The three capitals of China: which one is right for your Chinese HQ?

When Steve Fitz was searching for the right city in which to establish an Asian regional headquarters for EMC two years ago, he weighed several factors. Not least among them was access to good quality, English-language schools for his four young children. Thanks to a Hong Kong government-sponsored promotional group, InvestHK, Fitz got what he wanted. In a scene that illustrates how competitive corporate location has become in China, InvestHK lined up several headmasters of the top schools in Hong Kong and asked each to enroll in their academies not only Fitz's kids but also those of his management team. They agreed.

Fitz, president of Asian operations for the $8.1 billion data-storage company based in Hopkinton, Mass., was understandably pleased. He ultimately chose Hong Kong over other cities on his list of contenders--Singapore, Shanghai and Tokyo--based on a host of considerations, including its large English-speaking talent pool, Westernized lifestyle, efficient transportation links and proximity to China's quick-growing market just across the border. "Singapore was the most attractive on a cost basis, but was too far away from our markets," explains Fitz from his office, which has a panoramic view of the Hong Kong harbor. "Japan was expensive from a tax and cost-of-living perspective, plus the flying access was not as good. Shanghai was a runner-up to Hong Kong, and a lot of companies have moved their headquarters to Shanghai, but the infrastructure is not there yet--it's not nearly as flexible in terms of flights within Asia."

Previously, Fitz was based in Tokyo for a year after relocating from New York, and his five top managers were spread across several Asian cities. "Now, instead of having discussions over the phone, we meet here at least once a week for a formal meeting and for informal gatherings, too, which fosters better communication throughout the firm," he says.

The strength of China's markets is pulling some Asian headquarters away from Tokyo and Singapore, but which of China's "three capitals" makes the most sense--Hong Kong, Beijing or Shanghai? The answer, it appears, is that each has strengths and weaknesses, and chief executives making decisions about where to set up shop need to understand those and factor in the nature of their own businesses. Getting the right matchup is critically important--a wrong decision can lock a company into deep frustration.

Among its strengths, Hong Kong touts that it's part of the Pearl River Delta, close to thousands of factories, new airports and seaports in Shenzhen and Guangdong Province. Shanghai, transformed over the past decade into a modern metropolis, boasts of its position in the Yangtze River Delta, encompassing a semicircle of eight industrial cities. China's capital, Beijing, has been compared to Washington, D.C., and Chicago combined. To play host to the 2008 Olympics and an influx of business, the city's infrastructure is being rapidly improved.

By industry, generally Hong Kong is seen as the preferred location for companies in trading, logistics, banking and media--and it is also a hub for Asian operations. Beijing wins out for companies in heavily regulated industries, where close proximity to key government officials help build guanxi, or key connections--the all-important ingredient to success in China. Shanghai is emerging as an entrepreneurial center and a base for certain high-tech sectors such as semiconductors. It is also a financial hub for doing business within mainland China.

All three cities sport modernized air-ports and transport links, choice restaurants with international cuisine and numerous five-star hotels, many with more creature comforts than at top U.S. hotels. Prices for real estate and office space are fairly comparable, and English is now commonly spoken in all three Chinese capitals, although Hong Kong retains a clear lead in that department.

Hong Kong actually keeps track of the number of regional headquarters of overseas companies it attracts. In the most recent tally, it weighed in with 966 regional head offices, up from 948 the year before--despite the SARS scare. The territory's low 17.5 percent tax rate was cited as an important draw in choosing Hong Kong as a location, according to a survey by the Hong Kong government. Other factors included the free flow of information, political stability and security, corruption-free government, rule of law and an independent judiciary--characteristics inherited from Hong Kong's pre-1997 standing as a British colony and many of which cannot be guaranteed in mainland China.

But what Hong Kong does not provide is intimate access to key decision-makers, and China's economy is still dominated by Communist Party and government officials. If that is a company's top priority, then Beijing's central Chaoyang business district--the equivalent of midtown Manhattan--is one place to be. It's home to more than 60 percent of the city's foreign-invested companies and offers good transport links plus sightseeing; the Forbidden City and Tiananmen Square are a short cab ride away.

