Insight & Analysis

Tough trading conditions hit European businesses in China

Published: Jun 2023

European businesses in China say trading has become more difficult citing the drop in revenues to decoupling trends and a politicised trading environment. In response companies are developing divergent supply chains and operational systems for China and the rest of the world.

Barriers to market access and rising tensions between Beijing and Washington that are intensifying decoupling trends means more European companies operating in China are finding doing business more difficult. According to a study by the European Chamber of Commerce in China that surveyed 570 companies, European corporates have started reviewing their investment and operational strategies to ensure their supply chains are fit for more uncertain conditions.

A majority of survey respondents (64%) reported that doing business in China became more difficult in the past year, the highest on record. Sectors including medical devices, automotive, and transportation, logistics and distribution have been hardest hit.

Meanwhile, the highest number of respondents on record reported year-on-year (y-o-y) revenue decreases impacting sectors like aviation and aerospace, medical devices, legal, petrochemicals, retail, and food and beverage most. Other noteworthy trends include a disproportionately high percentage of SME members reported y-o-y decreases in their bottom lines.

The survey found the importance of companies’ China EBIT margins relative to the rest of the world fell in 2022 for the second consecutive year. For the first time since 2016, the number of respondents that reported a China EBIT margin lower than their average worldwide margin exceeded the number that reported a higher China EBIT (36% vs 31% respectively).

Decoupling

It is leading to continued decoupling trends. 11% of respondents have shifted existing investments out of China, and 8% have taken the decision to move future investments previously planned for China elsewhere. One in ten report they have already shifted, or plan to shift, their Asia headquarters or business unit headquarters out of Mainland China and there has been a 13-percentage point reduction y-o-y in the number of respondents that view China as a top-three destination for future investments. Three quarters of respondents said they have reviewed their supply chain strategies over the past two years.

Decoupling of European and China operations has increased primarily to manage risk, with nearly three quarters of respondents saying they have localised IT and data storage infrastructure. Significant localisation of company staff has also taken place over the last half decade, with 16% reporting their China operations no longer employ any foreign nationals.

In a flip side, executive search firm Odgers Berndtson notes the departure of foreign nationals is boosting opportunities with MNC’s for local talent. “Over the past year, a significant number of international ex-pats have departed China, highlighting the growing importance of localising senior talent within the country. “For the first time since 2022, we are witnessing senior executives receiving multiple offers from MNCs, indicating a dynamic job market as companies begin to unfreeze previously halted recruitment plans,” Colin Wong, Managing Partner, Odgers Berndtson, Greater China, told Treasury Today.

Still, these developments come at a considerable cost to companies and to China, warns the survey. The need to create divergent systems for China and the rest of the world means the overall efficiency brought by global economies of scale is lost. Meanwhile, the reduction of foreign nationals is resulting in reduced transfer of knowhow and best practices, communication difficulties, deferred investment plans, and even China operations being closed. “The negative trends we see in this year’s survey are concerning and reflect both recent challenges—brought by uncertainties in China’s policy environment and rising geopolitical tensions—and the persistence of long-standing market access barriers,” said Jens Eskelund, President of the European Union Chamber of Commerce in China. “For China to turn the tide and allow European companies to develop and contribute to their full potential, we really need to see concrete action.”

“Unless further steps are taken to address the uncertainties confronting companies, then the trend of supply chain diversification is likely to strengthen in the medium term,” adds Denis Depoux, Global Managing Director of consultancy Roland Berger. “Many European companies are now focusing more on how to make their China operations more durable instead of capturing greater market share, which is not good for competition.”

While a majority of survey respondents remain committed to operating in China, the proportion who regard the country as a top-three destination for future investment declined to 55% from 68% a year ago.

In another trend, six out of ten respondents said the business environment has become more politicised over the past year. For example, some stakeholders want businesses to pull out of parts of the country where Beijing is accused of human rights abuses, such as Xinjiang and Tibet – but others demand the opposite. The European Commission has unveiled a strategy aimed at mitigating economic coercion from China.

Companies can also come under pressure to produce goods containing either no Chinese or no US components, depending on which of the two markets the goods are bound for, the study said. Other considerations include Chinese cybersecurity and other regulations, and US export controls intended to keep certain high-technology goods and services out of China’s reach.

Signs of change?

Wong believes that the recent visit by the US Secretary of State has helped ease the tensions and hopefully set the stage for mending the relationship between the two largest economies.

The report concludes it is premature to rule out China’s ability to respond positively to the challenges faced by European businesses. Many respondents (63%) report they would be willing to increase their China investments if market and regulatory barriers were removed. There also remains huge scope for strengthening European Union (EU)-China ties in areas such as trade in services, which is significantly below potential given the size of their respective economies. “With China now ‘reopening’ to the world, following three years of isolation, there is a window of opportunity for the government to demonstrate the pro-business promises recently made by its leadership are more than just words,” the report says.

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