this arrangement expired. As a result of the expiry of this arrangement, China's export volume within the textile and clothing market began growing rapidly, growing by over 100% in the first year (Business Monitor International, 2006) However, this growth led to China being the target of EU and US policies designed to limit the growth of Chinese textile imports to these two economies. These policies created yearly quotas, resulting in an export war by Chinese businesses eager to fill as much of these quotas as possible. As a result of this massive growth and the resultant issues with the quotas, there is a risk that the WTO may implement measures to slow the growth of the Chinese textile and clothing industry, and may apply similar measures to other booming Chinese industries (Business Monitor International, 2006).
Potential Strength and Weakness of Chinese SMEs
The major potential strengths and weaknesses of the Chinese SMEs are very similar to those of the Chinese economy as a whole. The main strength of the Chinese economy is that the company possesses the largest supply of cheap labour in the world, giving it major cost efficiencies and attracting the largest amount of foreign direct investment of any country in the developing world (Business Monitor International, 2006). In contrast, the main weaknesses of the Chinese economy is that, due to the extensive government intervention in the market, many of its major trading partners claim that the country doesn't have a market economy. This, combined with the counties perceived poor protection of intellectual property and lack of respect for patents, makes it easier for other countries to impose anti-dumping duties and other protectionist policies, such as the textile quotas mentioned above. This is a major weakness for many SMEs, as it inherently restricts the extent to which they can aggressively grow their export business.
However, as a result of this weakness, privately owned SMEs in China have learnt to respond quickly to environmental changes and challenges (Tan 2001), and also to develop extensive personal contact networks (Siu 2001), giving them a competitive advantage over their large, state owned and foreign multinational counterparts. Indeed, many Chinese SMEs have developed significant personal contact networks, and these are their primary forms of marketing. Indeed, the personal contact network, or network marketing concept, is actually one of the concepts most commonly applied entrepreneurial growth around the world (Johannisson 2000).
A further advantage of SMEs is that, during the economic reforms of the 1980s, the Chinese government devolved large amounts of market decision making power to enterprises, and gave them greater control. This released resources to the market, but only gradually, thus whilst large enterprises were often unable to secure the resources they needed to grow, SMEs were often able to use their contact networks to access all the materials they needed. Furthermore, under the two-economy system (Malik 1997), the government retained responsibility for strategy in the development of heavy industry, thus further hampering the activities of large corporations, and leaving the Chinese SMEs to dominate the labour intensive smaller consumer goods markets. This further enhanced the ability of the Chinese SMEs to rapidly read and respond to signals from the market; and to create new products and brands to differentiate themselves in the emerging market segments (Siu 2001). Indeed, some Chinese SMEs exploited these opportunities so successfully, that they have followed Davis et al's (1985) model, and developed into large firms that produce and export national brand products.
However, this focus on relationship marketing has led to many Chinese SMEs placing significant emphasis on establishing various relations with customers, buyers, suppliers, government institutions and various middle men. Whilst this is consistent with Chinese cultural values, it has led to many Chinese SMEs tending to carry out minimal long term strategic marketing planning, which places them at a disadvantage when compared with other, more meticulous, firms (Lee et al, 2001). Furthermore, as the SMEs attempt to build stronger marketing strategies, involving brand development, promotion, and the gathering of market information, they frequently encountered problems due to government intervention; both specific instructions from institutions and general changes in policy (Siu et al, 2006).
A final weakness is that, whilst Chinese SMEs have started to build their e-commerce infrastructure and to create online offering, they are still weak in actually conducting successful e-commerce transactions; largely due to the inherent barriers in the market, together with legal and cultural issues In addition, different market sectors, including manufacturing, retail and financial services, are pursuing differing internet strategies, leading to confusion amongst consumers and the lack of a common technological platform (Tan and Ouyang, 2004). Similar confusion arises due to large state owned firms and SMEs having different e-commerce strategies and technologies, and the SMEs are at a significant disadvantage here, as the government policies are designed to support the state owned enterprises.