U.S. insurer MetLife set up shop last April in a modern commercial complex in Chaoyang after it received government approval to sell individual life insurance policies in China through a 50-50 joint venture with the state owner of Beijing International Airport. Under current World Trade Organization rules, MetLife can't own a majority stake in the entity. But if and when the rules change, Robin Chi, general manager of the joint venture, wants to be close to the central government decision-makers and insurance regulatory officials.

Chi hired nearly 100 telemarketers and insurance agents last spring, and he expects China to contribute some 5 million of its anticipated 100 million new customers by 2010. Profitability should follow two years later, promises Chi.

Where the People Are

The European conglomerate ABB put its base for ABB China in Beijing's central business district not only for proximity to government decision-makers but also because of access to the right kind of labor. China is seen as a cornerstone of its growth strategy, and hiring and training local talent is key to fulfilling its goals. Chairman and President Peter Leupp says ABB has been adding 1,000 employees annually and out of a total 7,000 staffers, there are only 100 expatriates. "We are earning good money here, and there is no unit anymore that is losing money," says Leupp of the $1.7 billion Chinese entity, now wholly owned by ABB.

The company began investing in China by setting up joint ventures and wholly owned foreign enterprises from 1994 to 1998, and has been building up local sales and distribution channels to take advantage of lower trade duties and increased market opportunities arising from China's entry into the WTO three years ago. One such new opportunity is the Three Gorges Power Project. The firm recently won a $60 million contract to supply power transformers to the huge dam. ABB has a dominant No. 1 or No. 2 position in most of its product lines in China, and most of its products are made with a high percentage of local content, saving import duties and investment dollars.

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As ABB expands, however, it has encountered growing pains in Beijing. Leupp says the company is facing a several-month delay in getting approval to build a new factory on farmland close to the airport. The problem stems from the central government's close control of the ratio of farmland to land used for factories. Leupp expects a decision on the site of the new factory will be reached within a few months, and says he has alternatives in six other Chinese cities. That's the sort of issue that would be difficult to sort out from a Hong Kong headquarters.

Beijing, like its rivals, is home to dozens of high-tech companies, many of them founded by Western-educated and experienced entrepreneurs who have returned to China. Robin Li. CEO of the Chinese search engine company Baidu, put his office in Beijing's northwestern high-tech district, Zhongguaneun, close to China's leading and highly regarded technology schools, Peking University and Tsinghua University, so he can tap young software talent. Li and his staffers have built a Chinese version of Google, and, in fact, Google recently bought a minority stake in Baidu. Microsoft's Chinese headquarters is also located in northwestern Beijing.

Hong Kong hasn't yet been able to establish itself as a major technology hub. It has developed a "Cyberport" for emerging businesses and also the Hong Kong Science and Technology Park for research and development, but it does not seem to possess the risk-taking, highly trained technical talent that exists on the mainland. Shanghai's technology hopes seem linked to the semiconductor industry. Taiwan's SMIC, which went public on the New York Stock Exchange earlier this year, used vast open land in the emerging Pudong district to erect two plants and build residential housing, schools, shopping, restaurants and recreational facilities. Chairman and CEO Richard Chang says such convenient access to services keeps his staff productive as he aims to make SMIC the leading semiconductor producer in China. Other chip plants are located as far away as Suzhou, which is considered part of Shanghai's economic zone. Shanghai is called the "dragon's head" and outlying areas represent its "tail."

Overall, it's clear that the center of gravity for many companies has shifted toward the mainland, and that means even the companies with deep roots in Hong Kong have to shift some functions, whether or not they maintain headquarters in the former British colony. Hong Kong players such as the trading firm Li & Fung are finding that they need to straddle both markets. Group managing director William Fung says that 40 percent of his company's supply-chain management business comes from China, and it's "growing like crazy." To help service those clients and to help lower the cost of its own operations, Li & Fung has moved clerical staffers north of the Hong Kong-China border. But top managers still handle production and sourcing from a drab office in Hong Kong's Kowloon section, not far from what Hong Kong bills as the world's busiest seaport.

