Italian enterprise

How a small-medium Italian enterprise can successfully get in Chinese market

Introduction

The Italian industrial model is well known worldwide for the high concentration of SME and is a successful example of endogenous development. How an Italian SME can exploit its capabilities to enter successfully in the Chinese market?

In this paper I will try to emphasize the importance of SME for the developed and developing countries identifying the distinctive characteristics of small and medium enterprises in international business. Then I will highlight the strengths and weakness of Italian economic model strongly dependent from SME, and I will try to give some useful suggestion to an Italian SME that want enter Chinese market, by analyzing the main drivers of success for market entry into China such as entry mode and cultural distance.

Finally I will try to offer some advices to manage cross cultural differences in management underlying the key role of "guanxi" and "face" in doing business in China.

The final goal of this paper is to provide a small medium Italian entrepreneur with some essential information and suggestions to get in successfully in the Chinese market.

SME: definitional gaps, distinctive characteristic, benefits and challenges

Definition of SME

There are some definitional problems which complicate discussions of trends in the SME sector; comparisons among countries are difficult because of the highly variable standards to measure firm size.

According to European Union definition companies with fewer than 10 employees are classified as "micro", those with fewer than 50 employees as "small", and those with fewer than 250 as "medium".On the other hand, in the US, ifsmall businessis defined by the number of employees, it refers to those with fewer than 100 employees, while medium-sized business refers to those with fewer than 500 employees.

In many industries, SMEs are responsible for driving innovation and competition. Globally SMEs account for 99% of business numbers and 40% to 50% of GDP.

Main features of SMEs Challenges for SME growth

Recent studies[1] show that there is still a huge gap between the size of the SME sector in developed and emerging countries. This research shows a positive correlation between a country's overall level of income and the number of SMEs per 1,000 people (Appendix 1);

There are several reasons for this disparity but the most important is that SMEs face regulations and bureaucratic practices that increase the supremacy of large companies in the officially regulated economy. These preclusive factors strongly affect SMEs because of their limited human and financial resources. Data from theInternational Finance Corporation (IFC 2006)shows that the "number of formalized SMEs in a country increases with a more favorable investment environment, which includes a low cost of doing business and a short average time to start an enterprise" (Appendix 2).

Is clearly visible that SMEs are significantly undercapitalized. A study of South-east Asian countries reports that only 3-18% of SMEs could borrow money from banks[2] . The Inter-American Development Bank estimates that in Latin America, 90% of entrepreneurs are forced to source much of their financing from personal savings (Smith 2003).

Finally, SMEs are considered to be at a greater risk of insolvency, partially because company directors may have less management experience or business expertise than larger companies[3].

Uniqueness of Italian SME: main features and weakness

Italy is known for the high concentration of small firms, in fact within Europe only Spain and Greece have a similar structure and firm's average size. (appendix 3 and 4)

Italian case is interesting because is the unique country among the largest economy in the world where 98% of industrial firms have fewer than 100 employees and almost 90% of firms have less than twenty worker.

In manufacturing industry Italy registers the highest EU presence of SME, the Italian small firms usually tend to export high-quality products, usually consumer goods connected to the fashion industry or other product connected to high design.

Italian SME's have some distinctive features that trigger the success: these companies are extremely dynamic and are mainly family business; there is a more direct control that implies a stronger flexibility to respond quickly to the external change. Usually because SME are more static than big corporations, are more likely to have links of dependence and familiarity to their communities, which will guarantee to protect their reputation and relationships among customers.

Often Italian SME's enterprises are located in a delimited geographic area committed in the production of the same product. This model is called "industrial district" or "cluster". There is competition among the firms located in a district but usually there is also a high level of cooperation. The competitive advantages of companies located in a cluster are specialization, cooperation and flexibility. Firm specialization is crucial to the success of the companies because it consents small firms to focus their resources (which are limited) on the core competencies. This model allows for flexibility and short time to response to the market that large firms, with fixed assembly line, usually don't have.

Italian SME's are known worldwide for their highly rate of internationalization and moreover for the high degree of innovation, in terms of design and quality.

Even if is Italian SMEs are on average successfully, they present some main weakness that could be summarized in three principal lacks: limited financial resources, there is a limited access to equity found because the family don't want open the capital to external investors and limited access to the bank credit because (even more in crises period as today) the banks prefers to borrow money to big corporation which have less probability of insolvency, for this reason SME has a high financial costs and usually financial structure is under-capitalized. The second main limitation is that there isn't a separation between propriety and control, between owner and management; these companies miss a professional management structure, they have a limited skills and scopes of knowledge and for this reason are quite conservative. The third weakness is an organizational deficiency, organizational structure is very simple, there are few hierarchical levels and there aren't staff functions. Some function as human resources or operative system doesn't exist and there is a very low employee turnaround rate that could reduce productivity and imply a static environment. How to manage these shortages to enter successfully in a complicate foreign market like China?