The business strategic perspective on Chinese SMEs
Chinese SMEs have long found themselves in a difficult situation, as symbols of capitalism in a country where socialism has been the dominant ideology for fifty years. Indeed, the concept of private business, such as SMEs, was seen as socially and culturally unacceptable in China, even after Deng Xiaoping's economic reforms (Siu, 2005). As such, Chinese SMEs have had to adapt to an uncertain political, social and economic environment, which could easily turn against them at very short notice. As a result, Chinese SMEs have adopted a strategy of defining themselves using terms like collective enterprise, joint venture, small collective business to gain fiscal benefits and political acceptance (Malik 1997). Whilst this strategy enables Chinese SMEs to avoid political penalties, the unwillingness and inability to define themselves as business enterprises means that Chinese SMEs often lack access to the formal financial market, and they thus have to look for specialist financial institutions, which may be unlicensed and offer very poor credit terms.
Alternatively, to save costs, some SMEs pursue a strategy of using municipal and county governments to access the resources provided by the local community, including land and buildings. As their access to resources are so limited, some SMEs also pursue the business strategy of building relationships with other entities, such as forming joint ventures with multinational corporations, acting in partnership with large firms, assisting research institutes or universities, or forming SME collectives enabling the firms to pool their resources and technology. Indeed, Siu (2001) argues that, due to the influence of Chinese government policies and cultural values, Chinese SMEs need to focus their strategy using their contact networks in order to acquire new resources and develop their business. Thus, in developing their business strategies, Chinese SMEs operate in a unique market based on informal relationships and substantial government intervention.
Siu and Liu (2005) tested these arguments through a study of the business strategies and marketing practices of over 300 SMEs in mainland China, and compared their finding with the practices of Hong Kong and Guangdong SMEs, which operate in a 'truer' free market economy. The study found that the majority Chinese SMEs often have a strategic focus on regional markets, as their relationship driven marketing is ineffective when competing with other SMEs in the international markets and even the Guangdong based SMEs in the Chinese national markets. Indeed, Siu and Liu (2005) found that very few Chinese SMEs possessed the necessary ability and desire to analyse the market and develop superior marketing strategies in order to compete in the global and national markets. However, whilst Siu and Liu (2005) found that Chinese SMEs generally fail to be as competitive as Hong Kong and Guangdong SMEs, they found that they pursued strategies of using customer relationship management in order to develop relationships, and ensure excellence in product performance. This is because, in the absence of sophisticated branding and market analysis, Chinese SMEs have learned to focus value-added products and services as part of a well rounded marketing strategy in order to gain market share.
As a result of their lack of sophisticated marketing skills and information, SMEs in China are increasingly viewing market research as an essential strategic activity, both to obtain marketing information and to develop sustainable competitive advantage. Indeed, many Chinese SME managers now require their staff members to monitor the product market and identify new products and developments. They also recognise the need to collect general market information and also continuously observe their competitors actions. They attempt to absorb useful product and marketing ideas and use them to build their reputation and service, whilst absorbing advanced technology and using this to build their business (Siu, 2005).
Another key aspect of the strategy of Chinese SMEs is the development, importance and pressures in human resource management (HRM) in the Chinese economy, and the corresponding impact on Chinese SMEs. Cunningham and Rowley (2007) examined research data on the pressures placed on HRM, the differences between Western and Chinese HRM, and how the practice is changing in Chinese SMEs. They found that many Chinese SMEs are moving away from historical Chinese HRM practices, and pursuing HRM strategies that combine western best practice examples with Chinese cultural characteristics and considerations. This demonstrates how many Chinese SMEs are pursuing a 'middle way' strategy, by trying to adopt enough capitalist practices to give them an edge in the market, whilst maintaining enough socialist characteristics to avoid any government or regulatory interference or penalties (Cunningham and Rowley, 2007).
