Chairman’s Report on the AeA Trip to China
April 12 – 14, 2005

Dear Fellow AeA Executive:

I had the pleasure of leading the fourth annual AeA Trip to China as the Chairman of the AeA Board of Directors and can report that we had another very successful excursion. In reviewing the trip at dinner on our last night in China, our member company executives all agreed that the trip was well worth the investment of time and money and that AeA should plan on continuing this program next year. 

Whether you have been to China many times, as I have, or are coming for the first time, this AeA trip offers insights into the rapidly changing economic environment in China that are important to every U.S. high-tech company. Several of the members of the delegation had been on earlier AeA trips and came back this year to take advantage of the contacts, information, and customer building opportunities it provided. For first-timers, like Dave Ness, CEO of Hardy Instruments, the program opened his eyes to tremendous growth potential in the China market. Dave had this to say about the trip:

"My expectations for the AeA China Trip were substantially exceeded. I expected to have an introduction to China and a glimpse of how to do business there. I did not expect to walk away with a game plan of how I'd take my company to this market. The meetings arranged with government officials, consultants, and operating companies were superb. The many discussions held between delegation members who are already doing various forms of business in China was priceless. The rules are changing so fast in China that the only way to get the straight story is to go there and talk with those that are doing business, rather than listen to those who claim to know how over here in the U.S.. I also thought this would be a one time event for me, but I'll be back next year, to keep up with changes and to make more contacts to help me in my business." 

The delegation met with a variety of high-level Chinese government officials, including Ministry of Commerce Director General HE Ning, Shanghai Vice Mayor YANG Xiong, as well as the U.S. Ambassador to China, Clark “Sandy” Randt and his staff. We also met with a variety of China experts, businessmen, lawyers, consultants, American expatriates, and journalists who spoke about the challenges and opportunities for U.S. companies doing business in China. 

In summarizing our trip I will focus on some of the key highlights and insights rather than providing a chronological report.

• China’s Economy: China continues to enjoy growth rates in excess of 9 percent per year despite efforts by the government to slow growth through various administrative measures aimed at restraining investment. By 2040 it is estimated that China’s GDP will match or surpass that of the U.S. While sustained growth is essential to continued job creation in China and maintaining social stability, concerns remain with the weakness of the banking system and the quality of the investment activity. 
  
• China’s Political Situation: On the day some of us arrived in Beijing, 20,000 people were protesting at the Japanese Embassy a block from our hotel. During this same week, Premier WEN Jiabao met with the Prime Minister of India and touted a fundamental shift in China-India relations. In March, an anti-secession law, aimed at Taiwan, was passed by the National People’s Congress. Interestingly, our local experts had somewhat differing views on what these various events said about the current government. Some felt that President HU Jintao is still in a very weak position and is using nationalism as a tool for maintaining control and building stronger public support for his regime. They felt that the lack of cohesive leadership was slowing down economic reform even though the country needs quick action to fix its financial, legal, and capital markets systems. Others felt that he has moved more quickly to consolidate his position than his predecessor. They also pointed to the progress he has made in the area of foreign policy, especially overcoming earlier fears of many Southeast Asian countries that China posed a threat rather than an opportunity (e.g., the India visit). Our speakers seemed to agree that this government is working to rebuild the authority of the Communist party through much tighter control in a range of areas. Earlier hopes that HU would be a reform-minded leader and move China towards a more democratic approach to government have been put to rest. Social stability is their primary objective.
  
• U.S. – China Relations: Secretary of State Rice had just recently visited China and relations between the U.S. and China are, at one level, as good as they have ever been. The U.S. is looking to the Chinese government for help in managing the North Korea situation and they share common concerns with global terrorism. On another level, however, tensions are festering over the anti-cession law aimed at Taiwan, China’s growing trade imbalance with the U.S., and U.S. efforts to stop Europe from lifting its arms embargo against China. While the rapid growth of China’s economy has been apparent for many years, it seems that many in the U.S. are just now starting to grasp the enormity of the impact that China will have on the global economy and its political implications. Both governments are grappling internally with debates over how to deal with the other from a long-term strategic perspective.
  
