Foreign direct investment in China: beyond the representative office.

• Author: Quer, Diego

INTRODUCTION

Choosing the most suitable mode of entry abroad is one of the most relevant strategic decisions that a firm must adopt during its internationalisation process. In recent years, many research studies on this topic have focused on China, a country which is becoming a basic reference for the global environment where firms have to compete (Peng et at 2001). China offers a very important potential market, for out of its 1300 million inhabitants, approximately 80 million have a purchasing power similar to the average one in Western countries. In 1979 China started a progressive opening-up policy, leading to a thorough reform of its economic structures. Since then, one of China's main objectives has been to attract foreign capital, which has led it to progressively liberalize foreign investment and to attempt to create a suitable framework for such investment. The financial and technological boost coming from abroad has become a cornerstone of the country's economic development. In 2004, with a record entry of 60,630 million dollars, China was the world's third-largest recipient of foreign direct investment (FDI), behind the United States and the United Kingdom (UNCTAD 2005).

FDI in China may be carried out in various modes, the most frequent being the following. Firstly, the representative office, which is usually the next stage after exports, allowing the development of a liaison structure and an increase of the trade activity. Such offices are not allowed to execute agreements on behalf of the company they represent, and must operate through agents and distributors. However, in practice, the presence in China of foreign representatives has permitted many firms to establish real distribution channels which are supported by one single representative office.

Secondly, there is the joint venture, for which there are two alternatives: equity joint venture, with limited liability on the equity, where the Chinese and the foreign party jointly manage the business, but the foreign share cannot be lower than 25 per cent; and cooperative or contractual joint venture, which is more flexible, for the partners may agree a share of the profits different from their share in the equity. This latter option is an interesting one in those cases where the foreign partner will contribute most of the financing, but its share is limited to a maximum percentage, as the sector is a restricted one.

The third option is the wholly foreign owned enterprise, permitted as of 1986, only for projects which favour Chinese economy and fulfil at least one of the two following purposes: use of international advanced technology, or export of all or most of the products manufactured.

Given the characteristics of these three generic modes of entry into China, it may be considered that the foreign firm will choose a higher degree of commitment insofar as it moves from a representative office towards a joint venture, and from there towards a wholly-owned subsidiary.

In recent literature on international business we may find various studies on the factors conditioning the degree of commitment for entry into China, although with different approaches: impact of experience and imitation on foreign subsidiary ownership (Guillen 2003); test of a hierarchical model on the factors influencing the choice of mode of entry, between equity-based [joint venture or wholly-owned subsidiary] or non-equity-based [contract or exports] (Tse, Pan and Au 1997; Pan and Tse 2000); influence of four-level contingencies (nation, industry, firm and project) on the choice between joint venture and wholly-owned subsidiary (Luo 2001); factors influencing the mode of entry (contract, joint venture or wholly-owned subsidiary) and their impact on performance (Chen and Hu 2002); or factors determining the ownership share of the foreign partner in joint ventures established in China (Hu and Chen 1993; Pan 1996; Chadee 2002; Chen, Hu and Hu 2002).

A review of these contributions shows some issues that need further research. On the one hand, from a theoretical point of view, these studies have focused on the most advanced FDI modes (joint venture or wholly-owned subsidiary), without considering representative offices, which often constitute an initial step prior to later, more committed investment. On the other hand, from an empirical point of view, the foreign firms discussed in these studies originate from more than one country, usually those with a greater presence in China (Hong Kong, USA, Japan, Korea, Singapore, Germany or UK).

This paper would like to help to overcome these limitations by including representative offices as an initial step towards FDI, and considering a sample from one single country (Spain), whose FDI flows in China so far has been lower to that of the aforesaid countries (China FDI 2003). In addition, our analysis may be the first to specifically focus on the choice between FDI modes by Spanish firms in China. Regarding this issue, the only study carried out so far is that by Duran, Jun and Ubeda (1995) on Spanish firms which took part in Spanish Expotecnia in Beijing in 1994, which might be potential investors in China. That study analyzed whether governmental support and specialized information conditioned the gradual nature of the internationalization process.

Based on the traditional theory on FDI and the resource-based view of the firm (RBV), we would like to offer a contribution to the knowledge of the firm-specific factors that affect the investment strategy used to enter the Chinese market. In the following sections, we begin with a theoretical foundation and follow it with a set of hypotheses. Methodological issues and major results are then provided. Finally, we present the main conclusions, contributions and limitations of the study and suggest some lines for future research.

LITERATURE REVIEW AND HYPOTHESES

One of the pioneering approaches explaining FDIs and, as a result, the existence of a multinational enterprise (MNE) is the Monopolistic Advantage Theory (Kindleberger 1969; Hymer 1976). Such conceptual framework, based on Industrial Organization Economics, argues that a foreign-owned firm must possess some specific advantages allowing it to compete on equal terms with local enterprises. According to this hypothesis, FDI occurs because the structural imperfections of the market (economies of scale, knowledge advantages and diversification, amongst others) allow firms to obtain a monopolistic power in foreign markets. Firm-specific factors are also one of the basic foundations of the Eclectic Paradigm of International Production (Dunning 1981, 1988). This model argues that the first condition for a firm to commit itself to FDI is its possessing an ownership advantage over firms from other nationalities. The Eclectic Paradigm also includes the internalization advantages (which determine whether the firm will organize its activity through the market or through internal means -hierarchy-) and location advantages (which influence the choice of country).

Dunning (1988) defined two categories of ownership advantages: assets advantages and transaction advantages of MNEs. While the former arise from the proprietary ownership of specific assets by MNEs vis-a-vis those possessed by other enterprises (size, experience, monopolistic power, technological or commercial resources, etc.), the latter mirror the capability of NINE hierarchies vis-a-vis external markets to capture the transactional benefits (or lessen the transactional costs), arising from the common governance of a network of assets, located indifferent countries.

Therefore, within ownership advantages we might include not only tangible assets, but also those of an intangible nature (such as a firm's experience, technology or commercial brand), which are one of the cornerstones of the RBV This major approach to Strategic Management argues that a firm's resources and capabilities are the way to create and maintain a competitive advantage (Barney 1991; Peteraf 1993).

The RBV is compatible with traditional NINE theory. In fact, Dunning (1988) suggests that ownership factors relate to the multinational's ability to compete in foreign markets and that these advantages derive from unique country, industry, and firm specific variables. Thus, ownership advantages are similar conceptually to firm-specific resources, in that they are the unique internal factors that generate the firm's competitive advantage in the marketplace (Fladmoe-Lindquist and Tallman 1994).

Penrose (1956), one of the forerunners of the RBV, had already offered an explanation for the continued growth of firms through foreign investment, arguing that the "productive oportunity" which invites expansion is not exclusively an external one. It is largely determined by the internal resources of the firm: the new areas in which it can successfully set up plants depend on the kind of experience, managerial ability and technological know-how already existing within the firm.

Later, the RBV has been applied to the study of more specific issues concerning FDIs. For instance, it has been used to supplement the explanations on the ownership mode based on minimizing transaction costs (supplied by the Internalization Theory), with comments linked to the administration of the value of a firm's know-how, and not only to the exploitation, but also to the development and display of its capabilities (Madhok 1997). Additionally, the model has been used to justify a firm's degree of investment commitment in a specific country, based on the resources and capabilities possessed (Trevino and Grosse 2002).

Ownership advantages may not only condition the FDI decision, but also the choice of investment mode. Firstly, they may cause firms to go beyond the establishment of a representative office and choose a more advanced mode (joint venture or wholly-owned-subsidiary). On the other hand, if a firm possesses all the resources and...