An increasingly important consideration in for many of the SMEs in China is the extent to which they need to consider their reputation and public image, especially given the increasing concern amongst Western markets and consumers around sustainability. As the Chinese SMEs represent such a diverse segment of the Chinese economy, the extent to which different SMEs engage in corporate sustainability is a very complex issue. Yu and Bell (2007) examined how China's SMEs perceive and practice sustainability, and also looked at some of the main strategic drivers for environmental and social engagement, and some of the barriers. They discovered that many of China's SMEs displayed a high degree of social awareness and concern around social aspects, but were taking very few steps towards sustainability and social responsibility. They found that the most important motivator was a desire to improve the enterprise's corporate image, followed by increasing national and international government legislation, including WTO regulations. However, they also found several significant problems, including insufficient financial and other resources, a lack of perception around suitable actions to take, and insufficient external support from government and the market.
The impact of WTO membership on the business strategies of Chinese SMEs
The entry into the WTO in December 2001 has led to a period of further reform for the Chinese economy, based on the requirements the organisation has placed on China Whilst the Chinese economy is adapting quickly, and growing rapidly, the country is still facing pressure from several WTO members, most notably the USA, for failing to abide by some of the WTO requirements, such as reducing market barriers, and protecting intellectual property However, the Chinese government has repeatedly reiterated its commitments to improving the Chinese business environment, and developing a recognised free market economy. As part of this, the Chinese government has pursued several multilateral and bilateral free trade negotiations as a priority, signing deals with the EU in May 2000 and the US in November 1999 (Business Monitor International, 2006).
As a result, Chinese SMEs have been exposed to the effects of globalisation at a very early stage in the development of the overall economy. As such, many Chinese SMEs have begun pursuing strategies of internationalisation, an entrepreneurial strategy employed by many SMEs in developed economies. This strategy has focused on increasing the amount of foreign direct investment generated by Chinese SMEs, and has also increased the amount of exports from the sector (Jianguo, 2002). This activity, combined with the use of cooperative agreements and alliances among SMEs has lead to a dramatic increase in foreign direct investment flowing into the sectors of the Chinese economy that are dominated by SMEs. This is consistent with Lu and Beamish's (2001) finding that internationalisation strategies have a significant positive impact on SME performance if they successfully attract extra, targeted, FDI.
In accordance with this finding, many Chinese SMEs have been successfully attracting large amount of FDI, and thus their performance has increased significantly after some early difficulties. This is also consistent with Lu and Beamish's (2001) finding that when firms first begin actively pursing and attracting FDI, their short term profitability suffers, due to the firm diverting effort from its core activities. However, once greater levels of FDI are attracted, and the relationship has been combined with an exporting strategy, higher performance is achieved by the SME. Indeed, exporting helps drive the relationship FDI has with performance in the latter stages, as firms which attract high levels of FDI tend to experience higher profits than those with little connection to their target markets (Lu and Beamish, 2001). Indeed, when such a strategy can be expanded into an alliance with foreign partners, the sharing of local knowledge can be an effective strategy to overcome the deficiencies SMEs face in resources and capabilities, when they expand into international markets (Lu and Beamish, 2001).
An expansion of this partnering into the formation of full international joint ventures is another strategy pursued by some Chinese SMEs since China's accession to the WTO, and has given them an important strategic advantage among the other internationalised Chinese SMEs. Partnering strategies in the formation of international JVs have been found to have significant positive benefits for SMEs attempting to expand their offering to the international markets. Lu and Beamish (2006) conducted a study examining how the two types of resources contributed by each side of an international joint venture: local market knowledge and financial and other resources, impacted on the performance of the overall JV. Whilst their sample was based on international JVs established by Japanese SMEs, they still have explanatory power for the choice of the same strategy by some Chinese SMEs.
