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Thriving in the Regulatory Environment of E-Commerce in China: A Guanxi Strategy.

Introduction

E-commerce can be defined as any commercial transactions conducted over the Internet (Shah & Sterrett, 1998). In many Western countries, the Internet has become an important channel through which international business activities take place. However, in China e-commerce is still in its infancy (Associated Press, 2000). Over the past 20 years, China's economy has grown rapidly. Developing international e-commerce has been a key initiative of the Chinese Communist Party's (CCP) economic liberalization project. Although foreign investment in e-commerce is not allowed in China at present, foreign investors are likely to flood into this huge market after WTO entry (Kennedy, 2000).

Internet connections were first allowed in 1994; by the end of October, the number of Internet users reached 620,000 (The New York Times, 1996). Growth since has been exponential; at the end of June 2000, there were 16.9 million Internet subscribers and 27,289 websites in China (CINIC, 2000; Reuters, 2000, July 28). The number is expected to grow to around 40 million by 2003 (Jusko, 2000). To support this growth in the future, the Chinese government is urging many local businesses -- notably state enterprises -- to continue to promote e-commerce development. In 1993, the government spent RMB 50 billion (U.S.$ 714 million) laying fiber optic cable networks under all major cities (McGill, 2000). This demonstrates the CCP's commitment to support e-commerce.

Official estimates are constantly under revision, but indicate that online transactions in 2000 are expected to amount to a rather spare U.S.$ 42 million (Smith, 2000) or a slightly more generous RMB 800 million (U.S.$ 96.7 million) (BBC, 2000). However, these figures represent from six to 14 times the previous year's total, with another ten-fold increase forecast for the next two years (BBC, 2000).

Despite the Internet's growth, the government is also attempting to devise laws and regulations to oversee its burgeoning development (Lapres, 2000). The aim is to restrict access to politically harmful information and to safeguard national security. This highlights the fundamental contradiction of e-commerce development in socialist China. The CCP wants to enjoy the economic growth brought about by Internet technology while restraining it by maintaining control over the free flow of information (McCarthy, 2000). Such a contradiction would lead China to follow a route that deviates from that of many industrialized countries in the future development of e-commerce. This aspect will be explored more broadly in future research.

This paper specifically examines the five major regulations affecting the Chinese Internet: domain name registration, the taxation of e-commerce, encryption, Internet policing, and Web media monitoring. In combination with these regulations' constraints on business strategies and liberties, the lack of a strong enforcement regime compounds the inherent complexity of the Chinese business environment. We will discuss the resulting implications for prospective foreign investors. Finally, the importance of guanxi (relationships) with selected key constituencies in business and government will be addressed. We believe that cultivating guanxi with these different groups can help minimize legal uncertainties embedded in the current situation of Chinese e-commerce, although questions may be raised about the nature and ethics of guanxi itself.

The Regulatory Environment of E-commerce in China

At present, both public and private access to the Internet in China is restricted to four state-controlled Internet service providers (ISPs) (Kennedy, 2000). These include ChinaNet (China Network), China GBNet (China Golden Bridge Network), CERNET (China Education and Research NETwork), and CSTNet (China Science and Technology Network), all of which are governed by the Ministry of Information Industry (MII) -- the ultimate body that deals with Internet-related regulations and licensing for online companies (Kennedy, 2000; Lovelock, 1999). Local private and foreign-invested ISPs (with up to 49% equity share from the date of WTO accession) can offer their services to their clients only through these four state-controlled ISPs, through which business permits are issued (Kennedy, 2000). Individual clients can obtain Internet access either indirectly from private providers or directly from one of the four government ISPs (Kennedy, 2000). Once connected to the Internet, they must "register with the local public sec urities authorities within 30 days" (Kennedy, 2000). The chart summarizes China's present system for Internet access.

This system was the outcome of the Regulation of Public Computer Networks and the Internet promulgated in April 1996 and revised in December 1997 (Kennedy, 2000). It gives the CCP more confidence in regulating the Internet and a mechanism for censoring information that flows into and out of the country. The purpose is to ensure that Mil serves as the gateway for global information exchange through the World Wide Web. Although some people criticize the system for being too bureaucratic and impractical, it nevertheless is an important step toward China's development of international e-commerce.