• China’s WTO Compliance: China continues to open markets and take steps to comply with its WTO commitments, but it also continues to look for ways to protect local industries or impede foreign business (especially in the high-tech sector). For example, the issuance of 3G licenses continues to be delayed as the government hopes to make its own standard, TDSCMA, viable. The proposed software procurement rules are designed to promote the Chinese software industry. Some in the Chinese government continue to press for adoption of the Wireless LAN Encryption Standard (WAPI) standard that would favor local companies. The U.S. and other countries may increasingly turn towards the WTO dispute mechanism if China continues to develop protections for local companies. However, some of the technical or regulatory standards issues can be difficult to pursue in the WTO.
  
• Intellectual Property Protection: Ambassador Randt highlighted the ongoing challenge of protecting intellectual property in China. Earlier in the year he had organized an IPR Round Table and he noted that Secretary of State Rice had raised the issue in her meetings with Vice Premier WU Yi. The U.S. government is trying to establish some benchmarks for measuring China’s progress in this area and welcomes specific examples of piracy or counterfeiting from U.S. companies. In our meetings with the Ministry of Commerce, they acknowledged the importance of the IPR issue and assured us that Chinese technology companies share our concerns. While the Director General and his staff outlined the steps taken to date by the Chinese government, such as the recently issued Judicial Interpretation and the national working group set up by WU Yi, our group was not convinced that the issue is being effectively addressed through aggressive enforcement. This concern was confirmed in our discussions with the Allbright Law Firm. The lawyers believe the laws are good but regional protectionism, lack of coordination among administrative authorities, and lack of precedent undermine enforcement. They urged every U.S. company to establish an IP protection plan that included, among other things, a strict confidentiality system for employees, non-competition clauses, maintainence of IP registrations, and regular checking of the market to enforce IP rights. 
  
• Government Procurement of Software: The week before we arrived in China, the government issued draft regulations for government procurement of software that would effectively exclude most U.S. companies from qualifying for the “domestic software” preference. We raised our concerns with MOFCOM in the context of China’s commitment to begin negotiations to join the WTO Government Procurement Agreement as soon as possible. While MOFCOM is not the primary ministry on procurement, they acknowledged that they would not want to enact a law that would later have to be changed and invited us to provide comments on how the proposed rule would not be consistent with the principles of the GPA. 
  
• Distribution Rights: Many U.S. companies are interested in distribution rights and China’s WTO commitments provide for this. But one member of our AeA delegation has had trouble getting the local authorities to accept his application for a distribution license and raised this with MOFCOM. We were assured that current policy allowed for him to obtain a license to distribute directly to Chinese wholesalers. When we also raised this with Shanghai Vice Mayor YANG, he turned to his staff and asked them to work with our member to address this issue. 
  
• China’s Energy Policy: Jim Brock, an energy expert in China, gave our group much to think about regarding the rate of change in energy consumption in China which he expects to double every 7 years. The country is currently using 2 billion tons of coal and that will increase to 3 billion tons of coal per year by 2010. The Chinese currently use one-fifth of the energy per person used in the U.S. If the country moves to just the world average, this will require a massive increase in energy use and have a dramatic impact on the environment. The government is adding capacity at a rapid rate but another expert, Ben Gunn of Sinosphere, believes many regions in China will be short of power for years to come. When visiting the Agilent facility outside of Shanghai we learned that they have had to negotiate with the government over reductions in energy use. Since the coal is in western China, some companies are moving into these regions to be closer to the energy. The cost of energy will be a significant factor for new investors to consider. 
  
