2014, August 7
If you are a company that is considering to market your software in China, what should you do ? Let me analyze the market and legal issues around the export of software and business development in China.
First of all, on which kind of software one could expect to make money there ?
Chinese market is especially hungry for the solutions in Smarter cities, Cloud management, and Business intelligence. Following in demand are social analytics, platform-as-a-service, internet of things and big data. As for the value of the market for this type of software, you need first to know that in this country, 5 milion IT professionals generated in total $500B revenue in 2013. When you deduct what was exported and add what was imported, you arrive at the total value of IT market at $200B per year. The value of the enterprise software market in 2014 is estimated by various sources at $10B-$20B, and business intelligence with big data accounts for about 10% of that value. Of course, big players dominate in around 70% of this market segment, but at the current growth of around 25% per year, I would say that there is still enough meat for smaller and innovative companies. Compare this with negative growth in Europe.
If this proposition sounds interesting, the next question could be: how to get a piece of this pie ?
The best answer would be : do carefully a preliminary SWOT analysis taking into account your strengths and weaknesses, and the opportunities in the surge in smartphone use and e-commerce, and the government push declared in the 12th five-year plan for the development of smarter cities. Take equally into consideration the risks in intellectual property rights (IPR) protection and costs of localization and marketing.
The second step – open a representative office in China. This structure is very simple to register and allows you to study your future clients, their customization expectations and pricing structure. You are not allowed to make revenue from this office, but it is helpful in the initial phase of your project.
If all this leads to a conclusion that your software has revenue potential in China, the question will be : how to manage the risks ?
The biggest risk will be protection of your intellectual property. In most cases, a good mix of licensing mechanisms, copyright protection and trademark registration will be sufficient. If your software is a true novelty, you might consider to protect it through an international patent registered also in China. For this, consider using WIPO’s international filing system. In China, it is generaly possible to register patent on a software product, but it needs to meet the conditions to be able to “solve a technical problem by a technical measure to produce a technical effect”. Good news is that Chinese government is doing more and more in protecting domestic and foreign intellectual property and software piracy is in constant decline. If you want to do repeatable business in China, consider early enough protecting your trademark to avoid the case of Apple having to pay $60M to an individual who was the first to register “iPad”.
When you find clients and become ready to perform the first transaction, you will start wondering about the appropriate business model.
Here you have the following options:
1. set up your own subsidiary as Wholy Foreign-Owned Enterprise (WFOE),
2. create a joint venture with a local partner (the most common and the most flexible form would be Cooperative Joint Venture), or
3. use an intermediary agent to import and resell your software to the final customer.
If you decide to setup your own WFOE with the business scope of provisioning IT services in software import, distribution and support, the initial capital requirements will be between $10K and $50K. Don’t forget to apply for the authorization with China’s State Administration of Foregn Exchange (SAFE) to be able to buy your own home currency (CHF, EUR, or USD) for the transer to your bank account. The best choice for the headquarters for smaller companies might be one of the 2nd tier cities like Hangzhou, Suzhou, Tianjin, Nanjing or Chengdu, with higher growth potential and still lower operating costs. Check this source of detailed advice.
Import procedure may look very complicated, but in fact it isn’t.
You will probably want to download the executables from your servers abroad. In this case of non-tangible goods (no CD to present to the customs) there is no VAT to pay, but rather business tax at 5% on the service. This will change in the near future into VAT, but the tax rate will stay low (6%). So, the importer will have to pay this business tax and withholded enterprise tax on behalf of the exporter, which in total will represent 15% of the price of your software license. If you have yearly licensing schema, your import company will have to repeat this procedure each year. This amount of tax represents the input that you will credit when the final customer pays to your Chinese company the invoice and associated business tax.
Before selling it to the final customer, you need to perform the mandatory certification of your software with the Ministry of Industry and Information Technology (MIIT). You need to fill out an application form and submit the following documents: sample of your software, attestation that the owner or the copyright holder is authorizing the sales of the software in China, and certificate of examination issued by the China Software Industry Association. The certification process takes in total about one month.
In the end, when the money is paid on your account in China, you will submit the contract signed by you and your customer to the bank for the currency conversion. Since Dec 2013, the foreign currency payments for the service import are simplified. Don’t forget in the end to check if your country has double taxation treaty with China, because in that case you would be able to deduct the withholding tax from your revenue.
When all is finished, the business is done and your software is running on your client’s platform, you can start collecting lessons learned and see how you could leverage on this first software deal to increase you presence in China. But this is already another story..
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