Westward push in China carries risks and challenges assumptions

While U.S. investment in China is concentrated mainly in the eastern provinces, more U.S. companies are eyeing western expansion in the increasingly liberalized Chinese economy.

Whether to expand market reach, be near a specific partner or facility, or reduce costs, the western region of China presents a host of opportunities for foreign investors.

But there are risks associated with such expansion, experts say. Unlike the more developed and sophisticated eastern cities, such as Beijing and Shanghai, China's western provinces lack the same infrastructure and business savvy, experts say.

As such, business interruption and transportation exposures remain high and qualified employees are hard to obtain, they say. Corruption also remains an issue in China, experts say (see story, page 14).

Due diligence is a "huge deal" when it comes to expanding operations in China, said Frank Hawke, chairman of greater China for consultant Kroll Inc. in Beijing.

"China is a very different culture from the West...and so they approach problems in a different way," he said. "You just can't simply take your assumptions from doing business in Des Moines and apply them in Hubei Province and feel like you'd be successful."

"You're also dealing with a system, which for the past 56 years has been a communist/socialist system," Mr. Hawke added. "So layered on top of the cultural issue is a system that is different, and the way the economy runs is very different. And when you're talking about the western part of China, you're talking about a part of China that hasn't emerged from that system to the extent the eastern seaboard has."

But U.S. investors--especially those that have had a presence in China's eastern provinces for several years--are increasingly venturing out to new locations. In many instances, they are looking to expand their market base in the world's most populous country or are following suppliers and other business partners, experts say. In other cases, they are taking advantage of cheaper land, labor costs or other incentives that the government might offer, such as tax breaks and cheaper utilities, to spur development in the Chinese west.

In addition, the western provinces tend to have a more stable workforce, compared with the eastern provinces where there is "tremendous" competition for talent and a 40% turnover rate among workers, said Cy Quadland, a New York-based managing director and leader of Marsh Inc.'s private equity, mergers and acquisition practice in Asia.

Western China "may not have as sophisticated an infrastructure from an accounting and legal standpoint, but it has a lot of advantages in that there is not as competitive of a work environment," Mr. Quadland said.

'Second-tier' investment

According to the American Chamber of Commerce in Shanghai, 45% of the 274 members it surveyed last year remain focused on their established commercial operations and investments in the more traditional strongholds of China including Beijing, Shanghai and Guangdong. But more than 15% of the AmCham members said they are putting more than 75% of their investment in second-tier locations and 10% said they have their entire investment in second-tier cities.

With this expansion comes a variety of risks, experts say.

For example, while China has invested a lot of money in building power stations and some areas have abundant electricity, in other western areas of China the supply of electricity is "very unstable," said Howard Tsang, executive director of Willis Risk Solutions China, based in New York. As a result, "you might have increased business interruption exposure caused by lack of supply of electricity."

Indeed, business interruption is "one of the major issues" foreign investors have to consider, said Mr. Quadland. In addition to frequent brownouts and blackouts, "some of the supplier plants are not up to spec as far as fire conditions go. It's critically important to have--for both suppliers and large customers--really top-flight business interruption coverage," he said.

Logistical issues related to transporting products to and from western China also could create risk, experts say.

The huge territory in western China is still "not as well-served" when it comes to the availability of train cars, which could cause issues when it comes to shipping or receiving in materials or products, Kroll's Mr. Hawke said.

It's also very expensive to ship products from the west, Mr. Quadland added.

"It costs as much to ship cargo from Chengdu to Shanghai as it does to ship from Shanghai to the United States," he said.

Finding qualified workers, including locals with senior management skills, also remains a key challenge and a risk for companies seeking to expand operations west (see story, page 21).

"The infrastructure is probably less well-developed outside of Shanghai and the greater Hong Kong area, so it's difficult to get talented people," said Bill Mila-schewski, director of risk management at Cabot Corp., a Boston-based global specialty chemical and materials manufacturer that operates in several cities in China's eastern provinces and is looking to expand.

Cabot requires an educated workforce, which could prove difficult should operations expand west, he said. "We operate chemical facilities so it's important that we operate them efficiently and in an effort that pays high degrees of attention to the safety of our employees and our neighbors and to environmental controls to ensure that we follow all the environmental regulations," which are "stringent" in China.

At the same time, China has a "different way of looking at construction standards," Mr. Mila-schewski said. "So the infrastructure isn't really there yet in some of those areas outside of Shanghai."

Although Cabot is looking for other opportunities to expand in China, which Mr. Milaschewski said has an "insatiable demand" for its products, it's unclear whether the company will expand its existing sites in China or whether it will move into new areas.

"We've had chit chat" about moving into western China, but it's "still just in the discussion phase," he said.