INFLUENCES ON SMALL AND MEDIUM ENTERPRISES IN CHINA

AN ANALYSIS OF CURRENT CHALLENGES AND

SUGGESTIONS ON HOW TO ADAPT TO THEM

Prepared by:
Martin Witthoeft

Module Title: SMEs in an International Context

Module Leader: Robert Jones
Module Code: BC315015S

Academic Year: 2008/9

Semester: One
Level: 3

Submitted: 17 December 2008

 Table of Contents

1. Challenges for SMEs in China ............................................................................................. 1

1.1. SMEs in China - Driver of Economic Growth ............................................................... 1
1.2. SMEs in China in a Global Context ............................................................................... 1

2. Influence No. 1: Impact of the Financial Crisis on SMEs in China..................................... 2

2.1. Access to Financing for SMEs in China ........................................................................ 2
2.2. Auditing Problems within SMEs in China .................................................................... 3

3. Suggestion for No. 1: “SME-volution” – E-commerce for SMEs in China ......................... 4

3.1. Infrastructure for E-commerce .................................................................................... 4
3.2. Web Marketing for SMEs in China............................................................................... 5

4. Influence No. 2: IPR Infringement and its Consequences for SMEs in China ................... 6
4.1. IPR Legal Framework Inadequate in China .............................................................. 7
4.2. High Rate of Returns for Piracy ................................................................................ 7

5. Suggestions for No. 2: Specialisation and Networking among SMEs in China ................ 8
5.1. Internal Strategy for SMEs in China ............................................................................. 8
5.2. External Strategy for SMEs in China ............................................................................ 9

6. Influence No. 3: SME’s War for Talent in China .............................................................. 10

6.1. Graduates for SMEs in China ..................................................................................... 10
6.2. Professionals for SMEs in China ................................................................................ 10

7. Suggestion for No. 3: Attracting and Retaining Talent at SMEs in China ....................... 12
7.1. Talent Attraction for SMEs in China .......................................................................... 12
7.2. Retaining Talent Strategy for SMEs in China ............................................................. 14

8. Conclusion: Immediate Actions for SMEs in China ......................................................... 14

9. List of References ............................................................................................................. 16

i
 List of Tables

Table 1: Productivity of SMEs in China....................................................................................... 1

Table 2: Chinese Exports vs. SME Exports .................................................................................. 2

Table 3: Loans of SMEs in China ................................................................................................. 3

Table 4: Check List for E-commerce Costs ................................................................................. 4

Table 5: Web Marketing Strategies for SMEs ............................................................................ 5

Table 6: Recruitment vs. Talent Attraction .............................................................................. 13

Table 7: Check List for Immediate Changes ............................................................................. 15

ii
 1. Challenges for SMEs in China
This report focuses on assessing three major challenges considering the most important
resources of a SME in China, funding, information and people, and suggests solutions of how
to adapt to them in an effective way.

1.1. SMEs in China - Driver of Economic Growth

SMEs are the main driver of economic growth in China. Table 1 below shows that SMEs are
responsible for increasing employment, expanding exports and contribute to the reduction
of poverty in China (Liu, 2007).

Productivity of SMEs in China

• 40 million SMEs
• 99.6% of total number of enterprises
• 59% of GDP
• 60% of sales value
• 68.65% of imports &exports
• 48.2% of taxes paid
• 75% of employment providers in urban areas
Table 1: Productivity of SMEs in China

Source: Adapted from Liu, 2007

1.2. SMEs in China in a Global Context

The number of SMEs established in China in the last 10 years amounts to about 40 million,
compared to a combined 35 million in Europe (19 million) and the US (16 million) (Hall,
2007).

As outlined in Table 2 below, the contribution of SMEs to export has grown from 62 per cent
in 2002 to 68 per cent in 2005. These exports were worth $ 518 billion in 2005 (Hall, 2007).

1
 Chinese Exports vs. SME Exports

in billion $ Total exports SME exports SME exports in %

2002 438.23 272.48 62.3 %

2003 593.32 390.44 65.8 %
2004 761.99 518.16 68.0 %
Table 2: Chinese Exports vs. SME Exports
Source: Adapted from Hall, 2007

2. Influence No. 1: Impact of the Financial Crisis on SMEs in China

China’s economy took severe damage from the recent credit crunch just as the rest of the
world.