More specific regulations are promulgated on an ongoing basis, affecting particular sectors of business activity involving the Internet. For example, MII announced that telecommunication firms would require a permit to offer telephone services over the Internet. Despite recognizing that such services would be substantially cheaper than traditional telephone services and would actively encourage competition in reducing the cost of calls, a restricted number of permits would be issued following a trial period to allow the government to resolve any difficulties (Techserver, 1999). Local regulations can add further bureaucratic layers, notably in Beijing and Shanghai (for details of several such regulations, refer to Kennedy, 2000).

The stringent control over the Internet highlights the fundamental contradiction of e-commerce development in China today. The government recognizes the positive effects of information technology but fears that the unrestricted spread of ideas and knowledge would subvert its one-party dictatorship (McCarthy, 2000; Penbera, 1999). To cope with this fear, officials in Beijing have applied strong measures to regulate the local Internet in the following areas: domain name registration, the taxation of e-commerce, encryption, Internet policing, and Web media monitoring. Each is discussed below.

* Domain Name Registration

The China National Network Information Centre (CNNIC), an organization under the Chinese Academy of Sciences, handles all domain name registrations (Lovelock, 1999). Web companies that intend to register domain names in China must have at least one of their branch or representative offices established in the country (Kennedy, 2000). Since October 1999, companies have been able to apply for either a dot.com or a dot.cn registration (Kennedy, 2000). Due to the popularity of dot.com domain names, several government agencies -- such as China-Channel.com, Eastern Communications, and XinNet Corporation, ail of which are members of ICANN (Internet Corporation for Assigned Names and Numbers) -- will be offering such registrations soon (Gillmor, 2000; Kennedy, 2000).

However, a major problem of this domain name system has not yet been solved. The CNNIC currently does not possess effective mechanisms to handle disputes over domain name registrations. CNNIC does not have the responsibility to investigate whether a requested domain name violates the trademark or existing usage rights belonging to another organization. Owners of potentially offended companies or trademarks must themselves provide evidence for CNNIC if they wish to raise objections to any proposed domain name registration. Further, the existing domain name rules do not specify the maximum amount of time allowed for CNNIC to respond to each case after submission of evidence. This uncertainty has eventually led some companies to take their domain name disputes to the People's Court (Kennedy, 2000). For example, DuPont recently sued a company in Beijing, Guowang Information Consulting, for registering the duplicated domain name dupont.com.cn (Kennedy, 2000).

* The Taxation of E-commerce

Many countries have recognized taxation difficulties associated with e-commerce (The Economist, 2000, January 29), which often stem from a massive number of daily transactions conducted by anonymous people worldwide. They are further exacerbated by the development of highly secure encryption technology and anonymous e-money. However, some advanced countries, including Australia, Japan, and the EU, have begun drafting new tax rules in an attempt to sustain their government revenues and to cope with the diversity of online transactions (Farrell & Yuen, 2000).

In contrast, the Chinese government has not yet announced any specific e-commerce taxation policy. However, some commentators expect that China will be the first country to implement such measures. The head of the State Administration of Taxation (SAT) stated in July 2000 that all trade should be taxed, regardless of the nature of the medium (Associated Press, 2000). China's e-commerce is still in its infancy; the lack of affluent consumers with credit cards is a major constraint on the industry's growth (Einhom, Engardio, & Webb, 2000). Such a constraint gives Chinese policymakers more time to find ways to tax commercial transactions over the Internet. They not only consider Internet taxation a major potential source of revenue but also a way to exercise administrative control over illegal activities. A special task force has been established by the SAT to deal with the issue (Associated Press, 2000; Farrell & Yuen, 2000).

* Encryption

China is one of the few countries with regulations for controlling domestic encryption use; most governments only impose restriction on encryption exports. In China, the National Commission on Encryption Code Regulations (NCECR) was recently established to monitor the domestic use of encryption (Economist, 2000), and Commercial Use Encryption Management Regulations subsequently came into effect in October 1999. Under these regulations, all foreign companies, including those considering investing in Chinese e-commerce, must obtain approval from NCECR for their use of imported encryption products, while local companies are only allowed to use Chinese-made, state-approved ones (Economist, 2000).