"China is the world's largest factory, and Hong Kong is an ideal sourcing center for importing goods from China, for higher value-added jobs," says Fung. "Here you have connections to the financial community and there is a free flow of information and a legal system for protecting long-term contracts." He adds that China's cities are within "striking distance" of Hong Kong, meaning that the management team doesn't have to travel more than two to three hours to reach its far-flung operations in China.

The Case For Hong Kong

In the final analysis, Hong Kong possesses some strengths that neither Beijing nor Shanghai can yet boast and perhaps never will. Noble Group, a commodities trading company, maintains its management headquarters in Hong Kong, conveniently located next to the new Hong Kong Convention Center in Wanchai. CEO Richard Elman, who keeps track of the firm's cargo ships on a large computerized map displayed outside his office, says there's no way Noble could be in Shanghai. The simple reason is because of foreign exchange controls on Chinese currency. "If you're only marketing within China, that's fine," he says, "but if you are doing business globally like we are, it doesn't work." No one knows when or if China will lift those controls and make the renminbi fully convertible.

It's also hard to overestimate the power of the rule of law, which Hong Kong has and the mainland simply does not. T.L. Ng, a managing director at Energizer, learned the hard way why he shouldn't base his high-end manufacturing in mainland China--it's called counterfeiting. "In Hong Kong, the intellectual property rights are respected. There's a very mature and proven legal system," says Ng. "But in China, it's a little looser."

Indeed, Energizer moved production plants out of China to Korea a few years ago after finding that its flashlights were being copied and sold at huge discounts. Despite legal action, the offenders simply changed their company name and continued selling the low-cost flashlights. With little recourse, Energizer discontinued its brand name flashlights in China a few years ago and now markets a lower-priced flashlight, called Sunco, there.

Because of the complexity of creating a winning management and operational structure in China, some CEOs are opting to split their headquarters functions so they can take advantage of what Hong Kong has to offer and yet be close to their desired market or production base on the mainland. Peter Lam, president, greater China, for Emerson Electric Asia-Pacific, is officially based in Hong Kong, but spends 60 percent of his time in mainland China, where 16,000 of the firm's 25,000 Asian employees are based in some 32 facilities. "Our growth rate in China is in the double digits and already accounts for 11 percent of total Asian sales," says Lam.

To help oversee those growing operations, Lam recently decided his firm needed a dual headquarters: a base in Shanghai for close control and a base in Hong Kong as the "eyes and ears" for Emerson in the region. His business card includes addresses and contact details for both Hong Kong and Shanghai in English on one side and in Chinese characters on the other. "That says it all," he says with a smile. Ultimately, Western CEOs have to be as flexible and adaptable as the Chinese are themselves.

BEIJING

Advantages                              Disadvantages

* Guanxi (connections)                  * City sprawl limits mobility
* Cultural/heritage attractions         * Developing infrastructure
* Good tech schools                     * Harsh weather
* 2008 Olympics                         * Political risk
* Diplomatic district                   * Limited patent protection
* Western corporate community           * RMB not convertible
* Club scene
* Peking duck

SHANGHAI

Advantages                              Disadvantages

* "Buzz" central                        * Developing infrastructure
* Entrepreneurial hub                   * Traffic jams pollution
* Yangtze River Delta location          * Limited patent protection
* Pudong industrial zone                * RMB not convertible
* Highly regarded universities          * Political risk
* Young, talented work force            * Real estate prices soaring
* New "mag-lev" train to airport
* Best hotels in China

HONG KONG

Advantages                              Disadvantages

* Low corporate taxes                   * Out of the center of action
* Easy access to China                  * Limited land for expansion
* Rule of law                           * Tech hubs not popular
* English language common               * Regional, not China, hub
* Good infrastructure
* Westernized lifestyle
* Pearl River Delta location