Is China a pot of gold or a pitfall?

China, its growing middle class, and a total potential of 1.2 billion new customers remains a strong draw for Western companies seeking to expand into new markets.

Besides the success stories, a trio of recent reports serve as reminders that there is a significant dark side to the Chinese market.

For Yum! Brands (YUM) — purveyors of Taco Bell, Pizza Hut, and KFC — China has been an unalloyed hit. Operating earnings in the second quarter grew 25% on a 28% increase in revenue, compared with a 28% decline in operating earnings in the U.S. Total restaurants in the country grew to more than 4,000, with 99 in the second quarter alone.

KFC's Chinese managers celebrate on the Great Wall. Source: Yum! Brands

Put another way, the company opens an average of more than one restaurant a day in the Middle Kingdom.

Jeweler Harry Winston (HWD), known for lending out diamonds to drape Hollywood starlets for Oscar night, also sees a bright spot in China.

“Nothing is too big, nothing is too beautiful, nothing is too expensive for Chinese today. They are on a quest for true luxury,” said Chief Executive Frederic de Narp, who is making it the company’s mission to “seduce and serve the creme de le creme of China.”

The company plans to have 10 stores in China in five years, compared with just one each in Beijing and Hong Kong today.

“All luxury brands see China as a mass market. We see China as the most exclusive market in the world,” de Narp said.

Behind the scenes, Chinese officials are driving very hard bargains with companies that want access to their markets. For a resurgent General Motors (GM), and the highly anticipated plugin electric vehicle Chevy Volt, the ability to sell on a level playing field may come with a heavy price.

To qualify for the subsidies of up to $19,300 a vehicle the government allows for electric cars, China is demanding GM give a Chinese competitor access to one of the vehicle’s key technologies, the New York Times said.

The Volt has a suggested retail price of about $41,000 in the U.S., excluding federal incentives of about $7,500.


GM's Chevy Volt. Source: General Motors

The new car market in China is currently estimated at a world-leading 17 million vehicles a year.

China’s R&D budget is too small to quickly duplicate the efforts that have resulted in the Volt. “We have to break through and master the core technologies,” Chen Jiachang, a deputy director of the ministry of science and technology, said in a speech Saturday at a conference in China, the paper said.

The Volt would compete with a sedan produced by China’s BYD Co., a firm backed by U.S. investor Warren Buffett.

The demand, which some say would violate World Trade Organization rules, is contained in a draft policy in China that is awaiting final approval.

GM’s competitors are waiting to see the outcome of the dispute before moving ahead with their own electric car plans for China. However, a Ford Motor Co. (F) spokeswoman said the company would share some technology with its Chinese partner, the civilian automotive affiliate of a large military contractor.

Nissan (NSANY) won’t sell its Leaf fully electric car in China, but is working with a Chinese partner to develop its own electric car for the country by 2015, the paper said.

And when it comes to the “rare earth” minerals that are a key part of many high-tech products, such as electric cars, cells phones, and advanced light bulbs, China is using its position to hold on to supply and attract investment. The country produces virtually all of the world’s supply of 14 rare earth minerals — lanthanum through ytterbium, plus scandium, yttrium and lutetium — and carefully controls their export.

For the past two years, export quotas have limited supply to 30,000 tons a year, compared with worldwide consumption of double that number in previous years. In addition, exports of raw versions of the minerals are subject to taxes of up to 25%, plus value-added taxes of 17%, while items that undergo some processing in China may leave tax-free, including the VAT.

“We saw the writing on the wall — we simply bought the equipment and ramped up in China to begin with,” Mike Pugh, director of worldwide operations for light bulb maker Intematix, told the Times.

Despite sharply lower costs for labor and equipment, amounting to pennies on the dollar, Intematix would have preferred to keep its production closer to its Fremont, California, headquarters to protect its jealously guarded proprietary processes.

Finally, faced with skyrocketing shipping costs in 2008, Brazil’s Vale (VALE) decided to buy its own ships to carry iron ore to China, its biggest customer.

Earlier this year, the Chinese refused to allow the first of those enormous bulk carriers to dock at its ports. The Vale Brasil, touted on the company website, had to be rerouted to Italy instead.

The ship, the world’s largest bulk carrier with a capacity of 400,000 tons, is only the first of 19 the company pledged to buy, including a total of seven from a shipyard in Korea for $748 million and 12 from China for $1.6 billion.

Vale is now in talks with other shipping companies, including China’s state owned COSCO Group (CICOY), to sell or lease the fleet.

“We don’t want to be a major freight operator or make money out of our shipping business,” Vale’s global marketing director Pedro Gutemberg told Reuters. “We just want to make sure that our freight cost doesn’t shoot up. So any person that wants to partner with us is very welcome.”

COSCO is struggling as the economic downturn has slashed rental rates for ships to about $25,000 a day, down anywhere from 50% to 75% from the peak three years ago.

“Our counterparts should hope for the best for us because right now we are in the restructuring process of our bulk carriers,” a COSCO official, who wished not to be named because he was not authorized to speak to the media on the subject, told Reuters.

“In maybe one or two years, China COSCO will be stronger, more efficient and a much more reliable friend to cooperate with. All the outside parties should see this issue in this way.”

The company’s shares are down more than 50% so far this year.

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