According to the General Administration of Customs China, there were 3,900 toy factories
going out of business in the first half of 2008 of which 93.1 per cent were SMEs with exports
below $ 100,000 per year (Wang, 2008).

CEIC data shows that in 2007 year on year export growth fell from 162 per cent in February
and 60 per cent in August to negative growths of - 17 per cent in February and - 2 per cent in
August in 2008 (Wang, 2008).

The slowdown of the global economy paired with the macroeconomic control in China
makes it difficult for SMEs to survive, the most serious problem being financing (Xiandong,
2006).

2.1. Access to Financing for SMEs in China

In China it is very difficult for SMEs to get financing on the market. They have to rely on loans
from the government and public finance agencies (Skoko, 2008). Table 3 below shows an
overview of sources of funding for SMEs in China.

2
 Loans of SMEs in China

• 14% from banks

• 8% from private finance agencies
• 24% inter-enterprises borrowings
• 54% from other sources

Table 3: Loans of SMEs in China

Source: Adapted from Skoko, 2008

Lack of Indirect Financing for SMEs in China

Chinese banks are reluctant to lend to SMEs because small single loans are not very
profitable and the lack of information on SMEs makes it difficult to control loan risks and
leads to low confidence in repayment abilities (Xiandong, 2006).

Difficulty in Direct Financing for SMEs in China

China’s share market is still in its infancy and the financing options are very limited with only
119 SMEs in China floating on the stock market in December 2007 (Ran, 2007).

2.2. Auditing Problems within SMEs in China

The majority of SMEs in China are not making much profit and therefore cannot invest into
IT infrastructure. The result is that they often provide inadequate data when applying for a
loan (Ran, 2007).

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 3. Suggestion for No. 1: “SME-volution” – E-commerce for SMEs in China

Since SMEs in China find themselves in such a tough situation, they need to adopt strict cost
saving measures and therefore spend their limited budget effectively by targeting
consumers through low-cost online channels such as E-commerce (iResearch, 2005).

The market for E-commerce in China promises a great return for relatively low investment
due to its fast growth with internet users in China skyrocketing from 620,000 in 1997 to 162
million in mid 2007 (Chao, 2007).

3.1. Infrastructure for E-commerce

In order for SMEs in China to “go online” with their services the costs shown in Table 4 have
to be considered.

Check List for E-commerce Costs

1. Set up costs Implementing E-commerce in a SME involves a
period for transition and it takes time to
generate profit.
2. Maintenance IT systems need to be serviced regularly and
these costs have to be added to the overall
calculations.
3. Outsourcing Certain areas of IT services should be
outsourced to specialists and consultants can
assist with change management for staff.
Table 4: Check List for E-commerce Costs

Source: Adapted from Usher Project, 2008

Use the SME Business Installations and Equipment Loan Guarantee Scheme

In order to finance these IT costs SMEs in China can collect funds via relatives, friends, angel
investors, venture capital and even initial public offerings. However, in China it is also
possible to apply for a government loan specifically for the set up of ecommerce
infrastructure: the SME Business Installations and Equipment Loan Guarantee (So, 2001).

4
This loan aims at funding the needs of SMEs in China for computer software and hardware or
office equipment. SMEs can apply for a three year loan from any Chinese bank with the
Chinese government guaranteeing for 50 per cent of the approved loan up to $ 128,000 (So,
2001).

So far 4,700 SMEs in China have used this opportunity amounting to over $ 3.3 billion in
government guarantee. SMEs can apply on the internet or via the SME Funding Schemes
enquiry hotline (TDC Business Info Centre, 2008)

The only conditions for SMEs are that they are creditworthy, have a good track record, and
are able to demonstrate business prospects (Fung, 2003).

3.2. Web Marketing for SMEs in China

Due to the tight budget of SMEs in China in today’s global crisis, the owner-manager has to
be creative and find new ways to market his company. Table 4 shows examples of how web
marketing can be used as a cost-effective way to achieve exposure for the company.

