Chairman’s Report on the AeA Trip to China
April 4 - 6, 2006

Dear Fellow AeA Executive:

For the fifth year in a row AeA organized a trip to China for senior executives from member companies that provided invaluable insights into the economic and political environment in the country as well as practical tips on doing business in China. As Chairman of the Board of AeA, I had the honor to lead this delegation for yet another very busy and successful program of meetings, briefings and facility tours.

Having participated in three of the five AeA China trips, I can say that each trip provides new information, contacts and experiences. This was particularly true this year as the group traveled to Shenzhen for the first time. Everyone in the delegation was impressed with the reception we received in Shenzhen and the positive environment for high-tech business in one of the first economic zones in China. Our visit to ZTE, one of the largest domestic high-tech companies in the country, opened our eyes to the rapid advances they are making technologically and in terms of their international marketing.

During our visit to Beijing and Shenzhen we met with a variety of Chinese government officials, including Ministry of Commerce Deputy Director General Sun Peng, Deputy Secretary General of Shenzhen Municipal Government Li Ping, and Deputy District Head for the Nanshan District of Shenzhen Wang Ke Li. We also met with David Sedney, Deputy Chief of Mission at the US Embassy to China as well as a long list of China experts, businessmen, lawyers, consultants, and American expatriates who briefed us on the challenges and opportunities for US companies in China. Finally, we toured the Qualcomm Research and Development Center in Beijing, ZTE, and Chungnam Electronics.

In reporting on our trip I will focus on some of the key highlights and insights rather than providing a chronological blow-by-blow.

• China’s Economy: As it has for several years, China’s economy grew by over 9 percent last year and is expected to continue growing at close to that rate for 2006. The most recent 5 year plan calls for “sustainable development” and a “harmonious society” reflecting the desire to keep growing at a rate that avoids social tensions while protecting the environment.
   
• China’s Political Situation: Despite this sustained growth rate and the improved standard of living for many Chinese, we saw more evidence this year of internal struggles over the approach to the economy. As Jim Gradoville, President of United Technologies China, noted, some in China feel that reform has gone too far too fast. The government still faces the daunting task of taking care of the 500 million people who live on the land or are migrant workers. Many of these people do not have access to schools, health care, or living quarters. As a result, the key policy concern for the Chinese government continues to be social stability and it has been taking measures to deal with mounting frustration in the rural areas by, for example, eliminating a 2,000 year old farm tax.
   
• US – China Relations: We arrived in China at a critical juncture in trade relations between China and the US. Two weeks before, Senators Graham and Schumer had visited China and decided after their trip to postpone a vote on their bill that would impose a 27.5 percent tariff on Chinese goods imported into the US unless China adopted a more flexible currency rate. They concluded that the Chinese understood the economics of their currency approach and the need to move towards a more flexible exchange rate. They also gained a better understanding of the social risks confronting the Chinese leaders.
  
  In the coming weeks there would be a meeting of the Joint Commission on Commerce and Trade (JCCT) and a visit to the US by Chinese President Hu. Pressure was building for progress during these meetings to address growing US concerns over the trade deficit with China and the undervalued Chinese yuan. At the same time, the US continues to work with the Chinese government on issues related to North Korea, counter-terrorism, and Taiwan. Indicative of the current relationship was the struggle over whether President Hu would be hosted for a state dinner during his visit. In the end, he will attend a lunch at the White House but not a dinner. One speaker noted that US-China relations will determine the direction of the world over the next several decades but lamented that it is not getting the attention it deserves in Washington, DC.
   
• China’s WTO Compliance: Our meetings confirmed concerns that China is still not moving far enough in several areas to live up to its World Trade Organization (WTO) accession agreement commitments. Inadequate intellectual property protection (IPR) remains a serious problem and I will elaborate on this below. Despite a commitment to join the WTO Government Procurement Agreement “as soon as possible” the Chinese have not yet begun negotiations to join the GPA. In the area of standards, the government is still taking actions to favor the Chinese 3G telecom standard, TDSCDMA, and recently promulgated a rule on the use of its WAPI standard for government agencies. References in its 5 year plan and 15 year technology plan to “self-reliant innovation” have heightened concern that the government will try to advance its own standards in ways that disadvantage US companies. (In the JCCT meeting on April 11 the Chinese government began to address these issues through new commitments on IPR, government procurement and technology neutrality.)
   
