5 Key Legal Factors for Tech Companies Entering China

China is a major target for many software companies, but the legal system is full of challenges. Here are 5 issues you need to know about.

China has a population of more than 1.38 billion people, is the world’s second largest economy, and contributed approximately 30% to world economic growth in 2016. In 2016, China’s overall information technology market was worth more than USD 300 billion, with over 700 million people having access to the internet.[1] These are just some of the reasons that make it an unavoidable market for businesses to consider, as it has been for the past few decades.[2]

Navigation in China

From January to May of 2016, China preinstalled 2.074 million sets of car navigation. It is forecasted that in the next few years, China’s preinstalled car navigation will continuously increase to reach 9.55 million sets by 2020.[3]

But, the Chinese market has never been easy to enter, and it’s proving even more difficult to be successful and stay in the market mid-term as a foreign investor. Just remember UBER’s recent retreat after only being present in China for three years.[4]

We Speak From Experience

NNG has been present in the Chinese market, delivering both aftermarket and line-fit navigation solutions, since 2012. In cooperation with one of our Auto OEM partners, we successfully launched our first dealer update program in 2016. In order to strengthen NNG’s presence in China and to open new possibilities for NNG’s operation at the Chinese market NNG established its Chinese subsidiary as well in 2016.

Key Factors to Entering the Chinese Market

If you’re considering doing business in the IT, online communication, or e-commerce sectors on the Chinese market, here are five key factors you should think about.

  1. The Government Regulates All Foreign Investment in China

The 2015 Catalogue of Sectors for Guidance of Foreign Investment has to be examined to see whether the intended activity falls within the category of encouraged, restricted, or prohibited. For example, manufacturing and development of software products falls under the “encouraged” category, however, software is still subject to various regulations. On the other hand, online publishing services are a restricted area with a complete ban on foreign invested enterprises.

  1. How to Enter the Market

The second step is to decide whether a domestic Chinese entity has to be established or not. Having servers and websites located abroad has the advantage of transaction occurring outside of Chinese territory, thus software products and transactions will not fall under the scope of Chinese regulations. On the other hand, websites and servers located abroad can be easily blocked by the great Chinese firewall, making it unexpectedly impossible to conduct business from one second to another.

Depending on the intended activity and the sector, different corporate structures may be required and activities may only be carried out upon establishing a wholly foreign owned entity or a joint venture, in sectors like value added telecom services, with a domestic Chinese partner. In areas where foreign investment is restricted under the Foreign Investment Catalogue (e.g. e-commerce or online publishing), the so called VIE structure has been often used, also chosen by Alibaba or Baidu to attract foreign investment. The VIE structure refers to a variable interest entity, where one entity is consolidated into a separate one (i.e., the investor) for financial reporting purposes.  Despite being often used and tolerated by the Chinese authorities, the VIE structure aims to circumvent Chinese regulations and bears considerably high risk within for foreign investors, not to mention possible change in the tolerance of Chinese authorities and state.[5]

  1. Intellectual Property Rights

IP theft is one of the biggest risks in China, especially in the IT industry, as software is highly vulnerable to infringement of intellectual property.

Even big companies, such as Hugo Boss or Microsoft, have severe difficulties protecting their IP in China. Microsoft had so many pirated copies of Windows in China, that they decided to give Windows 10 for free to everyone with a computer — including all the pirated users.[6]

Companies should have a carefully structured intellectual property protection strategy in place before establishing a physical presence in China, and even this may not prevent competitors from copying and using their IP.[7]

  1. Cultural Differences and Domestic Competition

Foreign investors are strangers in China, and may feel the same as Alice did when she arrived in Wonderland. Even if it’s not necessary to partner with a local Chinese entity, it may be advisable to discuss with potential Chinese partners and consumers. Additionally, it’s wise to conduct market research and think outside the box. Carefully choose your Chinese partners and employees, and accept that you may face many challenges.[8]

Also, local competition can improve dramatically. For example, eBay basically gave up on China when Alibaba found better ways to attract consumers in a low-trust environment: using escrow, instead of up-front fees for goods.[9]

  1. Applicable Laws and Regulations and Chinese Authorities

The Cybersecurity Law of the People’s Republic of China will become effective on June 1, 2017. This follows the Online Publication Services Administrative Provisions meant to govern online publications in China put in place in 2016.

