Table of Contents

Executive Summary……………………………………………………………………………………………1

1. Introduction……………………………………………………………………………………………………….2
   • The Industry……………………………….……………………………………………………………………….2
   • The Countries………………………..……………………………………………………………………..2 – 3
2. Chinese National Business System and Cultural Conditions……….…………………….4
   • National Business System………………………………………………….………………………………..4
   • Characteristics of National Business System…………………………………………………4 – 5
   • Business Culture………………………………………………………….…………………………………..5
   • Demographic and Lifestyle…………………………………………….……………………………..5 – 6
3. Pattern and Trend of Trade between two Countries……..…………………………….……7

3.1 US Outward Investment………………………………………………………………………………..7 – 8

3.2 Trade between Countries……………………………………………………………………………..8 – 9

3.3 Trade between Industries…………………………………………………………………………9 – 11

3.4 Restrictions on Trade in Retail Industry……………………………………………………………..12

3.5 Competitive advantage of Look Good Cosmetics……………………………………………..12

4. The Exchange rate regimes in China and the United States………….………………….13

4.1 Exchange Rate…………………………………………………………….……………………………………..13

4.2 Exchange rate risks and the currency appreciation issues within China’s

Economy……………………………………………………….………………………………………….13 – 14

5. Means of Investment and Types of Foreign Direct Investment (FDI)……………….15

5.1 China’s FDI Outlook…………………………………………………………………………………………..15

5.2 Merger and Acquisition approach of Look Good Cosmetics………………………15 – 16

6. Problems concerning Business Ethics and CSR in China……..…………………………..17

6.1 Training and Educational Development of Employees……….….…………………………..17

6.2 Cosmetics Health and Safety Issue…………………….……………………………………….17 –18

6.3 Employees rights and salaries……………………….…………………………………………………18

7. Conclusion………………………………………..……………………………………………………………19

References………………………………………………………………………………………………..20 – 22

Appendix………………………………………………………..………………………………………23 – 25

Executive Summary

A team of researchers working for Look Good Cosmetic, a multinational company based in the UK, have been asked by the CEO of the company to write a report on the company’s new investment in China.

The main objective of this report is to advice the CEO to decide whether the company should engage in trade via export or investment in China. The other objective is to provide a comprehensive overview of the Chinese cosmetic retail market and also to provide a thorough analysis for Look Good Cosmetics in terms of why sales in China could be a feasible and viable venture for the company.

Look Good Cosmetics need to develop an entry strategy because cosmetic market in China is already being controlled by foreign multinationals. However, due to the fact that Look Good is one of the leading cosmetic companies in the US, operating in China by different means of FDI would be required to meet the needs of the Chinese customers. China Cosmetic market is still open to any multinational as the entry barrier is low, which is good for the company.

Base on the detailed data that researchers have collected in recent time, the report will analyse the status, characteristics, competition pattern and other relevant trading issues of China’s national business environment, especially an investigation in the developing trend of Cosmetics and toiletries market.

1. Introduction

1.1 – The Industry

Cosmetics and Toiletries is an industry that is growing worldly because of the desire and zeal of people to look and smell good. The products range from skin care, hair care, baby care, sun care to fragrances, depilatory, bath and shower product, deodorants etc. In the US, cosmetics and toiletries is one of the thriving industry flooded with lots of manufacturers. Innovation into “premium end and anti ageing product” recently gave the US industry a turnabout (Pitman, 2006).

The United State skin care market generated total sales of $8.3 billion in 2007 leading to a growth rate of 3.5%. China on the other hand, has been experiencing a stable growth in its cosmetics and toiletries industry. Skin care market experienced a growth of 3.10% in 2007 to attain sales of RMB28, 978.3 million. Appendix 1 and 2 shows the United State and China skin care industry value in recent years.

• – The Countries

Look Good in Home Country A (United State) is seeking new growth and expansion opportunities through its global market penetration strategy. Overseas market Host Country B (China) becomes more attractive for multinational companies due to its large market, competitive advantage and drive for sophisticated product.

Country A (United State).

United State is a developed country with the largest and most powerful economy in the world. Diversifying and leadership position in the manufacturing and services industry give the economy strength. It is a leader in industries such as aerospace, motor vehicle, chemicals, electronics, information technology etc (Datamonitor, 2008).

Country B (China).

China is a developing country with the biggest market in the world. The fourth largest country in the world (in size) with a population of over 1.3billion. also, China’s economy is the fastest growing in the world with consistent annual growth rate of around 10.3% between 2002 to 2007(Datamonitor, 2008). Fig 1 below shows the GDP growth in China from 1971 to 2007.

