Market Access Report: Distribution

Domestic Distributor. One of the most common channels for manufacturing FIEs to sell and distribute their brands and products in mainland China is to establish contracts with licensed Chinese distributors in the form of a commission agency, wholesale arrangement, etc. However, the Chinese distribution sector remains highly fragmented and favours strongly protected local manufacturers; further, the selling cost is more expensive than that in Western countries. Despite these weaknesses, knowledge of the local operating environment, culture and network helps local distributors maintain a considerable advantage in competition.

Direct Sales Activities. In the early 1990s, the direct sales marketing model was allowed in China. With the emergence of many pyramid companies during that period, the regulatory framework underwent a significant change. In 1998 the PRC State Council required that companies that had previously obtained approval to conduct direct sales activities adopt different business models for marketing and sales. An additional notice issued in June 1998 set out detailed procedures and methods for FIEs that were engaged in direct sales activities to alter their business model from direct marketing to store-based businesses. Some well-known international direct sales companies, such as Anyway and Nuskin have successfully gained access to the Chinese market. However, they have all had to invest huge amounts to establish manufacturing facilities and to open dozens of stores in China in order to survive the changes. According to some recent non-official information, the direct sales business model (considered to be different from pyramid sales that, the authorities claim, may affect social stability in China) would be permitted again for those FIEs that already have large-scale manufacturing facilities and have realized substantial turnover.

Toll Manufacturers. Although the general requirement is that an FIE can only sell those products it has manufactured itself, there does not appear to be any official definition of "self-manufactured products". In practice, if an FIE procures products through a toll manufacturing arrangement with a Chinese toll manufacturer, a relatively strong argument could be made that these products become the FIE's self-manufactured products and, thus, their resale by the FIE on the Chinese domestic market should be in conformity with PRC requirements.

Holding Companies. FIEs that have explicit approval from the Chinese authorities to exclusively engage in investment activities can lawfully purchase products from their invested enterprises and resell them in China or overseas, provided such distribution rights have been approved by the relevant authorities.

Shanghai Distribution Companies. The Shanghai Foreign Economic Trade and Relation Commission (Shanghai COFTEC) recently issued an internal trial circular (Trial Circular) that offers foreign investors easier access to the local market. The Trial Circular allows them to establish distribution joint ventures in Shanghai to sell or distribute brands and products manufactured by its FIEs, provided either of the following conditions are met: (i) the FIE exclusively conducts investment activities (approved by the Ministry of Commerce) and its registered capital has been totally paid, or; (ii) the manufacturing FIE is established in Shanghai, and the total investment of its affiliates in China exceeds US$30 million, at least three affiliated companies have started production, and the total annual turnover is more than Rmb1 billion.

According to the Trial Circular, such distribution companies should take the form of equity or cooperative joint ventures with a minimum of 25% equity interest held by the Chinese party. The Trial Circular also characterizes the nature of such a distribution company as the extension of a manufacturing FIE and not a merchandising company.

Conclusion

Even though foreign investors still have a long way to go to create valuable distribution networks and to secure real market share in China, some recent success stories prove that no serious international business players can afford to miss out on the potential opportunities in China.