Web Marketing Strategies for SMEs

1. Search engines Setting up a keyword search including city and product/service

category at the most popular sites in China: Google & Yahoo
2. Web directories Portal sites like SMEcare.com & Timway have business directory
sections where company information can be posted free of charge
3. Auction sites eBay and Red-dots are offering platforms to generate additional
sales for only a little fee per transaction
4. Blogs Setting it up is free but keeping it alive is very labour intensive but
also rewarding since customer interests can be identified
5. YouTube Free video broadcasting website which can be part of the marketing
strategy. It is used for product introduction, training and customer
service
Table 5: Web Marketing Strategies for SMEs

Source: Adopted from Kwan, 2007

5
Use the SME Marketing Fund Scheme

For marketing expenses of SMEs the Chinese government offers another specific guaranteed
fund: the SME Marketing Fund Scheme (Hughes, 2006).

This government fund aims to promote SME participation in fairs and to cover expenses such
as creating a web presence guaranteeing for 50 per cent of the costs up to $ 1, 280 (Hughes,
2006).

The SME Marketing Fund has so far been granted to 15, 000 SMEs amounting to nearly $ 150
million in subsidy. A 2007 survey by TID Polytechnic University showed that the SME
Marketing fund helped 85 per cent of businesses to improve their export promotion
activities and 66 per cent of them stated that it contributed to strongly increase their
exports (Hughes, 2006).

4. Influence No. 2: IPR Infringement and its Consequences for SMEs in China
China is the world's top offender in copyright theft. By entering into the World Trade
Organization copyright violation is becoming increasingly important for SMEs in China
(Chynoweth, 2003).

According to the Business Software Alliance, the personal software piracy rate in China was
82 per cent in 2007 down from 92 per cent in 2003 causing losses of $ 6.7 billion in 2007, up
from $ 3.8 billion in 2003 (PhysOrg.com, 2008).

Bearing Point’s 2004 MII report states that software piracy is regarded as their top enemy by
60.8 per cent of Chinese software SMEs (Kharbanda & Suman, 2002).

The importance of the Chinese software industry to the overall GDP was 0.16 per cent or 160
billion RMB in 2003, having increased annually by an average rate of 38 per cent between
1992 and 2003 (Lai, 2008).

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 4.1. IPR Legal Framework Inadequate in China

In a nutshell, IP laws give temporary monopoly power to inventors so they can retrieve the
cost of their R&D investment (Lai, 2008).

With the agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS),

technology-originating countries like the U.S. want to strengthen their IP rights and
therefore cause significant wealth transfers away from China. In theory they then have to
ensure China’s access to affordable knowledge goods and open their markets for the
Chinese goods to make up for it (Lai, 2008).

Reality is somehow different what can be seen from the example of Microsoft’s strategy of
charging the global price for its software in China which is about 5 per cent of the average
worker's annual income making it clearly unaffordable for them (Yingzi, 2008). However
Chinese consumers with low incomes still need to have access to this kind of technology.
Microsoft's Windows XP operating system serves a premium example for this discrepancy
since it was sold for $ 4 on the street markets in China even before Microsoft formally
released its $ 180 legal version for the Chinese market (Kahn, 2002).

The free download of pirated software is not restricted in China since there is a provision in
Chinese law that requires pirated goods to be sold before violators can be prosecuted
(Stinchcomb, 2006).

4.2. High Rate of Returns for Piracy

IP protection in simple terms means the protection of a valuable idea. Yet in China ideas are
often copied at little cost (Lai, 2008).

According to William Lash, assistant secretary of commerce for market access and
compliance in Hong Kong, there are three reasons that “fuel piracy”: Up to 5,000 per cent
return on investment, no chance of being caught and no real punishment (Iyengar, 2004).

7
 5. Suggestions for No. 2: Specialisation and Networking among SMEs in China
In order to stay competitive, SMEs in the Chinese software industry should get certified and
shift to the piracy-free enterprise software market. In the long run they should focus on
improving their visibility towards overseas subcontractors by entering federations to
eventually partner with an overseas firm to tap into new markets.

5.1. Internal Strategy for SMEs in China

Get CMM and ISO 9000 Certified

In order to prove that an SME possesses the ability to perform contracted software projects
it needs to get certified in CMM (Capability Maturity Model) (Jayaram, 2007).

Currently there are only 12 companies that have a CMM certificate in China. The fifth-grade
CMM certification is the highest level with 58 software institutes worldwide satisfying this
standard of professionalism, 32 of them are in India and none in China (Kharbanda & Suman,
2002).