• China’s Environment Policy: The increase in the number of cars throughout China and the burning of coal are just two of the factors contributing to an already problematic air pollution situation in China. The government has adopted an alternative energy law to address the terrible acid rain costs of coal consumption, but we heard from Ben Gunn that many local companies find it cheaper to pay the fines than invest in clean technology. He also noted the lack of enforcement of environment policies when set against the competing interests of economic growth, job creation, and social stability. This problem is accentuated by local government interference and the lack of enforcement capacity. However, to make us feel better, he noted that enforcement is often better against foreign companies. Ben added another note that got the attention of our executives – under Chinese law managers are personally liable for pollution violations. There is no corporate shield. 
  
• China’s Workforce: George Hu with Sterling HR Management Consulting Co., Ltd and Bill Gu with Shanghai Korn/Ferry Human Capital Consulting Company Ltd., confirmed that it is still hard to find good mid-level managers in China. In fact, many multinational companies are slowing down their process for localizing management because of the lack of qualified managers. They also noted that it is hard to find a local Chief Financial Officer with strong financial data analysis skills. Overall, salaries for mid-level managers increased about 8 percent over the past year and retention is an ongoing challenge for all companies as poaching of good talent is prevalent. 
  
• China’s Business Opportunities: In visits with CCID Consulting Co., Semiconductor Manufacturing International Corp. (SMIC), and Shanghai Zhangjiang Hi-Tech Park, we caught a glimpse of the potential of the high-tech industry in China. CCID projects that the IT hardware sector will experience a compound annual growth rate of 13.1 percent through 2009. Over the same period, the software sector will grow at a rate of 19.8 percent and IT services will increase at a rate of 23 percent per year. SMIC projects that demand in the China IC market will be $88.8 billion by 2008 but local production will only amount to $6.5 billion. China is working to rapidly build its IT capabilities through the creation of numerous high-tech parks such as the Zhangjiang Hi-Tech Park we visited in Shanghai. The 25 square kilometer park includes hundreds of companies working on projects in the areas of software, bio-tech, semiconductors, optical electricity, digital content, and information security. The park, which employs over 46,000 people, reflects the strong support of the government and provides several advantages for potential investors such as: a complete high-tech industry chain; integration of industry, universities, and an R&D system; access to venture capital and government funds; and one-stop service for incoming projects. 
  
• Doing Business in China: Dave Willet of Agilent, who has been managing their facility outside Shanghai for several years, shared with the group his recommendations for a U.S. company operating in China:
  
• Establishing a local presence will lead to faster growth and better understanding of customer needs.
• Vision, leadership, and organizational “will” are critical to overcoming organizational inertia.
• Set clear management expectations with integrated plans, measurable goals, and accountability.
• Keep in mind that China is “strategic” and don’t apply all the same measures as in the developed world.
• Invest in relationships with government, customers, and others.
• Site selection: do your research, look at the track record, and talk to other companies.
• In China: “Everything is possible, everything is difficult”.
  
• Conclusion: China’s economy will continue growing at an impressive rate for the foreseeable future and U.S. high-tech companies need to be in this market to remain globally competitive. Participating in the China market is not without risks and challenges that require on-the-ground involvement of senior managers. In addition, you have to go to China to fully understand the scale of changes and to keep abreast of the pace of change in the country. This rapid economic development will have a major impact on the global political and economic situation with implications that many political and business leaders are just starting to appreciate. 

Since I could only briefly summarize the wealth of information we received over our three days, a number of the handouts and presentation materials from the trip are available on the Members-Only side of the AeA website. You may also view the trip itinerary. 

I would like to thank the participants on the trip. The discussions among the group, sharing their own experiences in China, were as valuable as the exchanges we had with the people we met in China. If you have not made this trip before, I strongly recommend that you participate next year. If you participated in an earlier AeA China trip, it is time to go back and see how quickly the country is changing.

View Pictures from the 2005 China Trip  ||  Read the Chairman's Report for the 2004 Trip

Upcoming China Event
Practical Insights on China:  Opportunities and Challenges
July 21, 2005 in Massachusetts

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