Manufacturing in China? Key facts for getting started.

Encouraged by China's explosive economic growth and news of favorable changes in laws and regulations, increasing numbers of smaller American companies are considering setting up operations in the People's Republic of China (PRC). Such a move can yield good results, but, it's essential to understand some key issues before making irreversible commitments.

* The business environment. First, the obvious: it's a big country. Business conditions, customs and resources vary from one place to another. In one region, business practices may seem reasonably close to those in the U.S.; in another, they may differ markedly. And some regions may offer a more favorable environment for manufacturers than others.

This vast regional variability makes it imperative for interested U.S. companies to get informed advice--from official sources in the PRC and from others with direct experience on the ground.

* Local resources. Yes, there is inexpensive labor in the PRC, especially in areas like the interior provinces of Sichuan, Anhui and Heilongjiang, where manufacturing companies are especially welcome. But in more developed, "wired" coastal areas, such as Guangdong, Jiangsu and Shanghai, workers with the requisite technological and industrial skills are significantly more expensive, and competition for skilled labor among foreign companies can raise those costs even higher. Also, when hiring skilled workers, competition doesn't end, as other companies still try to lure employees away with better offers. While "cheaper," inland labor costs are often offset by training and transportation costs to get export-bound goods to the coast.

The energy supply, too, is largely dependent on location. Resources are more abundant in the central and western regions, such as in the provinces of Shichuan, Liaoning and Inner Mongolia. The PRC government is working to bring this situation into greater balance.

* Local connectivity. It's critical to understand local culture and customs, and the respect government officials feel is owed them. Face-to-face meetings help build this understanding and form the kind of personal relationships that can ease the entry process. Given the complexities of getting started in the PRC, this point can't be stressed strongly enough.

* Organizational structure. When China first began opening up to foreign business, many U.S. companies thought joint ventures with indigenous firms were a smart choice. Over time, however, it has become clear that the difficulties with joint ventures often outweighed the advantages. Working with venture partners can be frustrating, and can thwart overall corporate strategy. Today, strategic alliances--such as contracting to procure a key component locally for goods intended for sale outside the PRC--are perceived as the better option.

* Laws, written and unwritten. Foreign companies have an acute need for experienced advice on local laws. Tax law, labor law and commercial law; multiple levels of government and inconsistencies in the application and interpretation of laws and regulations all combine in a maze that can confound ambitious plans.

It's not that unusual for local governments to make promises they have no legal authority to deliver on. For example, a local or county government may offer tax reductions and other incentives to foreign companies. But after setting up operations in one of these locations, they may later be dismayed to see a higher level of government step in, overrule the local government and reduce or strip away the promised incentives. Seek informed guidance and be aware that local governments in China, as elsewhere, don't always have the last word.

* Manufacturing strategy. Choosing the right strategy for manufacturing operations also demands careful consideration. A U.S. company might find itself weighing one of these three options:

1. Manufacture key components in the U.S., ship them to China for final assembly and then ship them back to the U.S. for sale;

2. Make the components in China, then send them back to the U.S. for assembly; or

3. Make both components and finished products in China, and sell the products in the PRC.

Each choice has tax consequences. For example, under China's Processing Trade Program, foreign companies may bring components into the country free of value-added tax (VAT) or customs duties, provided the finished goods are sold outside China. But if the company later sells finished goods inside China, it may incur additional VAT and customs costs.

* Communication. Even sound planning and good execution won't produce success without one more, absolutely indispensable ingredient: clear and frequent communication between senior corporate management in the U.S. and management of the Chinese operation. Leadership must know what's going on.

Bottom line: your manufacturing operation can operate successfully in the People's Republic of China if you 1) understand regional differences; and 2) get good advice. It is strongly advised that you start with good advice!

Alexander Pan is a partner with PricewaterhouseCoopers' Private Company Services practice in Los Angeles and can be reached at [e-mail].