Six hard rules for SMEs to succeed in emerging markets

A research (Shankar, Ormiston, Bloch, Schaus & Vishwanath 2008) have established six keys to success in emerging market (Appendix 5). Even if these findings are applicable to all type of enterprise (micro, medium or MNCs) these rules are of paramount importance for SME, which are characterized by a lack of financial resource and of experience and therefore should manage its assets in the more efficient way.

The first rule to be followed is that the foreign companies should go beyond premium segment, focusing on "good enough" market (reliable-enough products at low enough prices) to achieve scale in distribution, manufacturing and brand building.

Local companies have enormous advantages because a better understanding of the market and of consumer needs and therefore foreign companies should localize the 4p's. The first step is to localize the product on the basis of consumer insight; then the placement have to be adapted, foreign companies should get a deep understanding of dynamics of local distribution. After which A SME have to establish a price that is competitive on the market but still make profit for the company and finally the promotion that have to be focused on aggressively strategy to build the brand credibility.

The third key of success is to manage costs aggressively by avoiding too much specification, localizing management and sourcing and reducing overhead. Moreover the foreign companies should build local team, empowering local management and providing them with global career paths and deeply training. The role of foreign manager is slightly different in China, they have to develop local talents instead of manage them. (Some SMEs in China have built local growth team, which are responsible to develop new innovative product which better fit local needs)

Finally the company should acquire selectively, they have to be sure that local acquisition have a strong business fit for example by adding popular local brands or broadening its reach with a stronger distribution network. The foreign companies should maximize their investment by building dedicated emerging market capabilities and organizational structure. They should develop a deep understanding of main features of emerging markets with similar characteristic and then exploit their know-how extending it into other emerging markets.

Drivers of success for market entry into China: entry mode and cultural distance.

Italian SMEs in China

In China, Italian FDI are mostly directed to these industry: machinery and mechanical industries, chemical industries, textile industries, forwarding company and legal and consultancy firms. There are around 2000 Italian company in China investing in "traditional" sectors for the Italian economy. Only 10% of Italian FDI in China has made by SME. The problem is that SME mainly actives in import and export and are not willing to direct investment abroad.

Why to invest in China?

China is currently the third economy in terms of PPP of the world and some forecast suggest that by 2020 China will pass Japan and in 2050 will become the leader economy of the world. These are already enough reasons to enter in China but there are much more, China is a huge market (1,3 billion population), the investment incentives are high, is an emerging market but have good commercial, transport and communication infrastructure compared with others developing markets, the labor cost is really cheap and there is an high flexibility and commitment of workforce.

Most important drivers for a successful enter into China

Mode of entry is a critical decision a SME makes when it enters a new market because this choice affect directly the firm's marketing and production strategy.

There are five main classes of choice and each has strengths and weakness:

Export, license and franchise, alliance, JV and WFOS.

The main difference among these modes is the degree of control that company have over its resources. Of course export and license have the lowest one and the WFOS have the higher degree of control.

Resources based theory affirms that as the degree of control increase, the firm's chances of success increase because the firm can deploy key resources that are essential to success.

On the other hand transaction cost theory affirms that cost increase with increasing control of the mode entry and that implies that higher investments are needed.

A research (Johnson & Tellis 2008) has showed that in China SMEs' entry strategies with a higher level of control are more successful. These findings could be justified through different reason but the most important is that the greater control provides the entrant with an opportunity to compete on its own unique strengths, control success and failure closely and make changes in strategy, moreover it ensures a better efficiency in operation and future development and a better protection of intellectual property and technology which in China plays a role of paramount importance. This entry mode strategy implies a huge initial investment and therefore higher risk, moreover a foreign SME is unable to get cheaper alternatives for land acquisition and is very hard to obtain government support.

Finally probably the SMEs doesn't know anything about the culture and the market of the host country , and for this reason some firms use a JV or a franchising to enter a market, then when they accumulate enough knowledge about it they move to WFOS.

An in depth study (Borgonjon & Hofmann 2008) has showed that in the last years companies that have used JV to enter China has been less and less because it has become more difficult to establish a JV. Foreign investors that choose this route now face stronger Chinese counterpart, and the relative bargaining power of foreigner investors has weakened. Some potential Chinese partners are less willing to form JVs because they already have strong market position, knowledge and distribution networks moreover Chinese companies are optimistic about their future and less likely to share future profit with others.

For the SMEs, in market driven by domestic demand rather than investments and exports, a JV partner can provide local business and cultural insight, because local knowledge is fundamental in China market, only firms with localized management can success in the future. The initial investment is reduced and therefore less risky, it's easier to obtain capital and government support.

On the others side find the adequate partner is not an easy task and negotiation may take long time, moreover due to cultural differences between the partners, conflicts might happen frequently.

Wholly foreign-owned enterprise, Sino-foreign contractual JV and Sino-foreign equity JV, which options to take will depends also on factors such as the investment climate, investors' investment direction, and the amount of investment to be assumed. In general WFOS enterprise requires examination and approval from many government bodies and this process can be quite tough and time-consuming for a SME. According to (Borgonjon & Hofmann 2008) there are three main differences between an EJV and a CJV:

"An EJV is always a legal person and thus a limited liability company, a CJV can be a legal as well as a non-legal person. The latter option is not very common because it would mean that the partners of the JV would be personally liable for any losses the company might have.

