China: CEOs Urge a Pragmatic Approach to Risk

China is the "'place to be" in Asia and the world's preferred destination for foreign direct investment. But exclusive research by Accenture among more than 200 CEOs confirms that the risks of doing business in China are high, and that short-term profitability may not be a realistic target for many foreign companies. Crucially, multinationals must take care to understand and evaluate the risks in China market economy before they go in—or the price of China market entry could be high.

The Organization for Economic Cooperation and Development (OECD) recently confirmed that China has overtaken the United States as the biggest recipient of FDI, attracting US$53 billion in 2003. However, China is a market where opportunities and risks come hand in hand. Despite the rush to invest, many foreign companies have had their fingers burnt in China—and deep pockets and a willingness to forgo short-term profitability have emerged as two of the key qualities for doing business there. So companies need to rein in their enthusiasm to tackle the Chinese market and take a measured and pragmatic approach to risk management.

To assess the balance between risk and opportunity in China, Accenture has worked with a leading global research firm to carry out interviews with more than 200 CEOs and other senior executives in China, Australia, Hong Kong, India, Japan, Singapore and South Korea. Participants gave their assessment of the risks of doing business in China and outlined the steps they are taking to address them. More in-depth interviews were carried out with CEOs of major Accenture clients to complement the survey results. The findings make fascinating reading—and amount to a practical risk roadmap for companies looking to capitalize on China's huge potential.

Accenture's research confirms that China is considered by far the most attractive country for investors in the region in the near and medium terms. Virtually all respondents (94 percent) identify China as the country with the biggest growth opportunities in Asia. More than three-quarters of respondents have operations in China, and a quarter of these say China is already their biggest revenue contributor in the region. Nearly 80 percent of all respondents judge that their investment in Asia will increase in the next two to five years, with the major portion of this investment being channeled into China.

However, while China presents the greatest growth opportunities in Asia, it also presents the greatest risks. When asked to identify the three countries with the highest risk potential in the region, business leaders rate China amongst the top grouping in terms of total risks, with China-specific risks representing the single most important group (see Figure 1). Two out of the top three economic risks identified in the region are linked to China's economic performance—namely the danger of an economic "hard landing" and the rising price of raw materials. The survey also suggests that geo-political tensions in the region are focused around China, with more than half of respondents citing tensions between Mainland China and Taiwan as the region's most significant potential flashpoint.

Our research shows clearly that companies lack confidence in their ability to manage the numerous risks they face in China. More than 80 percent of the executives surveyed believe that their current risk management approaches are only "fairly" effective or not effective at all. Companies already active in China need help in identifying and managing the risks they are facing. Their high hopes and expectations for the long term often sit uneasily with the reality of struggling to achieve short-term profitability.

Accenture's CEO interviews uncover four key China-specific risks that pose management challenges and demand pragmatic risk management approaches. These are:

1. Possibility of a hard landing—Despite the Chinese government's apparent success in avoiding an economic hard landing in the short term, businesses are still concerned that unstable elements may precipitate a hard-landing in the medium term. This situation would demand extraordinary skill from the government to continue the reform process while navigating between foreign interests, domestic social and political change and sweeping institutional reform.
   
   
2. Political risks—Tensions between Mainland China and Taiwan are identified as the key potential flashpoint by many businesses. CEO responses show that the nearer they are to China, the higher the level of risk they perceive. Concern over these geopolitical risks is magnified by uncertainty over the reaction of the international community, particularly the United States.
   
   
3. Management styles—There is a stark difference between Chinese and Western management styles. Foreign companies looking to operate in China struggle to find local managers with Western management skills. In China, companies traditionally have been owned by or linked to the government, meaning management decisions have been influenced by broader objectives than profit and value creation. Chinese managers with Western management training and experience are in high demand.
   
   
4. Economic and financial risks—Businesses have identified economic and financial risk areas in the Chinese business environment. The banking system needs serious reform and the opening of financial markets to foreign banks brings new risks. At the same time, legal institutions and often impoverished local government bodies lack the means to enforce the law or provide adequate protection and governance, resulting in problems in areas such as intellectual property rights.

These risks are compounded by the fact that China is actually a collection of regional markets with different economic, political, social and operating conditions. China's government is trying to even out the regional imbalances, but these restructuring and investment programs will take time. In the meantime, foreign countries must tread carefully in China—and take a painstaking and pragmatic approach to risk.

This article was produced with Accenture's Policy & Corporate Affairs group. The Policy & Corporate Affairs group produces innovative and authoritative insights on key strategic issues for business leaders and policymakers, drawing on Accenture's practical experience and resources across the world. The group uses a combination of primary and secondary research, strategic analysis, scenario planning and ongoing dialogue and debate with partners, clients and other outside experts.