The ISO 9000 certificate demonstrates that its holder has basic quality procedures, controls
of documentation, traceability and internal auditing in place (Kharbanda & Suman, 2002).

Educate Managers about IPR

Few managers of SMEs in China have in depth knowledge about IPR. Although “IPR is a tool
of large firms and the developed world”, it is important to understand its implications for
SMEs in China (Macdonald, Turpin & Anog, 2005).

Specialise in Piracy-free Enterprise Software

The most profitable segment of China's software market is enterprise software since it is
largely piracy-free. About 50 per cent of SMEs in China have computers although only four

8
per cent are using customized business software making it a market with great potential
(Weitao, 2007).

5.2. External Strategy for SMEs in China

Enter Export Federations and Zones

To compete effectively in global outsourcing, software SMEs in China must consolidate by

entering clusters and networks. There are software export experimental zones throughout
China like the Ningbo International Software Park and software export federations in
Shanghai, Tianjin and Xian (De Filippo, Hou & Ip, 2005).

Become a Subcontractor and Partner up with Foreign Firms

Chinese software SMEs should aim to be subcontracted by foreign firms of the likes of SAP
and IBM or partner up with leading Western software providers like Microsoft to gain
knowledge about the processes used in the West (De Filippo, Hou & Ip, 2005).

However, a survey conducted by McKinsey in 2005 indicates that only 12 percent of Chinese
software SMEs consider mergers, acquisitions or alliances in the near future (De Filippo, Hou
& Ip, 2005).

There are mostly Indian companies which plan acquisitions of SMEs in China to get into the
Chinese software market, therefore Chinese software SMEs have to make quick changes in
order not to lose ground in their home market (De Filippo, Hou & Ip, 2005).

9
 6. Influence No. 3: SME’s War for Talent in China

McKinsey introduced the phrase „War for Talent“ in 1998 pointing out the need for being
proactive in attracting and retaining the best people (Chambers, 1998).

Due to the global financial crisis discussed in section three above, SMEs in China now have a
great variety of talent to choose from but the predicament of very limited funds for
recruiting.

6.1. Graduates for SMEs in China

The recent global slowdown is affecting the 6 million Chinese students that left university in
2007 with a quarter of them still looking for a job (Branigan, 2008).

Declining orders from overseas are forcing thousands of factories to close down. SMEs in
China are struggling to survive and have few or no job vacancies with the example of the
financial service sector reporting a drop of 12 per cent between July-November 2008
compared to the same period in 2007 (Ye & Wang, 2008).

An extreme example of the level of competition happened in the city of Guangzhou the
capital of the southern province of Guangdong where 286 graduates competed for 11
positions as street cleaners. The city ended up hiring one candidate with a PhD, four with
master's degrees and six with bachelor's degrees for the job (Landsberg, 2006). This
happened even before the time of the financial crisis and nowadays the situation looks even
worse for graduates.

6.2. Professionals for SMEs in China

Origin of Talent

Due to the one-child policy it is hard to find team players in China. During Mao Zedong's
Cultural Revolution of 1966-76 a whole generation of potential managers was instructed
that capitalism was evil and has now great difficulty to adopt Western working practices
(Manpower China Whitepaper, 2006).
10
The talent pool in China therefore consists of bureaucratic state firm managers or
entrepreneurs that are constrained by either capital or the law (Manpower China
Whitepaper, 2006).

Employability

In China 33 per cent of the university students study engineering compared to 20 per cent in
Germany and four per cent in India. China’s educational system focuses on entirely on
theory so when compared with their counterparts in Europe and North America, the 1.6
million Chinese engineering graduates lack practical experience and the ability to work
effectively in a team. The result is that only 160,000 of China's engineers are considered
suitable to work in SMEs dealing with overseas clients (Manpower China Whitepaper, 2006).

The main reason for rejecting Chinese applicants is their poor knowledge of the English
language with only three per cent considered for general service positions with contact to
foreigners (Manpower China Whitepaper, 2006).

The willingness of Chinese to work long hours to compensate for deficiencies in their abilities
is important in manufacturing but only makes a marginal difference for SMEs in the service
industry because of the need for specific skills (Manpower China Whitepaper, 2006).