The imposition of such regulations not only implies the importance of encryption technology for Chinese e-commerce but also signals the seriousness of the threat that it could pose to national security and public safety (Economist, 2000). It is clear that encryption registration will give the government the means to decode encrypted information and monitor the traffic of all transactions over the Internet. However, the defining criteria for what is considered a qualified encryption product remain unclear for many foreign investors. Many seem uninterested in registering because they fear that, once encryption codes are known, their commercial secrets will be leaked to outsiders -- possible to Chinese state-owned enterprises -- jeopardizing their market standing in the industry. China is now ranked 63rd out of 90 countries in terms of corruption, defined as abuse of public office for private gain, according to the 2000 corruption survey by Transparency International (The Wall Journal, 2000; Transparency Intern ational, 2000). Its longstanding reputation for corruption within government bureaucracies has not promoted confidence that sensitive information will remain confidential.

* Internet Policing

A new Chinese Internet police force was established in response to the rapid development of e-commerce (The Economist, 2000, July 22). The Internet police are charged primarily with combating Internet crimes ranging broadly from pornography to the dissemination of "state secrets." State secrets predictably include military, diplomatic, and economic matters, but also concern selected social and technological information (Kennedy, 2000). The establishment of the Internet police force is a result of the Secrecy Regulations recently promulgated by the State Bureau of Secrecy. The regulations cover all activities conducted through the Internet, including e-mail, chat rooms, newsgroups, and discussion forums (Economist, 2000).

In one recent case, Huang Qi -- arrested by the police in Chengdu of Sichuan province on June 3, 2000 -- created a Web site that revealed information about the June 4 Tienanmen massacre in 1989 (Agence France Presse, 2000, August 8; Reuters, 2000, August 9). The site also served as an international forum on human rights, democracy, and corruption in China. Under the Secrecy Regulations, Huang was charged with "subverting state power" and sentenced to a long term of imprisonment (Reuters, 2000, August 9).

Revealing state secrets is a serious offence in China. All local Internet content providers (ICPs) are now obliged to routinely censor the content of their Web pages and expunge politically sensitive material (Lapres, 2000). AU local ISPs are held responsible for registering their subscribers with the Internet police (Lapres, 2000). It is uncertain whether such regulations will eventually be viable for the future of Chinese e-commerce. Nevertheless, the Internet police are enforcing the regulations. Despite the popular belief that the internet would bring democracy to China, it seems as though the CCP is capitalizing on Internet technology to tighten its rule over the country.

* Web Media Monitoring

The Internet has opened up a new realm for political struggles. The report for 2000 by the human rights group Freedom House on the status of press censorship declared that 69 countries have completely free media, with 51 partly free and 66 experiencing heavy government censorship -- the latter including China. China also featured in the least-free group of 20 countries in terms of Internet access (Freedom House, 2000). Interference with Internet content ranges from e-mail censorship to closing Web sites and imprisoning the "cyber dissidents" (Sussman, 2000).

The Internet carries a wealth of knowledge for Chinese citizens but simultaneously delivers unwelcome ideas that challenge the authority of the communist regime. As a result, the CCP has passed new laws to constrain what the local media can publish online. Domestic online media are now prohibited from employing their own journalists and publishing original news (Economist, 2000). Only state-approved news -- released by the state media, such as the People's Daily -- is permitted for commercial Web publishing (Economist, 2000). Some overseas Web sites, such as CNN, the New York Times, and various human rights groups, are routinely blocked for their "politically misleading" content (Economist, 2000). At present, the Chinese government is giving extra financial aid to its communist media, supporting their development and dominance of online networks.

* Summary of Regulation Effects

All five regulations suggest that China's e-commerce will evolve in a manner that deviates from that of most industrialized countries. The main difference revolves around the rigorous control of the CCP over politically provocative information. The Internet, which could supposedly enhance the democratic freedom of China, has become a political battleground. The CCP wants the economic benefits of the Internet but jettisons the freedom associated with it (McCarthy, 2000). This highlights the inherent contradiction of e-commerce development in China.

Strategic Implications for Sino-Foreign Joint Ventures

Foreign investment in local ISPs and ICPs is still illegal in China at the time of this writing. In the remaining section, our discussion will be limited to strategic implications for foreign investment in the fledging e-commerce industry, specifically on prospective Sino-foreign equity joint ventures (with up to 49% foreign equity share allowed after China's WTO entry). Outside of the e-commerce industry, equity joint ventures are currently considered the most common type of Foreign Direct Investment (FDI) in China since 1989 (Coughlin & Segev, 2000). Other types of FDI are outside the scope of this paper. This section then discusses the importance of guanxi with three groups of people: local alliance partners, corporate executives of local firms, and government officials.

