European companies doing business in China are finding the market – once viewed as a near ‘saviour’ to lethargic growth at home – less attractive due to a host of problems ranging from a slowing domestic economy, rising labour costs, difficulties in attracting and retaining talent, lack of adherence to the rule of law and uneven regulatory enforcement and rise of Chinese domestic MNCs, amongst other factors.
“Business in China is already tough and it is getting tougher. European companies face a sober new reality from several persistent and deepening market challenges,” the report said.
Although the report’s authors note these challenges present no surprises, as they are the same ones identified as having the greatest impact last year, “the business outlook for growth and profitability suggests that these challenges are becoming entrenched and are here to stay.”
The survey, conducted by Roland Berger Strategy Consultants, with input from more than 550 European firms across a broad swath of business sectors, including manufacturers, retailers, financial companies and companies involved in transport, logistics and distribution, suggest the “golden days” of doing business in China are nearing the end.
The responses highlighted “an entrenched sense of pessimism, as persistent market challenges show little sign of abating. In turn, many firms are setting more modest expectations for revenue and profitability growth and are scaling back their investment plans for the Chinese marketplace,” said the survey’s authors. “However, implementation of meaningful reforms – in particular increased market access – would likely prompt a reversal of this trend,” they added.
China’s slowing growth
Of all the issues, companies are most concerned about an economic slowdown in China with 61 per cent of those surveyed saying this is the number one concern.
“After thirty years of almost unbroken rapid growth, the Chinese slowdown, caused primarily by rising labour costs and structural economic problems owing to a near decade-long stagnation of reforms – and further exacerbated by the massive stimulus package of 2009 that in effect turned the clock backward on reform – is already contributing to the steadily declining performance of European companies, both in terms of bottom-line and top-line growth,” the report said.
The Chinese economy continued to slow over the past year and this is reflected in the financial performance of European companies. Pressure on both bottom-line and top-line growth continues with the financial results of European companies in China declining following the markedly poorer performance witnessed last year, according to the report.
This includes fewer companies reporting increased revenue, fewer companies reporting profits – down to 63 per cent in FY2013 from 74 per cent in FY2010, with less than half the companies reporting EBIT growth.
Pessimism about profitability prospects has continued this year with less than one third of companies have an optimistic view about profitability, the lowest level of optimism for profitability in this survey’s history, but at the same time the number of companies with a neutral perspective has increased from 35 per cent in 2008 to 51 per cent this year.
The report notes, “this seems to indicate an expectation that the business environment will continue to remain very tight and that companies are adjusting their expectations to this sober new reality.” This is particularly the case with ‘veteran’ companies which have been in China for five to ten years, versus the ‘newcomers’.
Optimism also varies strongly among industries: Agriculture, food & beverage companies are the most optimistic (42 per cent of companies are optimistic), followed by automotive & auto-components companies (40 per cent) and legal companies (33 per cent). Transportation, logistics & distribution companies are the least optimistic (14 per cent).
For most companies EBIT margins did not grow and are now lower in China than global averages, the report’s authors note. Only 30 per cent of companies stated that their Mainland China EBIT margins are better than their company’s global average, compared to 42 per cent in 2012. A higher figure (33 per cent) noted that their Chinese margins are lower than their global average – the first time in the history of the survey that more companies noted that their EBIT margins in China are lower than their global average than vice versa, after having reached parity in FY 2012.
“This shows that the Chinese marketplace is becoming much tighter, with fewer opportunities for easy profits and supersized growth,” the report’s authors observed.
Over half the companies (51 per cent) stated that business has become more difficult over the last couple of years and only nine per cent stated that business has become easier. Overall, 32 per cent of companies believe that growth in their sectors will remain stagnant or decline over the next two years.
Two main human resource (HR) challenges identified by EU companies for two years in a row, have been rising labour costs and talent shortage, but the order reversed this year with talent shortage taking over as top concern. The reversed order suggests that companies are faring better at finding talent, but have had to pay more for it, the report said, adding that air pollution is further aggravating factor.
End of the ‘golden age’?
The survey asked companies if the ‘golden age’ for multinational companies (MNCs) in China was effectively over. Companies were divided on the question with the so-called ‘veteran’ companies more inclined to believe so.
Overall, nearly half (46 per cent) of companies believe that the ‘golden age’ has already come to a close. This varies according to sector with a full 62 per cent in the legal sector believing the age has passed, to 43 per cent in transportation, logistics and distribution the – second highest degree of optimism behind the machinery sector at 42 per cent.