In an EJV the distribution of profits will correspond to the ratio of the capital contributions made by the parties, while the distribution in a CJV can take place according to the parties' wishes.

In a CJV a party may, besides contributing registered capital, provide for so-called cooperative conditions, e.g. market access rights."

Government procedures for establishing Chinese-foreign contractual JV will be also very long. Thus Sino-foreign JV seems to be the perfect investment option for a SME as less governmental procedures and approvals will be required but other risks, as I mentioned before, should be considered.

The last drivers that should be carefully considered is the cultural distance.

Culture is defined as "the distinct ways that people living in different parts of the world classified and represented their experiences, and acted creatively"[4]. Culture also has been defined as "the collective programming of the mind which distinguishes the members of one group from another"[5] The cultural dimension of society affects consumer behavior but also the implementation of marketing and management strategies of a SMEs and it may represent the hardest challenge to face with.

How a SME can manage cross cultural differences? The role of "Face" and "Guanxi" in doing business in China

The Chinese culture is characterized as a highly collective society that prefers to conform to the norms of society compared with an individualistic Western culture society which is inclined to make individual choice and therefore more likely to be innovative and adopt new ideas. The Chinese culture also is characterized as a high power distance society, not likely to be open to new ideas because the lack of information. Finally the Chinese culture is also viewed as a long-term society with patience and traditional values and less likely to the quick adoption of new technology.

An Italian SME enterprise that want enter in the Chinese market has to show to be sensitivity to the local cultural, show the respect for the different values and try to understand how to interact and to build a relationship with the local people.

Three are the main point to take care when doing business in China:

Build the trust, give the "face" and keep the "guanxi".

The concept of "Face" plays a crucial role in the Chinese business culture. Give the appropriate respect according to rank and seniority is a must, the meaning of face corresponds to the idea of "respect" in the business culture.

Chinese business relationship becomes soon asocial relationship, unlike Western business relationship which remains professional even after a long time. Seniority is very important in China especially if you are dealing with a State owned or government institution.

A slight mistake can make the Chinese lose face and it can offend them. Doing business means build mutual trust and establish relationship with people.

Today, people look for a "win-win" situation and a long-term cooperation under a fair competition climate.

In China, Guangxi (relationship) is the core of the culture and is another complicated field.

But Guangxi (relationship) doesn't means only have inter-personal relationship and cultivate own self-interests, but mainly the Guangxi will have to include relationship with the government official, investors, partners and even relationship with workers. Because China is still a socialist state, government plays a large role in managing the investment and controlling the economy, so when doing business in China, it is important for foreign investors to learn to deal with the government. Another solution could be to looking for a local partner, it could be a shortcut and help to develop your business in China market.

Top management should develop the company's vision and values into the employees, it is important for foreign investors to be flexible in their management and be perceptive to China's culture in order to develop a management system appropriate for their companies' organizational culture.

Conclusion: common mistakes and suggestions

An Italian enterprise should not forget that investing in China is a big opportunity but China is still an emerging market and therefore characterized by some weakness such as asymmetric information, market information is controlled by specific channels (mostly by governments) and censorship still play a massive role, the market is not completely transparent and therefore there is inconsistency between regulations. Judicial system also is underdeveloped characterized by the lack of some external regulation and lack of enforcement mechanism. For these reason a SMEs should remember that there are opportunities but in depth market research is necessary before entering a specific market like China and SMEs should look for useful advices from local consulting company or home institution.

Moreover emerging economy are characterized by a low political and economic stability, changes are very sudden and the risk very high.

All these consideration imply that the firms should be very flexible and adaptable, should be prepared in advance, willing to learn by doing and adopt a long-term prospective to make profit.

China is not an unfiled 1.3 billion market, but is built out of several regions and the regions differ culturally, economically, legally and also customer needs. Chances of success are bigger in industrial and high-technology market and mainly in niche market then in mass product market where competition is fierce.

Some companies or entrepreneurship look at China still as underdeveloped market, where, to success, is enough to provide old technological products and sell it at cheap price. Some companies underestimate the competition of Chinese market (competition of MNCs but also competition of local companies that are becoming bigger and bigger) and above all sometime they don't consider at all the pressure of government (see Google's case).

Italian SMEs should think about China as a market and not only as "factory" where the manufacturing cost are very cheap. They should capitalize on the growing importance of the second and third tier cities by promoting the image of Italy in all its main components (fashion, furnishing, gastronomy, culture) and then focus on the idea of "Designed by Italy" and "Made in Italy" as synonyms of creativity and quality, two factors that still are missing in Chinese companies.

Appendix n. 1: Micro, Small and Medium Enterprise: Density by National Income Level

Appendix n. 2: Micro, Small, and Medium Enterprise: Density and Business Enabling Environment

Appendix n. 3 : Ranking of SMEs by value added in EU-27 countries

Appendix n. 4 : : Ranking of SMEs by number of person employed in EU-27 countries

Appendix n. 5: Key to emerging-Markets Success

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