Market Environment and Barriers to Entry
Energy in China Spotlight
- China’s Electricity Sector
- Current Policy Framework
- Energy Poverty in China
- Market Environment and Barriers to Entry
- Environmental Issues
- Key Recommendations for Social Enterprises
|The Chinese market environment for social business is very unique, and conditions vary on a local level. A combination of a large customer base, varied local traditions and business environments, and a complex and stringent regulatory environment may make entering the market tough for startups. Here we take a look at a few market sectors that may be possible avenues for social business, and describe some of the things that makes gaining a foothold in Chinese market particularly challenging.|
China’s cookstove market is highly diverse, consists of a large number of companies, and is experiencing rapid growth. A wide range of improved cookstove products are offered, from smaller cookstoves to large traditional kang dual use stoves. Due to the fact that the coal supply chain was already developed, the coal-fired stove market took off first. Both heating and cooking coal stoves are offered that mainly utilize coal briquettes as a fuel source. Product quality is variable and cooking stoves sometimes come without smokestacks, which creates indoor air pollution. Nevertheless, technology has improved considerably thanks to efforts by both enterprises and encouragement by the Chinese government. Thermal efficiency has improved and newer stoves on the market are less polluting.
The biomass stove market is struggling due to lack of an efficient supply chain and a lack of technology. Agricultural waste or forest products are an abundant fuel source in many areas, but the use of forest products is problematic due to environmental concerns. Furthermore, agricultural waste may only be available during certain times of the year. Many enterprises are working to develop more efficient biomass stoves and more efficient supply chains.
|The cookstove market, especially the coal cookstove market, is plagued with low quality stoves and bootlegged products. Although quality has increased overall as the market has matured, there needs to be more regulation to curb the distribution of bootleg products and make sure that consumers get what they are paying for. Many cookstoves are not cheap; some dual-use stoves can run around $150-200 USD; this is quite expensive for many of those who need improved cookstoves the most. The biomass stove market also needs to develop a better supply chain; this may require cooperation between enterprises due to the way the market is stratified. Some larger biomass enterprises have already taken the initiative to improve the supply chain, and offer collecting and processing services to their customers.
Solar cooker market
Among developing countries, China receives the largest amount of inward foreign direct investment (FDI). Inward FDI often comes in the form of foreign companies establishing themselves in China and serving the needs of Chinese consumers. The government also promotes investment into domestic companies and jointly owned domestic-foreign enterprises to encourage the proliferation of Chinese-run businesses. Regulations of investment are still fairly restrictive. China’s 2010 OECD FDI Regulatory Index Score hovered around 0.5 (higher scores indicate a country less open to foreign investment); this is second only to Iceland in restrictiveness. Although the system for government approval and regulation is restrictive, it his highly decentralized. This promotes healthy competition for FDI among enterprises. The Chinese government is also implementing policies that encourage investment into domestically-owned SMEs. This goal is outlined in the current FYP.
Thanks in part to government policy, the share of service-sector investment grew from 30.5% in 2000 to 52.3% in 2008, a growth rate faster than that of investment in manufacturing. Traditionally, the manufacturing industry has been the main destination of inward FDI. However, as the economy has matured and the Chinese middle class has grown, foreign investors have become more and more interested in domestic industries rather than export-based industries. This was reinforced by a change in government policies in the early 2000s; policy now focuses on balanced economic growth and development rather than overall economic growth that is dependent on exports. Regulations are the most lax in Hong Kong. Consequently, it is China’s prime destination for inward FDI.
China’s investment policy is geared towards protecting the interests of domestic industry. Protectionist practices are less stringent now, but still present. Equity joint ventures and contractual joint ventures have been promoted by the Chinese government as a means for promoting foreign investment while allowing Chinese businesses to retain a large degree of control over the market.
Currently, China has high inward FDI but growth is stagnating. Investor confidence is still very high thanks to China’s strong economy, but is weakening due to increases in labor costs, shortages of skilled labor, competition between Chinese and foreign-owned businesses, and changes in regulatory policy that investors view as negative.
Being very top-down, the structure of the Chinese banking system roughly mirrors that of the Chinese government. China’s central bank is the People’s Bank of China, which serves a role similar to the United States’ Federal Reserve. There are four large state-owned commercial banks in China: The Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China, and the Agricultural Bank of China. There are also a large number of smaller banks in China that are jointly owned by government and private interests. Local banks that provide large-scale financial services include village and township banks (VTBs), rural credit cooperatives (RCCs), and branches of the Postal Savings Bank of China (PBSCs).
Microcredit and microfinance are extremely important sources of finance that are often leveraged by social enterprises. The microcredit market in China is currently growing at an explosive rate. As of 2014, there were about 6,000 microcredit providers in China; 75% of which had only been in operation for three years or less. These microcredit providers consist of NGOS, quasi-governmental organizations, social enterprises, rural development associatons, and the AliFinance arm of Chinese e-commerce giant Alibaba Group. AliFinance alone has provided over 230,000 microentrepreneurs with loans since its launch in 2011. It has a loan portfolio of over RMB 80 billion ($13 billion USD).
Unfortunately, since the sector is relatively new, it is resting on shaky ground. Many microcredit companies lack adequate access to credit reporting information, which is held by the People’s Bank of China. This makes doing business for them more risky than it would be otherwise. However, microfinance is an extremely effective way for social enterprises to help their customers afford their product. Because many served by social enterprises have very low disposable income, they often are not able to pay the high upfront costs often associated with energy-related products. The use of microfinance is an excellent way to circumvent this problem. A social business operating in China may want to consider partnering with a local microfinance institution to help their products reach those who need them most.