A common critique of recent Chinese laws is that many terminologies remain vague and ambiguous. Some need to be further interpreted by the authorities (such as, Cyber Security Law (CSL), the national internet information authority) which makes it difficult for foreign investors to understand and adapt to, especially as the interpretation may differ by local agencies in different areas of China. To make things more challenging, these regulations also introduced restrictions making the life of foreign investors harder. For example, user information (and in certain cases, the undefined “important data”) needs to be stored within China and censor “prohibited” information and restrict online anonymity. Some are even impossible, such as the requirements for online publishing services only being allowed to be carried out by wholly Chinese companies.[10] Mapping is also a restricted area, and it is illegal for foreign entities or individuals. Further, China maps must even have a geographic offset, a kind of preordained cartographic drift preinstalled. In addition to all this, Chinese geographic regulations demand that GPS functions must either be disabled on handheld devices, or they must be made to display a similar offset in China’s territory.[11]

Even global players like Google, Facebook and Microsoft have had their difficulties with Chinese regulations and authorities. Google chose to pull its search engine in 2010, rather than accept Beijing’s censorship terms. It’s still banned from China, along with Facebook and other tech giants. Microsoft, has been working together with Chinese authorities and even given up on its search engine, Bing, and replaced it with Baidu in Windows.[12]


Is It Worth It?

All of these difficulties and obstacles just scratch the surface of the challenges of doing business in China. Despite that, China remains a “must enter” market for many businesses. Its size makes it unavoidable to enter for a truly global player, such as NNG, and worth the effort to establish a solid presence in order to seize the opportunities which this ever expanding market offers. Even Facebook is continuously working on a solution to enter, and just recently announced that they are already creating a censorship tool to meet Chinese requirements.[13] Are they going to be successful against local competitors such as Tencent or Weachat, who are already widespread and built by tech giants who understand the local mindset?

Even with all these challenges, there’s only one conclusion: China is the land of endless opportunities – which sometimes have an end.

[1] https://eandt.theiet.org/content/articles/2016/12/comment-why-china-s-new-cybersecurity-law-is-a-threat-to-international-businesses-and-innovation/

[2] https://www.weforum.org/agenda/2017/01/inject-chinese-dividends-into-the-world-s-economic-development/ and https://www.forbes.com/sites/timworstall/2016/10/30/chinas-only-15-of-the-global-economy-but-contributes-25-30-of-global-growth/#51bb76087b76

[3] http://www.prnewswire.com/news-releases/china-car-navigation-industry-report-2016-300302546.html

[4] https://hbr.org/2016/08/the-real-reason-uber-is-giving-up-in-china

[5] http://www.lexology.com/library/detail.aspx?g=1fd0c412-0c28-4cba-bff7-69b5998864e9

[6] http://www.nasdaq.com/article/8-ways-chinas-new-cybersecurity-law-is-bad-news-for-business-cm745534#/ixzz4Zab9qQFJ

[7] http://www.ckrlaw.com/our-voices/2016/08/17/5-key-factors-companies-should-consider-when-establishing-operations-in-china/

[8] https://medium.com/@KennethKing/8-things-i-learnt-from-being-acquired-in-8-months-in-china-911fbbdd68ac#.7fufnsrkj

[9] https://www.bloomberg.com/news/articles/2016-08-02/the-humbling-of-american-tech-giants-in-china

[10] http://www.lexology.com/library/detail.aspx?g=e23f90e9-85ac-430c-a5cb-54cdedef1ff9

[11] http://www.travelandleisure.com/articles/digital-maps-skewed-china

[12] http://www.nasdaq.com/article/8-ways-chinas-new-cybersecurity-law-is-bad-news-for-business-cm745534#ixzz4Zab9qQFJ

[13] https://www.nytimes.com/2016/11/22/technology/facebook-censorship-tool-china.html?_r=0