The study revealed that SMEs' international JVs with partners in countries around the world were often associated with decreases in the longevity of the relationships between the two partners, especially if the two sides to the agreement were able to use the JV to acquire local market knowledge. This implies that many SMEs do not see an international joint venture as a long term strategy, but as more of a method of entering new markets and attracting investment, whilst sharing the risks. The study also showed that the amount of experience of the partners in the JV did not have any direct effects on the venture's profitability, but that JVs between more experienced companies tended to be shorter in length (Lu and Beamish, 2006). Again, this implies that Chinese SMEs may be using international joint ventures as a way to establish a presence and obtain knowledge about the local market conditions. Hence, the more experienced the SME the greater the rate at which it can assimilate local knowledge and create its own local presence. Once the SME has assimilated enough information about the market to create its own venture in the market, the need for the joint venture disappears, as does the venture itself.
Another strategic move for Chinese SMEs has arisen from the fact that China is gradually opening up some of its major industrial sectors, which have previously been dominated by state owned enterprises, to foreign competitors. Tianji et al (2004) examined one of these sectors, the engineering construction services sector, and the impacts on this sector from China's WTO accession. They found that China's entry to the WTO, and the associated commitments it made, presented a threat to the large state owned enterprises, which were forced to significantly restructure their organizations to cope with the increasing competition. However, the market reforms also opened up the sector to SMEs to enter, mainly through joint ventures with foreign firms. These joint ventures enabled many Chinese SMEs to gain access to both the financial investment they needed and also the necessary engineering and management expertise to compete with the state owned incumbents (Tianji et al, 2004). Indeed, given the booming nature of the Chinese construction industry, this is arguably one of the single biggest strategic opportunities created for Chinese SMEs by the WTO entry.
The entry to the WTO has also had a significant impact those Chinese SMEs that were already incumbent in the construction sector, as these firms have also been forced to compete with a significant amount of foreign competition, whilst dealing with the challenges associated with the restructuring of the sector. Research has shown that, rather than taking the short term, relationship driven, marketing approaches, Chinese SMEs in the construction sector have been forced to look towards long term differentiation sophisticated marketing strategies, and a greater investment in research and development in order to increase their business performance and grow their market share (Tang et al, 2007). Tang et al (2007) further found that a focus on current products, a preoccupation with the impact of government policy, conducting regular market research, firm size measured by number of employee number, having a few regular suppliers, and having a wide range of high quality products were not significantly associated with business performance.
As such, these results show that Chinese SMEs in the construction sector, and the wider economy as a whole, need to adopt long term differentiation strategies, with a focus on R&D and new product development, in order to succeed in the modern Chinese economy. Indeed, competitive measures such as these have long been seen to be vital for small firms to adapt to the increasingly competitive business environment in the global economy (Porter, 1998), of which China is now a part. However, whilst the need for Chinese SMEs to develop their research and development functions, in order to drive new product development, is clear; the best ways for them to do that is not. Indeed, many researchers have highlighted the importance of the new product development practices of Chinese SMEs, and how firms themselves need to better understand the process by which they bring new products to market (Siu et al, 2006). Many Chinese SMEs have admitted that they do not have clear plans or practices for managing their new product development practices, which represents a significant strategic challenge, given the research and development and marketing capabilities of many western firms.
China's WTO entry has also impacted on the government's policies of directing foreign direct investment towards encouraged industries and regions, and the various incentive schemes designed to drive investment in high-tech industries and in the more deprived central and western parts of the country (Business Monitor International, 2006). Directly following the WTO entry, the Chinese government produced a new list of areas and sectors where foreign investment was encouraged, together with those where it was restricted or prohibited. The list has been refined in order to abide by the promised market reforms and liberalisations that were part of the WTO agreements, and have opened up the banking, insurance, petroleum extraction and distribution sectors. For example, as a result of these agreements, foreign investors can now invest in Chinese banks, however investors cannot hold more than 20% of the shares, and the combined foreign shareholding cannot exceed 25 percent (Business Monitor International, 2006).