More intense competition from local companies was cited as the key reason for why the ‘golden age’ is over. This includes the rise and improvement among Chinese MNCs in terms of brands, quality and know-how, as these companies mature. Another key factor for pessimism was the fact that China doesn’t need foreign direct investment as it did a few years ago.
Discrimination
European companies also perceive themselves to be discriminated against compared to domestic Chinese companies. This is particularly the case in the legal, financial services and transportation sectors, whereas agriculture, food & beverage was the only sector in which a higher percentage of companies believed that they are treated equally (48 per cent).
In particular significant number of regulatory obstacles continue to hinder companies doing business in China with the unpredictable legislative environment was identified as the key obstacle in FY 2013; with a cumulative 54 per cent of companies identifying it as one of their top three challenges.
The discretionary enforcement of regulations and administrative issues were ranked as the second and third most significant regulatory obstacles.
“European companies want, above all, to see administrative reforms that work to ensure that laws and regulations are fairly and transparently implemented in a predictable fashion,” the report said. The European Chamber conservatively estimates that in FY 2013 the Chamber’s overall membership (including those companies that did not participate in the survey) suffered approximately €21.3 billion in missed opportunities owing to market access and regulatory barriers in China, up from €17.5 billion in the last study, with nearly half of European companies stated that they have missed out on business opportunities in China because of market access or regulatory barriers.
The changing role of China
But despite this general pessimism, China is still a key market for Europeans, although the proportion of companies that regard China as an increasingly important market continues to slide, the report noted.
Mainland China also continues to be critical for global revenue generation with the number of companies that generated 10 per cent or more of their global revenue in China increasing over the past five consecutive years. Nearly half the companies surveyed generate at least 10 per cent of their revenue from China in FY 2013, up from 32 per cent in FY 2009.
“As the world’s second-largest economy with a fast-expanding consumer market, China will almost certainly remain very important for European companies. Many of these companies are already highly reliant upon the Chinese marketplace for significant portions of their global revenues and will therefore continue to invest to try to maintain their positions and grow.
“Despite this, there is a notable downward trend relating to the growing strategic importance of China in the overall global strategies of companies,” the report noted citing the fact that only 59 per cent of companies ranked China as increasingly important in FY 2013. This does however, represent a significant drop of 20 per cent compared to the 79 per cent who said so in FY 2010.
And fewer companies consider China as a top destination for investment. Only one fifth of companies (21 per cent) stated that China was their top investment destination in FY 2013 compared 33 per cent two years ago. Likewise, only 20 per cent of companies ranked China as the top destination for future investments, a drop from 30 per cent just two years ago.
While over half (57 per cent) stated that they plan to expand their current China operations, this is down considerably from the 86 per cent who said the same just one year ago.
Looking over the fence
A significant proportion of companies (48 per cent) are routinely reviewing investment opportunities in Asia (outside of China), but only a small percentage of companies (nine per cent) have shifted investment plans from China to other countries over the past two years, the report noted.
ASEAN and the rest of Asia continue to be the dominant region for such shifted investments, but companies are increasingly looking towards developed regions for opportunities as well.
As in 2013, only approximately 10 per cent of companies are considering shifting current or planned investment in China to other markets. Of those considering shifting investments outside of China, only 62 per cent reported that they would shift investment to ASEAN and other Asian countries compared to 95 per cent in FY 2012.
Developed regions like Europe and North America are becoming more popular again and amount to 23 per cent from just three per cent in FY 2012, reflecting the swing away from globalisation to on- and near-shoring that has been gaining momentum in the last few years.
What EU companies want
Increased rule of law and transparent policy-making continues to be ranked No. 1, the driver deemed most significant for China’s future economic performance, maintaining this position ever since it was introduced as an option in the annual survey. “This consistency shows the strength of conviction of European companies that increased rule of law is the reform with greatest potential dividends for China’s economy.
“The consistency also strongly implies that little improvement has been made in this regard over these years,” the report said. A substantial number of companies (55 per cent) said they would be more likely to increase investment if market access barriers were lifted.
While reforms laid out in the Central Committee’s Third Plenum Decision are viewed positively, after years of unrealised promises, European companies remain sceptical and have yet to be convinced that meaningful reforms will be implemented, the reported noted.