GDP GROWTH IN CHINA 1971 – 2007

2. Chinese national business system and cultural conditions.

2.1 – National Business System.

The national business system used by countries diver which could affect a firm’s business strategy. The United State is a typical liberal market economy, where firms enjoy great flexibility in business activities due to low government intervention. (Hall and Soskice, 2001). This system is characterised with a high social cost and high income. Also, the real growth rate is relatively low (the US real growth rate in 2007 was 2%. (CIA Factbook, 2008). On the other hand, China is one of the countries where there is strong state intervention in business i.e. Asian Capitalism. (Morris, 2006).

China has evolve from a highly regulated and regimented marketplace to an open and liberalized market due to the reform implemented over 20 years ago (Datamonitor, 2008). This reform was implemented in a gradualist fashion characterised by increased autonomy for state enterprise. (Restall, 2008). Look Good cosmetics need to develop its business strategy in line with China’s business system for it to transact business in the country.

• – Characteristics of national business system.

The major characteristic of Asian Capitalism is the close relationship between government and the business. Here, government intervention in business activities is high and also, the process is done through a system of administrative guidance rather than through formal legislation. There is a strong relationship between the financial system and business organisation in Asian Capitalism which led organisations in these countries to have a long view in their investment decision. Also, the system of “lifetime employment” is common in this business system which involves a co-operative relationship between management and labour (Singh, 1998).These features of China business system could be a limitation for Look Good Cosmetics who is coming from a different business system. Most MNC’s are used to a system where things are done formally with less governmental intervention or control. China though has changed over the years from a centrally closed economy to a more market – oriented economy(CIA factbook 2008), this change has to be incorporate into the business system to allow for more flexibility in order for MNC’s to have a more transparent and competitive business environment.

• – Business Culture.

According to Fang 1999, “the Chinese have always held themselves culturally in high esteem viewing their culture and nation as lying in the centre of human civilisation”. They respect their business culture which they believe must be respected by anyone or MNC wishing to transact business with them. They place a high importance on Guanxi which refers to “relationship networks or connections supported by reciprocal obligations” (Hill, 2007). Also, they respect the concept MianZi meaning “giving face or giving due respect” (www.alibaba.com). Look Good Cosmetics must respect these concepts in order for it to penetrate this new market.

The respect and understanding of countries business culture is essential for any MNC to succeed internationally. The US and China are from different ethnic background with different features and similarities. The problem of language and religion is inevitable for Look Good Cosmetics. Communicating with the people to satisfy their needs and convincing them to accept Look Good product pose a challenge to the company.

• – Demographic and Lifestyle.

In terms of demographic issues, the United State is a relatively bigger in size than China and it has the largest economy in the world (CIA factbook, 2008). Look Good Cosmetics have been operating in the US for some years and because of the fact that China’s economy is growing at a faster rate, the company is looking for investment opportunities in this new market. China is one of the fastest growing economies of the world with a population of 1.3 billion and an estimated annual growth rate of 10 % (Fig.2). However, according to Mcgregor and Dickie (2006) there is a wide gap in between the rich and poor in wealthy cities and rural areas. This is evident in comparing the standard of living and GDP of coastal urban area and rural western areas.

Fig. 2 Evolution of Demographic in China (1961 – 2003)

Source: Data FAOSAT, year 2005/ Y – axis: number of inhabitants in thousands.

Chinese shoppers attitude towards cosmetic products have change over the years as the skincare product have been successful in the wealthier metropolitan such as Beijing and Shanghai. (Datamonitor 2008). The shortage and lack of expertise in ingredient manufacturing have led the country to depend on import for most of its cosmetics ingredients over the years (Li 2003). This has led the foreign manufacturers to produce cosmetic products suitable and convenient to the needs of the Chinese customers. These foreign manufacturers have captured 80% of the Chinese market leaving the remaining 20% to local companies. Look Good Cosmetics situation analysis has been summarised into SWOT analysis in (Appendix 3).

3. Pattern and trend of trade between two countries.

3.1 – US Outward Investment

Direct investment from abroad by US companies rose from $310.2 billion in 2006 to $352.6 billion in 2007 as shown on the graph below (Fig 3). This shows an improvement in US companies investing overseas. This growth is an improvement on the side of US companies which is expected to grow even further as the standard of living improves.