Although the government has begun regulating the industry in recent years, regulations remain noncomprehensive and vague. Some are ambiguous and laced with loopholes. For instance, it is difficult to know precisely what is considered a state secret. The definition is broad, embracing almost everything deemed subversive or politically harmful, including commercial advertisements. With such a broad definition, accurate interpretation of what constitutes a breach of the Secrecy Regulations is difficult, especially when many local ISPs and ICPs (e.g. the local media) are now trying to exercise self-censorship (Lapres, 2000). Further, the dispute procedures for domain name registrations are not transparent. Firms are likely to face uncertainties about the ownership of their trademarks, including how much time CNNIC needs before actions can be taken. With respect to the Encryption Regulations, the registration requirements for all imported encryption products have led many foreign investors to reassess their inves tment plans in China due to their fear of disclosure of commercial secrets. Coupled with severe penalties imposed by the government, investment in Chinese e-commerce is both a risky and a challenging activity for foreigners.

* The Benefits of Joint Ventures

With the uncertainties and risks involved, prospective foreign investors must develop distinct business strategies for competing in the fledging Chinese e-commerce industry (Coughlin & Segev, 2000). As in other emerging economies, equity joint ventures are the most common form of strategic alliance. In fact, it is the only type of FDI that will be allowed in the industry after China's WTO accession. However, foreigners considering investing in Chinese e-commerce are likely to prefer this type of FDI for a number of reasons.

First, like many emerging economies, China has weak market-supporting institutions, such as Internet-related regulatory institutions and property rights (Ramamurti, 2000). Coupled with its rapidly changing economic environment, such weak institutions often increase ambiguity and create obstacles to understanding unfamiliar, ill-defined regulations. Joint ventures allow inexperienced foreign investors to minimize such uncertainty by relying on their local partners' inside knowledge about the regulatory environment (Arregle, Borza, Dacin, Hitt, & Levitas, 2000).

Second, access to local market information and an established customer base are also the deciding factors in forming strategic alliances in China (Arregle et al., 2000). Especially in the e-commerce industry, where foreign investment is currently not permitted, local businesses can benefit by being the pioneers in the market, seeking competitive advantage by capturing market share. They are likely to have first-hand knowledge about the market and the customer. Customer loyalty can also be nurtured easily with lack of competition before China's WTO entry (Reichheld & Schefter, 2000). Joint ventures allow potential foreign investors to capitalize on such intangible assets already possessed by their local partners.

Third, due to the fact that institutional constraints (i.e., laws and regulations) are weak in China, informal constraints are likely to play an important role in facilitating foreign investment (Ramamurti, 2000). The recognition of informal constraints, such as customs, norms, and values, is crucial for business success in many emerging economies (Arregle et al., 2000; Ramamurti, 2000). In China, these informal constraints include the distinct practice of doing business among firms and individuals, called guanxi networking, which is a salient aspect of all Chinese businesses (Luo & Peng, 2000). Joint ventures allow foreign investors to gain a competitive advantage by exploiting guanxi networks of their local partners.

* Guanxi Networking as a Strategy

As suggested, foreign investment in China's e-commerce will necessitate facing legal uncertainties, and minimizing these uncertainties improves all aspects of e-commerce in China. Although a Sino-foreign joint venture strategy is a critical step toward dealing with those uncertainties, it is, however, not sufficient to mitigate them if foreign investors are not capable of developing and maintaining good relationships with local alliance partners, corporate executives of local firms, and government officials. Each will be briefly discussed below.

Local Alliance Partners

Although a joint venture can provide the opportunity for knowledge sharing among the parties, trust must be established before any exchange activity can take place (Arregle et al., 2000). Trust is an important component of guanxi and a key component of any successful partnership (Tsang, 1998). In an environment in which formal constraints are underdeveloped, individuals are unlikely to rely heavily on formal rules and procedures for doing business. For instance, conflicts over contractual obligations may occur if foreigners choose to strictly enforce alliance agreements signed by their Chinese partners. Business standards used in developed countries may sometimes be unworkable in countries with great structural and legal uncertainties.