• Intellectual Property Protection: David Sedney, Deputy Chief of Mission at the US Embassy, explained that IPR will be a major focus for the US in the JCCT meeting. Some of the commitments they would like to see from China would include the closing of optical disk factories, a government budget for the purchase of legal software, and the transfer of administrative cases to the criminal courts. The US would also like to see President Hu make a strong statement on IPR protection that would have a real impact on the Chinese government bureaucracy. Maya Alexandri, USITO Advisor, highlighted some of the difficulties confronting companies trying to protect their IP: it is hard to get civil injunctive relief, there is no discovery, judgments are hard to enforce, and damages are too low. Companies need to invest in prevention. Patents need to be registered in China and this should be done close to the time of market entry. Many IP issues are related to employees so you need to pursue measures such as confidentiality agreements. If you are entering into a joint venture, get the right partner.
   
• China’s Workforce: On several occasions the AeA delegation heard that talent is a key issue for companies doing business in China – recruiting and retention. Garry Wang from Hewitt Associates Consulting observed that there is a woeful shortage of qualified middle managers. A McKinsey study found that China needs 75,000 professional managers to expand for the next 10 to 15 years, but currently there are 3,000 to 5,000. At the same time, managers from Taiwan or Hong Kong are generally not well-received. As a result, larger companies are turning to a mix of managers from China, the US, and Chinese speakers. Poaching remains a serious problem for companies with a turnover rate of about 14 percent in the country. And labor in China is not so cheap anymore as the cost is increasing the second fastest in Asia (after India). For smaller companies, Terry Crossman of Cross Search argued that they will need to position and sell their company to convince good managers to work for them. Some of the suggested keys to retention are providing career opportunities, rotating assignments, and cash to performance.
   
• Doing Business in China: Throughout the trip we received a wide range of insights into doing business in China and I have highlighted a few of these in the following bullets:
   
  • Align your business with the government’s priorities and verbalize this in your interactions with the government (for example how your business contributes to the government objectives for sustainable development).
  • Government relations matter. You need to develop relations with key people in the local and national government.
  • It is important to regularly visit China to keep feeding relationships and oversee the business.
  • Recruiting and keeping good talent is critical.
  • Salaries are not a secret so be careful how you handle salaries.
  • Choosing the wrong joint venture partner can be hell.
     
• Shenzhen: As I noted, we received a warm reception in Shenzhen that began with an elaborate dinner on our first night hosted by the Strength Group and the Nanshan District of Shenzhen a major high-tech zone. From a small fishing village 20 years ago, Shenzhen has grown to a city of over 8 million people and is still considered a small city in China. According to the city government officials, since becoming a special economic zone it has been the number one export city for 13 years with the highest GDP per person ($7,300) in China. It is third in local revenue behind Shanghai and Beijing and third in the number of patent applications. Its port is the 4th largest container terminal in the world. Shenzhen has one of two stock exchanges in mainland China. IT accounts for half of the industrial output for the city
   
• Doing Business in Shenzhen: The last official program of our trip was a panel discussion with executives from six companies (including Oracle) doing business in Shenzhen about their experiences in the region. Their comments were consistently positive citing some of the following points:
   
  • Shenzhen has a more business oriented government that has been very helpful in dealing with issues.
  • Many customers and partners have operations in Shenzhen.
  • Since Shenzhen is a small city by China standards, things move faster getting permits.
  • Shenzhen serves the whole Asia region and you can find multi-lingual employees needed to work with many different countries.
  • It is close to Hong Kong which can assist with international logistics, finance, and IP management.
  • It is easier for companies to get needed resources in Shenzhen, including energy.

It is difficult to capture the wealth of information that emerged during our three days of meetings which is why I would encourage senior executives to take part in these AeA programs. Some of the best information comes from the conversations with other people on the delegation as you compare notes on your experiences in China. This year was no exception as I met several executives for the first time and came away with new insights into doing business in China.

I want to recognize Rob Mulligan, AeA Senior Vice President International, for a great job in organizing another successful trip to China and urge member companies to follow up with Rob if you have any questions about the trip. I would also like to thank Bill Archey, the CEO of the AeA, for joining us and for helping to lead the delegation.

View Pictures from the 2006 China Trip  ||  Read the Chairman's Report for the 2005 Trip

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