EARNINGS ON US DIRECT INVESTMENT ABROAD

                   1996  1997  1998  1999    2000    2001  2002  2003    2004 2005  2006 2007

             Fig 3. Source: US Bureau of Economic Analysis

The liberation policies of China have expanded its economic and trade relations with the rest of the world. The US is the third largest trading partner of China and the bilateral trade between the two countries has been successful. China’s rapid economic development has been driven by a strong foreign direct investment (FDI). According to the Chinese ministry of commerce, “China drew more than $82billion in FDI in 2007 making it the world’s top multinational investment”. The bilateral trade between US and China hit $387billion in 2007 making China the 2^nd largest trading partner of the United State (Morrison, 2008)

Further, in 2007 China became the largest source of US import. China import into the US totalled $321.5 billion, accounting for 16.5% of US total import in 2007. This is a rise of 11.7% over the previous 18.2% in 2006 (Morrison, 2006). Over the years, US trade deficit with China has surged as import from China have grown much faster than the US export to China. The deficit rose from $34billion in 1995 to $256 billion in 2007.This can be observed from the graph below which shows the trade pattern between US and China from 2000 to 2007.

3.2 Trade between countries

Trade between the United State and China has bought economic and political benefit to the two countries. The rapidly developing Chinese economy affords US businesses a rare opportunity to become part of a large and expanding economy. Also, China membership of the World Trade Organisation (WTO) constrains it to comply with international trading rules which have expanded its market to more business transaction with the US.

However, the official trade statistics released by the US and China shows a large difference between their trade pattern. The difference is in favour of China ranging in billions of dollars. US trade deficit with China in 2005 was $201 billion but it rose to $232.5 billion in 2006. China has been accused for “unfair trade practices and for intentionally undervaluing its currency which policy makers and leaders of industry claimed create an uneven playing field for US companies when competing against import from China” (Lum and Nanto, 2006). The table below shows the trade between the US and China from 2001 to 2006 (Fig 4). Also, trend in their trade from 2000 to 2007 can be seen in Appendix 4

Fig 4: US AND CHINA TRADE FIGURE (2001 -2006)

3.3 Trade between Industries

The pattern and trend of trade of cosmetics and toiletries industry between two countries was difficult to obtain. Nevertheless, a good example that is relevant to this could be Procter & Gamble (P&G) Investment in China

Procter & Gamble a US based MNC have competed in the global market by expanding their business internationally. The leading company in US skin care with over 10% share of the market has invested over $1billion in China. The company is a market leader in China and has employed up to 6,500 employees in the country. The company boom in China came with the introduction of “made in China” for its product range which was accepted by the customers. P&G has expanded in China by owing 10 plants in cities such as Beijing, Chengdu and Shanghai (http://www.cnbc.com/id/20867352). Multinational companies such as P&G, L’Oréal China, Unilever, Amway, and Shiseido Liyuan are the top five cosmetics and toiletries players in China offering brand with international reputation. The table below shows the sales of cosmetics and toiletries in China from 2002 to 2007 (Fig 5) and the industry share value by NGO retail value from 2003 to 2007 (Fig 6).

Fig 5: SALES OF COSMETICS AND TOILETRIES BY SECTOR 2002 – 2007

Source: Global Market International Database for University of Bradford by Euromonitor

International. Cosmetics and Toiletries in China June 2008.

Fig 6: China Cosmetic Industry Share Value by NGO Retail Value from 2003 – 2007

Source: Global Market International Database for University of Bradford by Euromonitor International. Cosmetics and Toiletries in China June 2008

3.4 Restriction on trade in retail industries

China’s entry into the world trade organisation (WTO) in 2001 has led the country to bring its laws and regulation into compliance with the WTO rules. The country has revoked and reformed more than 1,100 laws and regulation, reduced tariffs and non trade barriers (Business Round Table, 2009).This has made its trade policies to become more liberal to investors from other part of the world. Multinationals from different part of the world are now competing in China’s cosmetic and toiletries industries. Also, the removal of restriction on foreign ownership has made the country to be one of the largest recipients of FDI in the world.

However, the administration of quality supervision inspection and quarantine (AQSIQ) in China has issued a new law regulating the amount of packaging on a host of consumer goods, including personal care. This law cover any consumer and personal care product that are manufactured or imported into China. This law will pose a challenge to cosmetic companies in China where packaging plays an important role. Also, the anti – monopoly law introduced by the Chinese authorities could affect foreign MNCs investment in China as well as a hindrance to their future growth. (Pitman, 2008)

3.5 Competitive advantage of Look Good Cosmetics

Look Good cosmetics is one of the leading cosmetic companies in the United State and some part of Europe, which is known for its quality and well branded image. Its investment in China will help the company to minimise its cost and maximise its revenue due to availability of cheap labour.

