McKinsey special report outlines concerns when doing business in China

China represents one of the world's greatest economic opportunities since the California Gold Rush, but is equally fraught with risk. Senior executives looking to do business in China—or who are already there—share common concerns that Gordon Orr, director of global management consultancy McKinsey's Shanghai office, sought to address in a special quarterly report. The top three questions among the seven addressed are the status of China's financial system; the country's progress in meeting its commitments to the World Trade Organization (WTO); and the success of China's efforts to protect intellectual property. Orr's comments on those areas are as follows.

Financial system: Most banks are performing better and working to pay down bad debts from when their primary role was to underwrite employment by supporting state enterprises. They are improving operating systems and skills and moving toward improved risk management. They are making money on new loans, due in large measure to the country's 9-percent annual economic growth rate.

But the banks lack general retail risk-management skills commensurate with the coming change they'll need to engineer when the source of their profit shifts from deposit-taking and commercial lending to retail credit, fee-based activities, and lending to small and midsize enterprises.

WTO commitments: The country is largely on-schedule to meet core commitments it made when it joined the WTO in December 2001. Non-bank auto financing and foreign life insurance companies are establishing a presence, and more retail opportunities are opening up, although navigating local-planning requirements continues to be problematic. The financial sector and imported foreign agricultural products, including genetically modified ones, are areas of improved openness.

The regulatory function of industry—e.g., concerning telecommunications—hasn't been made completely independent. The resulting conflicts of interest may hurt competition and add to uncertainty that holds investors back.

Intellectual property protection: The central government has largely followed through on its WTO commitments to create a stronger policy framework, though enforcement, particularly at the local level, leaves something to be desired. The decreased emphasis on requiring joint ventures, however, has encouraged many foreign companies to move to establish wholly owned enterprises as a means of improving control and protection of intellectual property. This provides stronger protection for process-based assets than product-based property, yet they are still open to reverse engineering and duplication.

As retail channels become more professional, counterfeit products likely will take a smaller share of the market than in the past, ending up in kiosks or mom-and-pop shops rather than on the shelves of major retailers. Channel protection could be strengthened further as links in the supply chain are reduced, with manufacturers delivering directly to retailers and effectively eliminating the chance of counterfeiting.