As such , guanxi should be cultivated and maintained in a way that secures collaborative relationships and governs appropriate codes of practice for successful partnership. We are not suggesting that formal rules and procedures are unimportant, rather that they should be implemented in conjunction with guanxi-building in the case of a Sino-foreign partnership. Guanxi-building enhances mutual trust (Tsang, 1998) and facilitates the transfer of local market knowledge that foreign partners lack (Arregle et al., 2000).

Corporate Executives of Local Firms

Building managerial connections with those at other local firms is another important aspect of guanxi networking (Luo & Peng, 2000). These connections are usually developed with executives at other local firms, including customers, supplies, and competitors. Informal contacts between executives are often the prerequisite for developing good business connections (Luo & Peng, 2000). Foreign executives who have developed close ties with leaders at other local firms are likely to obtain preferential treatment.

For instance, an e-business with a close relationship with its local supplier may receive timely deliveries of goods and services. Because transportation and institutional infrastructures are not present in China, formal business contracts and agreements would likely give the supplier extra incentive to make on-time delivery to the firm with which it has good guanxi. Thus, cultivating close managerial relationships among firms can help minimize the risks and uncertainties engendered by the embryonic legal environment in China. For foreigners, Chinese culture and language are barriers to the building of sophisticated managerial networks. However, a joint venture strategy may help remove such barriers.

Government Officials

In socialist China, government officials have great power to allocate critical resources and influence legislative decisions (Luo & Peng, 2000). Rules and regulations governing e-business in particular change at lightening speed, as Internet technology increasingly jeopardizes national security. As such, despite the past 20 years of the Open Door reforms, arbitrary government intervention remains a threat to many foreign investors.

Establishing guanxi with government officials is necessary for coping with legal uncertainties in Chinese e-commerce. However, not many foreigners are able to make contact with top officials because such guanxi networks often take years to establish before they become advantageous. Culture and language are, again, the main bafflers for foreigners. Despite the difficulties, some foreign companies in other industries have already set up representative offices in China and, for example, hired the children of senior Chinese officials as employees (Tsang, 1998). Other foreign companies have started to look for alliance partners with Communist Party connections. Recently, Motorola signed a U.S. $258 million contract with China Unicorn, one of the few state companies with licenses to provide cellular services, to expand GSM networks in five provinces (Agence France Presse, 2000, August 23). China Unicorn provides Motorola with strong support in many respects, such as earning official approval for its proposed inves tments in China. The contract gives Motorola more confidence in its future investments and helps strengthen its market position in China.

Developing guanxi with government officials by seeking alliances, by employing their children, or other means, gives foreign firms an edge over their competitors. Prospective foreign investors may rely on such a network strategy to reduce the investment and legal uncertainties of conducting e-business in China.

Conclusion

Regulation of e-commerce and other applications of the Internet in China will remain a minefield for the foreseeable future. In addition to the complexity of some regulations, influenced by policies designed to maintain governmental control over both content and revenues, the public and private sectors have developed a reputation for unpredictability tinged with corruption. Further regulation, increasingly differentiated by service and content type, appears inevitable, as does restriction of the role foreign investors and content providers will be allowed to play following WTO accession. Delays in adjusting various Chinese rules to comply with WTO conditions will also result in sporadic conflicts between bureaucratic elements and companies, both foreign and domestic.

In China, guanxi networking plays an important part in securing investments and ensuring appropriate codes of conduct. However, it should be recognized that guanxi networking is necessary but not sufficient for minimizing legal uncertainties. Formal constraints, such as contracts, laws, and regulations, remain vital for governing business practice. Because strong market-supporting institutions are not present in China, formal constraints cannot be appropriately enforced. Guanxi-building can protect foreigners from trouble in a gray legal environment, and a joint venture strategy can facilitate guanxi-building.

The possibilities for further research are vast, particularly regarding techniques of guanxi networking. The domain of e-commerce in China will continue to evolve rapidly and could well present novel approaches with applications in other nations.

Wattie Lo is a graduate student at the University of Ota go; his research interests include international management, cross-cultural issues, and

organizational theory. Andre Everett, a senior lecturer in management at the University of

Ota go, specializes in international management, operations strategy, and experiential learning

topics. His writings in this field have been

published or presented in over 20 countries.

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Author:W. Lo, Wattie C.; Everett, Andre M.
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Date:Jun 22, 2001
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