China’s cosmetics industry has witnessed a tremendous change from foreign investors who are producing product to the satisfaction of the public. The change in the taste of the consumers towards healthy cosmetic products have witness a boom in the industry. This led to the rapid expansion of health and beauty retailers in 2007 with increasing product availability (Datamonitor, 2008). For Look Good cosmetics to be accepted and win market share in the Chinese cosmetic market, they need to develop strategies that is unique and maintain their quality standard as this will be valued by the public. Look Good have the potential and the reputation to provide good quality cosmetic product to the Chinese public to satisfy their need.

4. The exchange rate regime in China and the United State.

4.1 The exchange rate

The United State over the past 30 years has operated under two distinct exchange rate regimes. The Bretton Woods system of fixed exchange rate was the first which lasted from 1958 to 1973. The second which began in 1973 and has continued to the present is the manage floating exchange rate.

This is a market driven price for currency, whereby the market forces of demand and supply determines the exchange rate with no governmental intervention (Dianne, 1990). On the other hand, China exchange rate has been fixed for some year before its introduction to the WTO. In 2005, after it’s joining of the WTO, the country exchange rate was changed from fixed to managed floating which is based on market supply and demand with reference to a basket of currencies (Jintao, 2006). According to the people’s bank of China 2005, the Chinese currency Renminbi (RMB) will no longer be pegged to the US dollar but the rate of exchange of the dollar against the RMB will be adjusted to 8.11 yuan per US dollar.

• – Exchange rate risk and the currency appreciation issue within China’s economy

The Chinese government have maintained a fixed exchange rate with the US dollar for relatively some years. The currency was pegged at about 8.28 yuan per dollar. As the dollar appreciated and depreciation in value to other currencies, likewise the yuan has appreciated and depreciated by the same amount relative to these other countries (Taylor, 2003).

However, the trade pattern between the two countries shown in Fig 4 and the trend between RMB and the dollar exchange rate (Fig 7) shows that the US is loosing in terms of trading with China. China, despite the revaluation of its currency upward in 2005 from 8.3 yuan to 8.11 yuan to the US dollar, “its central bank continues to intervene in the currency market in order to maintain a stable exchange rate”(Lum and Nanto, 2006).

The fluctuation of the exchange rate between the yuan and the dollar could affect Look Good cosmetics receipts and payments in the long run. However, Look Good Cosmetics can avoid these uncertainties by hedging its currency against future transaction and translation risk. Also, the company can engage in forward contract in order to minimise this effect to an extent (Begg and Ward, 2007)

Fig 7: Exchange rate: Chinese Renminbi (RMB) to one US Dollar (USD).

2003 – 2008

Source: Business Insight Limited 2008

5. Means of Investment and types of Foreign Direct Investment (FDI)

5.1 China’s FDI Outlook

FDI in China is on the increase with 13.8% growth in 2007 resulting in $82.66billion compared to $69.47billion in 2006. The major reason for this development in China’s FDI is because of its joining the WTO which has made its economy more flexible. According to USCBC 2008, “the country now remains one of the premier destinations for foreign direct investment.” In entering China, the major strategy for Look Good cosmetics is an appropriate market entering mode. China is a new market with a culture different to that which the company is used to. The most appropriate method for Look Good cosmetics to use in entering the Chinese Cosmetic market is Brownfield entry (merger and acquisition) rather than Greenfield entry (starting the business from the scratch).

Fig 8: CHINA FOREIGN DIRECT INVESTMENT

Source: US-China Business Council 2008

• Merger and Acquisition Approach of Look Good Cosmetics

Merger is when a company integrates its business activities with another company and share control in the combined business operation with the other owner while an acquisition occurs when a company buys another company and end up controlling the company (Business link, 2008). The best option for Look Good cosmetic to enter this new market (China) is through FDI. Foreign multinationals controls the Chinese cosmetic market and for Look Good cosmetic to be able to penetrate and compete in this market, an understanding of the market is required which can quickly be achieve through merger and acquisition. Some of the benefits of this process for the company are as follows:

• Cost efficiency: merger and acquisition with an indigenous company will create cost efficiency for the two companies. The production of cosmetics will be done on a much larger scale which creates economies of scale.
• Look Good cosmetic acquisition of a Chinese company will give it a share of the market. With this, the company can compete in the market (which is still open to investors) and generate more revenue.
• There is the benefit of time and cost savings for the company.

However, merger and acquisition comes with a high risk and the process is expensive. For Look Good Cosmetics to acquire a Chinese indigenous cosmetic company, they will have to part with a huge sum of money, the benefit of which would be felt over the period of time.