Shortage of Managers

Filling senior management positions is considered to be difficult by two out of five SMEs in
China. Replacing a high performance manager might account for 300 to 2,000
per cent of his normal salary (Manpower China Whitepaper, 2006).

Due to the shortage of suitable talent, accountants' salaries are rising by 14 per cent a year
according to Lai Kam-tong at the Hong Kong Institute of Human Resource Management.
Jurgen Viethen, general manager of F&G China Electric, is losing employees even though
offering them pay raises of 50 per cent (Kundu, 2006).

11
 7. Suggestion for No. 3: Attracting and Retaining Talent at SMEs in China
As shown in section six, the situation on the market for talent is quite contradictory. Even
though there are millions of graduates looking for jobs, the choice of suitable employees is
very limited for SMEs in China.

7.1. Talent Attraction for SMEs in China

According to the head of a global recruitment agency, SMEs in China now have the chance to
take advantage of the financial crisis in recruiting talents made redundant due to the
downsizing effort of many multinational companies (Yannan, 2008).

Tony Goodwin, CEO of Antal International, thinks that now is the best time for SMEs to “tap
the market for talent" and hire top managers that they would not have been able to find in
the past (Yannan, 2008). SMEs in China should therefore think long-term in their corporate
human resources strategy and invest in talent when its availability is high.

Develop an Employment Brand

SMEs that attract the best people will be most successful. It is therefore important to not
only promote its products and services but to advertise the SME to talent as a great place to
work. With all other things being equal, candidates will choose companies with the best
reputations as places to work. An employer with an inferior brand will therefore have to pay
more to secure top talent (MRI Network China, 2007).
SMEs with strong employment brands are so attractive that candidates will be eager to work
for them. Therefore, they face lower costs of finding talent and save time in the overall
hiring process (MRI Network China, 2007).

Start the Talent Attraction Process

Reaching out to talent has never been easier than today given the popularity of professional
networking sites like Xing and LinkedIn or their social counterparts of the likes of Facebook

12
and MySpace. The goal of focusing on talent attraction is to create long-term talent pools
(MRI Network China, 2007).

Table 5 below outlines the differences between the recruitment and talent attraction
process.

Recruitment vs. Talent Attraction

Recruitment Talent Attraction

• A tactical event when the need • A strategically focused process

arises
• Reactive (SME is the pursuer)
• A fluctuating prohibitive expense
Source: Adapted from Black Bag Talent Acquisition, 2006
that is ongoing
• Proactive (SME is being pursued)
• A predictable manageable expense
Table 6: Recruitment vs. Talent Attraction

Talent that is attracted to an SME can be hired for less money than talent that needs to be
chased and with short vacancy times freelance expenditures for the SME will be considerably
reduced. Another benefit is that salary costs will have greater consistency (Black Bag Talent
Acquisition, 2006).

With a talent attraction process there is pre-qualified, pre-screened, pre-negotiated talent

available so if a key employee resigns, the SME has his replacement already in the pipeline
and no longer has to rely on recruiting agencies and head-hunters (Black Bag Talent
Acquisition, 2006). SMEs therefore need to think long-term and invest in a talent attraction
process.

Link up with Universities

SMEs in China looking to hire should look towards universities in their area and set up
programs so they can get graduates with the particular skills they want (Paton, 2007).

According to Judith Banister, director at The Conference Board, this approach is “mutually
beneficial” because it trains students “in a way that is useful to the SME" (Paton, 2007).
13
 7.2. Retaining Talent Strategy for SMEs in China

Promote Overseas Assignments

According to a survey by Mercer Consulting Group, talent in China is attracted by overseas

assignments and it is regarded as a great retention factor across all levels (Mercer, 2008).

So far Chinese talent was kept in China because of language skills, local knowledge and
networks but it is important to offer international exposure to retain top talent (Fischer &
Chung, 2008).

Chinese professionals do not want to be seen as employed specifically for the Chinese
market but as part of the SME’s global professional team who “happens to be Chinese”
(Fischer & Chung, 2008).

SMEs in China should therefore offer frequent overseas assignments to its employees and
help them prepare for their stay abroad by offering them language courses. These
expenditures will not only be repaid to the SMEs by being able to retain their best
employees but also by providing additional benefits like international experience and
relations.

