In recent years, manufacturers flocked to China because of the relative cost advantages and the performance of Chinese factories. In 2007, United States manufacturers with Chinese operations earned a 50 percent median return on invested capital (RIOC) — nearly three times that of the U.S. plants' 18 percent RIOC. However, when compared to sales-per-employee productivity, the median in China is nearly identical to that of U.S. manufacturers, accounting, tax and business advisory firm Grant Thornton LLC explains.

Still, companies headed there in droves, many have stayed and more continue to arrive, Grant Thornton says. According to the U.S.-China Business Council's 2008 survey, 90 percent of the council's members are optimistic about expanding their businesses in China over the next five years, as the majority of these companies reported profitable operations. Although rising costs are a growing concern, nearly half say their margins in China were better than their margins globally.

So how can companies with operations in China maintain these margins or even expand their businesses?

Companies should first start with understanding China's manufacturing and business landscape. Expanding production capabilities requires careful analysis and comparable due diligence of global manufacturing and supply chain strategies, Grant Thornton says. It requires you to "understand that your business will function in a new way, developing measures to gauge potential operations performance, total costs and margins."

The following are three issues businesses must address to thrive in China.

Understand the Manufacturing Process.
Manufacturing in China continues to evolve. "To be poised for profit from sales in China, more manufacturers must rapidly upgrade their production models in China to develop and capture economies of scale and scope," strategy+business magazine says. "They should view China less as a low-cost country and more as a competitive manufacturing and sales environment, the hub for an Asian growth strategy."

According to a strategy+business survey, companies that have adopted such practices have had an average gross profit margin 4 percent higher than companies without them.

Understand the Labor Pool.
Companies need to understand how their workforce functions to manage workers properly. "There is little empowerment/self-direction among China production workers," Grant Thornton says. "A well-trained, empowered workforce is necessary to undertake improvement initiatives, particularly lean manufacturing and its culture of problem-solving and use of the scientific method." (See: Is Your Lean LAME?)

Also, keep in mind that workers' cultural attitudes may be different from your own. BNET notes that the Chinese put great emphasis on practicing proven strategies and that government and business relations are off-limit topics.

Understand Tax Laws and Other Government Policies.
Grant Thornton lays out 10 key governance factors that could affect a company's decision to expand their Chinese operations. Among them:

• Transfer pricing documentation compliance;
• Tax compliance;
• Accounting requirements;
• Due diligence for closing transactions;
• Banking policies in regards to foreign investments;
• Corporate governance; and
• Labor contract laws.

By not complying with, or being unaware of, the rules and regulations, companies could end up with audits, penalties or delays in closing business deals. (For more on how these issues can affect Chinese operations, check out Grant Thornton's Is China In Your Future? whitepaper.)

Companies should also harness the fact that China is not only a low-cost labor market, but is also a strong export and domestic market. The disposable income in China has risen three to five times faster than the income of the developed world, Boston Consulting Group (BCG) says. "Our survey indicates that most Chinese families plan to increase their spending in the near future."

Therefore, strategy+business recommends that multinationals in China focus on capturing the domestic and export markets by:

• Accelerating domestic market development to take advantage of the growing middle class, while reducing dependence on export markets;
• Tailoring product design to meet domestic demand and fine-tuning offerings for local market conditions and developing business models to support this initiative;
• Linking local manufacturing to the global supply chain; and
• Continuing to identify potential discontinuities in supply and demand.

When it comes to successfully marketing to the Chinese domestic market, businesses should understand their potential customers and know what drives them. Here are some thoughts on Chinese consumers and tips for winning them over.

Focus on Product.
Chinese consumers are driven to "trading up," BCG explains. There is a "natural desire to try new and better products as incomes rise and the economy improves. ... Western companies have been more successful in capitalizing on this trend with sophisticated marketing efforts and global brands that offer superior benefit."

To that end, companies are advised to focus on product innovation and improvements rather than prices, because "even a well-established brand can't maintain its position for long if its technical and functional benefits become undifferentiated from the competitor's," BCG concludes.

There is No Typical Consumer.
In his whitepaper, Winning Consumers in China: The Top 10 Things Marketers Need to Know to Succeed in the World's Fastest-Growing Market, Ad Age China's Hong Kong-based editor Normandy Madden writes that there is no typical Chinese consumer. Think of China as more like "dozens of countries, sprawled across five time zones and 22 provinces." Market to each "country" individually, Madden advises.

Don't Try to "Westernize."
Although Chinese consumers flock to international products, they remain firmly grounded in Chinese traditions and beliefs. They "have a fundamentally different world view than Westerners, and products have to be placed into that world view," Madden says.

Don't Underestimate Local Brands.
Breaking into the smaller markets in China can be a big challenge, as global companies need to compete with local brands that are more affordable, Madden notes. For example, to compete better, Procter & Gamble developed an innovative tiered-pricing strategy with more affordable versions of its products.

Beware of Mass Media.
Airtime on Chinese TV is expensive, and only a third of the viewers, at most, can afford to buy foreign brands. Madden advises to instead use one-to-one marketing to promote products. "Put your ad dollars to work through events, product sampling, retail sales promotions, and master digital marketing on the Web and mobile phones."

To grow a foreign business in China, companies must not only understand manufacturing operations but also the potential new market.

Resources

Is China in Your Future?
Grant Thornton, April 2009

Grant Thornton White Paper Offers Manufacturers 10 Things to Consider Before Doing Business in China
Grant Thornton, April 30, 2009

U.S. Companies' China Outlook: Market Growth...But Where Do We Go from Here?
U.S.-China Business Council, October 2008

Betting on China
by Ronald Haddock and Brenda Lei Foster
strategy+business, March 17, 2009

Winning the Hearts and Minds of China's Consumers
The Boston Consulting Group, September 2007

Winning Consumers In China
by Normandy Madden
Ad Age China May 4, 2009

Tips for Growing Your Business in China
by Laurel Wentz and Normandy Madden
Ad Age China, May 13, 2009

The U.S. Business Skill That China Doesn't Have
by Stacy Blackman
BNET, May 18, 2009