6. Problems concerning business ethics and corporate social responsibilities (CSR) in China.

A cosmetic company investing in China will be faced with issues on business ethics and corporate social responsibilities. China is still facing some challenges from human right issues, NGO, physical environmental issues, health and safety, labour issues etc. Investing in China, Look Good Cosmetics need to view the CSR in China as a strategic issue which must be incorporate into the company’s strategic planning. The company has the target of:

• Meeting higher product quality standard.
• Meeting hygiene standard for cosmetics.
• Meeting the intellectual property right (IPR) in preventing counterfeit production.
• Meeting China ministry of health standard on cosmetic production.
• Provision of job opportunities taking into consideration equal opportunities in respect of job position.
• Preventing pollution of the environment.

6.1 Training and educational development of employees

Look Good cosmetic need to invest in training and education of its employees. This will give room for mutual cooperation and respect between the employees. Also, this will assist in learning and inculcating of the Chinese culture into the business strategy. Training and educational development is essential and most be given a high priority if the workers from diverse cultural heritage are to work towards achieving the same objective.

• Cosmetics health and safety issue.

The United State has raised concern over the health and safety issues of Chinese manufactured products while the AQSIQ in China has issued a new law regulating the amount of packaging on a host of consumer goods, including personal care. According to Morrison 2008, “China is believed to have a rather weak health and safety regime for manufactured products” This led to the dominance of Chinese cosmetic market by foreign multinationals as the consumers prefer quality product. Look Good cosmetics must ensure that its production comply with the hygiene standards for Chinese cosmetics companies issued by the Ministry of health. Also, the company should maintain its reputation which is known for quality product in order to penetrate the market.

• Employees right and salaries

China is an attraction for most foreign multinationals due to its cheap labour cost. Foreign multinationals can produce in China at a low cost which serves as an advantage to the company. Also, these multinationals have the capacity and resource pay the Chinese workers more than what their indigenous firms are paying in salaries. The Chinese government due to the employment issues in the country have adopted various policies and measures to meet the needs of the people regarding employment. Some of the measures are:

• Written contract for any contract of employment.
• Payment of a minimum wage.
• Meeting health and safety measures.
• Recognition of national bank holidays.
• Termination and compliant.

Look Good must conduct business in China according to their business ethics. It is believed that the company will act according to the rules and regulation of the country regarding employment of workers.

China is one of the fastest growing economies in the world with GDP of 11.40% in 2007(Datamonitor, 2008). This rapid economic growth is driven by FDI. The United State is one of the major countries benefiting from this Chinese economic growth.

The size of the Chinese market has attracted a lot of foreign multinational into the country taking advantage of the knowhow of the people. The availability of these skilled human resources makes production at a cheap cost possible. However, this country’s size as make it impossible for no multinational to control the market.

It is recommended that Look Good cosmetics should focus on the urban area such as Beijing, Chengdu and Shanghai etc since consumers in these metropolises have more disposable income. They should set up their manufacturing plant in one of these cities through merger and acquisition of an indigenous company. Also, their product must be sold through the retail outlet e.g. supermarkets, high street shops etc in order to penetrate the market on time. They should focus on high quality product which the consumer prefer and be more market oriented to facilitate customer’s satisfaction.

REFERENCES

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Reports:

Datamonitor Industry Profile: Skincare in the United State, November, 2008.

Datamonitor Industry Profile: Skincare in China, February, 2004.

Datamonitor Country Analysis Report: USA In – depth PESTLE Insight, June, 2008.

Datamonitor Country Analysis Report: China In – depth PESTLE Insight, June, 2008.

Website:

Business Culture throughout China (2004)- Doing business in this ethnically and culturally diverse country

http://resources.alibaba.com/article/157/Business_Culture_throughout_China.htm (accessed 28/12/08)

Business Link (2008) – Merger and Acquisition

http://www.businesslink.gov.uk/bdotg/action/layer?topicId=1074407579 (accessed 08/01/09)

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http://trade.businessroundtable.org/trade_2005/china/wto.html (03/01/09)

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Central Intelligence Agency Factbook (2008): United States. https://www.cia.gov/library/publications/the-world-factbook/geos/us.html (accessed 02/01/09).

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P$G May Use Acquisition to boost position in China(2007)

http://www.cnbc.com/id/20867352 (29/12/08)

APPENDIX

Appendix 1: United State Skincare Market Value 2003 – 2007

Appendix 2: China Skincare Market Value 1999 – 2003

Appendix 3: Look Good Cosmetic SWOT Analysis.

Appendix 4: US – CHINA TRADE (2000 – 2007)

Source: USITC Dataweb