This has created several challenges and opportunities for Chinese SMEs. It has meant that wholly owned foreign subsidiaries are now the most popular entry route for investors. Whilst this has taken some foreign direct investments away from Chinese SMEs, it has also created significant opportunities for them to advise and partner with these foreign subsidiaries, which can give the SMEs access to both revenue and expertise. Also, even after the WTO accession, the policies and investment incentives are still strongly focused on the Special Economic Zones, which were developed over the two decades preceding WTO entry (Ng and Tuan, 2003). As such, SMEs have the ability to make a strategic decision regarding whether or not they position themselves in the Special Economic Zones and operate in the encouraged sectors of the economy. Should they choose to operate in said sectors, they will gain the benefit of increased foreign investment, and the exposure to the more advanced marketing and product development techniques needed to compete in the global economy. However, should they decide to avoid these sectors, they will benefit from less foreign competition, and also from the fact that many businesses are abandoning these sectors in an attempt to attract foreign investment (Ng and Tuan, 2003).
Whilst conventional wisdom states that SMEs should look to enter the largest and fastest growing markets, and attempt to secure niche markets for themselves, Yeung's (2002) examination of Guangdong province, one of the best known of the Special Economic Zones, provides some evidence to the contrary. Yeung investigated the changing competitiveness of foreign financed manufacturing firms versus local firms, and the implications for the regional development in Guangdong. The study tested the argument that multinational corporations and some competitive, large-scale, locally-funded firms in Guangdong would overwhelm the SMEs after the WTO accession. (Bach et al, 2000) This process of 'crowding out' the SMEs had already begun at the time of accession, and has accelerated as the majority of the SMEs were forced to compete directly with the multinational corporations, whilst their competitive advantages and ability to move quickly in the marketplace were diminished by bureaucratic red tape and the new government policies designed to make the markets more competitive. As a result, Yeung argues that close business linkages with foreign finance enterprises is one of the key strategic factors for Chinese SMEs to consider as they looked to success in the modern Chinese economy
Recommendations for Chinese SMEs' to succeed
Yeung's (2002) advice to Chinese SMEs operating in Guangdong, and the other Special Economic Zones, is one of the core recommendations that this piece makes to Chinese SMEs looking to successfully take advantage of China's WTO accession. The majority of Chinese SMEs have survived in the somewhat insulated Chinese social capitalist economy by using informal networks and relationships as their primary methods of marketing (Lee et al, 2001). Whilst these strategies have enabled many Chinese SMEs to compete effectively with their state owned counterparts, and have resulted in some SMEs growing to challenge said enterprises, they are unlikely to prove successful when attempting to compete with sophisticated Western firms, with advanced marketing and product development strategies.
Indeed, Chinese SMEs are so lacking in the required resources and capabilities needed to analyse markets, differentiate themselves from their competitors, and develop viable new products, that they are at risk of losing their market share in the more competitive 'encouraged' sectors (Bach et al, 2000). As a result, if they attempt to go head to head with the foreign backed multinational corporations, they face being completely obliterated by the marketing power of these firms. However, the multinationals are still at a disadvantage, in that they are unfamiliar with the Chinese markets and the bureaucracy and regulations associated with said markets. As such, there is a significant opportunity for Chinese SMEs to partner with foreign multinationals, allowing both sides to obtain knowledge, expertise and resources from the other (Lu and Beamish, 2006). The partners in the joint venture, or other arrangement, can take advantage of the other's unique knowledge and perspective to grow their own skills and resources, until they have reached a point where they can compete in the market on their own.
Another option for Chinese SMEs who are unwilling or unable to partner with foreign firms is to avoid the Special Economic Zones and the 'encouraged' sectors as much as possible. As other SMEs and state owned enterprises rush to grab market share in these rapidly expanding markets, they are like to devote less effort to their share of their existing markets, enabling opportunistic SMEs to expand in other areas of the economy. This is possible in China because the rapid increase in the country's overall prosperity means that almost all sectors of the economy are growing (Business Monitor International, 2006). As such, SMEs can take advantage of the fact that most attention is focused on the major 'encouraged' markets, and can instead build profitable niches in the less attractive, but still growing, regulated markets.
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