Barriers to Entry and Scale
Barriers to entry into Chinese markets are numerous and have to do with the nature of local business environments, investment practices, and government policy. This section describes what factors can make entering the market and doing business particularly challenging in China.
Investment and funding barriers
Due to the nature of China’s investment environment and social business environment, funding can be hard to come by. Restrictive and protectionist policies limit investment while taxation dampens the effectiveness of grant funding. FYSE’s survey of 52 social enterprises for their China 2012 Social Enterprise Report found that 86% of social entrepreneurs had difficulty accessing funding, particularly mezzanine funding. 47% of social enterprises also found acquiring seed funding challenging. This has forced many entrepreneurs to turn to family and friends, which is not a sustainable source of funding. A factor that contributes to this problem is lack of knowledge and information about funding opportunities. There are no platforms for acquiring information and connecting with potential investors.
Many enterprises lack a clear business plan and impact monitoring capabilities. This makes acquiring impact investment extremely difficult, because impact investors require information on how much of an impact an enterprise’s activities are having. Over 25% of social enterprises surveyed by FYSE have no information how many people their activities have benefitted, nor information on how great that benefit is. Such informational limitations make it extremely difficult to convince impact investors that the activities of an enterprise are having a positive social impact.
China’s protectionist inward FDI policies make acquiring investment difficult for foreign-owned enterprises that are seeking to enter the marketplace. Investment is preferentially directed towards Chinese-run enterprises because the Chinese government seeks to protect Chinese business interests. Furthermore, the Chinese government is less likely to subsidize foreign-owned enterprises, even when subsidies are available to be taken advantage of. Thankfully, enterprises can be hopeful with the advent of new regulations and China’s openness to social entrepreneurs. Moreover, problems acquiring impact investment can be alleviated simply by having an adequate impact monitoring system. Overall, in the Chinese business environment, having an effective and efficient business model is instrumental to acquiring investment.
Many of the markets that socially-driven energy enterprises commonly exploit are either highly competitive or too regulated to penetrate. For example, in many other countries, such as India and Haiti, socially-driven enterprises provide electricity in the form of solar home systems (SHS) or solar or biogas-powered microgrids (these are a few examples of many in terms of technologies that are used). The electricity market is dominated by government-backed utilities and larger enterprises. Regulations require that electricity-producing businesses connect their generators to the grid. This would force smaller enterprises into competition with the larger enterprises that already sell to the grid. Because the economy of scale is advantageous in the electricity generation market, a smaller generator would likely be driven out of business. Furthermore, grid connection makes SHS, gasification, and biomass generation technologies obsolete, so these enterprises would only be able to operate in non-grid areas for a limited amount of time anyways as China’s remaining unelectrified rural areas gain access to grid power.
The coal cookstove market is highly competitive and commercialized, and flooded with low-priced, low quality products. Poorly made knockoff and bootleg stoves are common. Regulation is inadequate and government support is almost nonexistent. Fluctuations in demand due to changing weather patterns and volatile coal prices is common; this can make things difficult on smaller enterprises. The biomass market, on the other hand, is highly dependent on government support. Limited and fluctuating supplies require an enterprise to establish an effective supply chain before growth can accelerate. With regards to biodigesters, the problem lies in the lack of a properly functioning service network. An enterprise seeking to sell biodigesters may have to take matters into their own hands by working to improve the existing system themselves. Although, there are plenty of subsidies to be taken advantage of in the biodigester sector.
Challenging local business environments
Historically, the Chinese have held the view that business and philanthropy should exist in separate spheres. Social entrepreneurship is a phenomenon that bridges the gap between these spheres. This makes gaining the trust of the public, and thus a building a good business reputation and loyal customer base, especially difficult. This problem has been exacerbated by a series of scandals that happened in 2011 in which several NGOs were accused of becoming too commercial and engaging in unethical practices. Establishing the right relationships with Chinese business partners and local government officials is essential to success in challenging local environments.
Due to cultural, economic, and geographic factors, certain products may not be suitable for certain regions. Developing a culturally appropriate product can be challenging, especially for foreign-born entrepreneurs who are unfamiliar with local traditions, customs, and community dynamics. Moreover, the supply of resources such as coal and biomass are also limited in the poorer regions of Western China, notably Tibet and the Tarim Basin. This makes having an impact across China very difficult because it makes developing a one-size-fits-all product is not easy. Many enterprises would be better off focusing on one or a few regions of China, depending on what sort of product they are planning to market.
The aforementioned business regulations make it extremely difficult for social enterprises and SMEs to establish themselves and take advantage of government subsidies and tax exemptions. There is currently no single government-sanctioned enterprise type that is suitable for a social business. Thankfully, the Chinese government is taking the initiative to make regulations more accommodating for socially-driven entrepreneurs.
Due to protectionist government regulations and practices, some sectors are off the table altogether for foreign enterprises. This includes the financial sector, and for the most part, the electricity sector. Public procurement is extremely difficult for foreign-run enterprises because of China’s Indigenous Innovation Policy. Furthermore, as mentioned before, inward FDI is also difficult to acquire for foreign-run enterprises. This restricts the operational capabilities of many social businesses and SMEs and requires that they either find a workaround, establish themselves in niche markets, or both.
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