8. Conclusion: Immediate Actions for SMEs in China

Summary

The three current external influences on SMEs examined above are funding, piracy and
talent shortage in China. Recommendations were given to opt for E-commerce and web
marketing to save on marketing, specialisation and subcontracting to avoid IPR issues and to
create links with universities and establish an employment brand to coordinate the supply of
suitable employees.

14
China’s economy is evolving at such a fast pace that it is vital for the owner-manager of an
SME to set aside time to stay on top of current developments in all of the three areas.

Check list

Table 7 below shows three agenda items which can be implemented immediately without
making structural changes to the operations of the SME.

Check List for Immediate Changes

1. Start internet SMEs can use the internet as a cost-effective way

marketing to get their message out to potential customers.
To be a specialist in a niche market is not enough
anymore, today the hitch is to choose the right
channels to communicate it.
2. Get certified SMEs which want to be seriously considered for
subcontracting need to be certified to pass the
pre-selection process of multinationals.
Certifications are also a prerequisite when looking
for prospects outside of China.
3. Look after SMEs should make their employees a priority and
employees keep them content by offering them overseas
assignments and holding on to them even in
times of economic downturn. This will keep them
in the company even if there would be slightly
more money for them elsewhere.
Table 7: Check List for Immediate Changes

Source: Author

The bottom line is that the main resources of SMEs bear the main challenges and the
greatest opportunities. It is wise to spend time on them since they will pay it back many
times over.

15
 9. List of References

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Branigan, T., 2008. Millions of Chinese graduates out of work after fivefold rise in university
places. The Guardian, [internet] 4 December.
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graduate-jobs
[Accessed 3 December 2008].

Chambers, E., 1998. The war for talent. The McKinsey Quarterly, [internet] August.
Available at: http://www.mckinseyquarterly.com/The_war_for_talent_305
[Accessed 3 December 2008].

Chao, C., 2007. The Market Potential of the Internet in China. China.org.cn, [internet] 28
November.
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[Accessed 1 December 2008].

Chynoweth, G., 2003. Reality bites: How the biting reality of piracy in China is working to
strengthen its copyright laws, Duke L. & Tech. iBrief, [internet] 2 November.
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[Accessed 2 December 2008].

De Filippo, G., Hou, J. & Ip, C., 2005. Can China compete in IT services? The McKinsey
Quarterly, [internet] February.
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Fischer, W. & Chung, R., 2008. Talent challenge in China. IMD Business School, [internet]
March.
Available at: http://www.imd.ch/research/challenges/upload/TC008-
08_talent_challenge_in_china_II.pdf
[Accessed 3 December 2008].

Fung, E., 2003. SME loan schemes are effective, timely. News.gov.hk, [internet] 25 March.
Available at:
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11001.htm
[Accessed 1 December 2008].

Hall, C., 2007. When the dragon awakes: Internationalisation of SMEs in China and
implications for Europe. CESifo Forum, [internet] February.

16
Available at: http://www.cesifo-
group.de/pls/guestci/download/CESifo%20Forum%202007/CESifo%20Forum%202/2007/for
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[Accessed 1 December 2008].

Hughes, T., 2006. SME Funding Schemes Play an Important Role. International Business
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[Accessed 1 December 2008].

iResearch, 2005. Opportunities in China Internet Market, [Online] (Updated 2005).

Available at:
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[Accessed 1 December 2008].

Iyengar, J., 2004. Intellectual property piracy rocks China boat. Asia Times Online, [internet]
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Jayaram, M., 2007. Capability Maturity Model, [Online] (Updated 6 Apr 2007).
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Kahn, J., 2002. The Pinch of Piracy Wakes China Up On Copyright Issue; It's More Than a
Trade Dispute. The New York Times, [internet] 1 November.
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Kharbanda, V. & Suman, Y., 2002. Chinese initiative in the software industry – Quest
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[Accessed 1 December 2008].

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Lai, E., 2008. Intellectual Property Protection in a Globalizing Era, Federal Reserve Bank of
Dallas Economic Brief, [internet] March.
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Landsberg, M., 2006. Jobs Scarce for China's Graduates. The Los Angeles Times, [internet] 29
December.
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[Accessed 3 December 2008].

Liu, C., 2007. SME financing in China. Université Paris X-Nanterre working paper, [Online]
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