Hong Kong Foreign Owned Export Business Analysis Report

Lance Hattendorf

Hong Kong Foreign Owned Export Business

Analysis Report

BC 303 - Statistics

Lance Hattendorf

SID# 20110202

January 11, 2011

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Introduction

Situated at the edge of the Asian Pacific, between China and Oceana, since

modern trade, the deep water port of Hong Kong has always been an important part of

linking Asian trade with the rest of the world. With English colonization and the

development of China’s “One country, two systems” doctrine, Hong Kong has been

positioned as an economic engine propelling Asia toward modernization and

globalization. Several distinct advantages attract foreign companies to do business with

Hong Kong. These advantages include a competitive tax rate, flexible and educated labor

market, a high standard of rule of law, and the freest economy in the world (The Heritage

Foundation, 2010).

For foreign owned companies wishing to organize and develop in Hong Kong,

three distinct business structures exist, a subsidiary company (market subsidiary),

distributor office (distributorship), or representative office (agency). No matter which

structure the foreign company decides to establish, Hong Kong does not restrict or

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require local participation in ownership or management, differentiating itself from many

other Asian trade ports (Russ Thai Consulting, 1998).

Although there are a few business structures available to the foreign enterprise,

just like Western nations, there exist many different types of companies, depending on

the product, revenues, market viability, etc. The purpose of this analysis is to determine

which wholly owned foreign enterprise (WOFE) exporter type, operating in Hong Kong,

is the most lucrative. Therefore, for the purpose of this analysis, the exact business

structure is not important, as much as the form of the foreign exporting structures

operating in Hong Kong, agencies, distributorships or subsidiary companies. The

following is designed to define the research question, discuss analysis procedure, define

the subjects and document the viability between these three distinct structures.

Research Goal

Working as a project manager and management consultant off and on in Hong

Kong for the past two and a half years, I’ve had business dealings with many types of

businesses with many different formations. Not so much as by pattern as much as by

identifying a niche to operate in, I became interested in foreign companies operating in

Hong Kong, particularly exporting through this bustling Asian port to the mainland

Chinese market.

At the beginning of the quarter, when a research question was posed, it struck me

that having insight into which WOFE exporting type was the most successful would be

valuable to know, not to mention the information gleaned from the research process. The

research question, therefore, I propose is as follows:

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“Concerning the different forms of exporting structures, agency, distributorship, market

subsidiaries (subsidiary) in Hong Kong, which are the most lucrative for sales?”

Through the course of my research, my research question has evolved

substantially without entirely invalidating the original viability of the research. The

success of Hong Kong as a port has created many problem in establishing statistical

tracers, among these are population tracking and therefore, sample tracking. Several

determinate factors has caused this evolution, among these are: a lack of ability to

identify exact company form due to market freedoms in Hong Kong, little amount of

available research on companies that went out of business, with so many exporting

companies operating in Hong Kong it is difficult to determine which are foreign or

domestic, and population/sample identification difficulties because companies can use

either English or Cantonese in their names and documents.

Research Collection and Methodology

A major challenge has been to identify and gather enough information for

preliminary analysis and inference between the different types of exporters. The sources

of information on the different companies have come from the Inland Revenue

Department of the Hong Kong SAR, Hong Kong General Chamber of Commerce, Hong

Kong Trade Development Council, Hong Kong Exporters Association and the Hong

Kong stock exchange – Hong Kong Exchanges and Clearing Limited (HKEx).

By narrowing the focus to three distinct groups, agencies, distributorships or

subsidiaries, and the opening up of the population to both foreign and domestic, each

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distinct group can be represented with stratified random sampling, thereby forming them

into three distinct strata. This also solves the problem of an unknown population and the

unknown sample size. By sampling an even number of units in each strata, indeterminate

figures such as population size become null.

By identifying a sample of companies’ financial statements, examining the

profitability components of the companies, the profit margin, return on assets, and return

on equity, comparing the profitability attributes of each sample within the strata, and

finally determining the mean of each attribute of each strata, we can infer the success

level of each type of business. Although it is possible that the sampling attributes will

conflict, I believe the nature of financial reports will show a coherent trend for each

strata.

Exporter Defined

Foreign companies have several different ways of breaking into foreign markets

depending on a variety of factors. Chief among these factors is whether the subject

company is considered a willing or unwilling participant in globalization.

An unwilling firm considers exporting a difficult, expensive nuisance and prefers

to focus on domestic sales. For the unwilling exporter, the various ways to handle their

foreign market sales include the use of an export trading company (ETC), using an export

management corporation (EMC), and piggybacking. The use of an ETC is a very simple

solution for the unwilling firm as the ETC is an intermediary company that will purchase

the firms products and then resell them to a customer in a foreign country. An EMC is

another type of intermediary that acts as an agent for the exporter that while it does not

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take title to the firm’s products, it does gain a commission on the sale of the products to

customers in the foreign country. Piggybacking is a choice for an unwilling export firm

that involves a supplier setting up manufacturing in the foreign country and the exporting

then piggybacks their products through the suppliers manufacturing facility (Pierre &

Stewart, 2008).

Like the unwilling exporter, several options present themselves for the willing

exporter, or a firm actively seeking foreign markets in which to become involved. These

exporting options include agency, distributorship, and subsidiary. It is these willing

exports that this analysis will focus on.

Agency

The use of an agent by an exporter in a foreign import market is usually a

strategic one. The agent is normally a small firm already physically located in the foreign

market that simply acts as a representative of the exporter. An agent will not take title to

the firm’s products but will receive a commission for the sales in the foreign market.

Several factors for the use of an agent for foreign market expansion are considered by the

exporter:

1) For potentially small sales with moderate or no growth potential (no more than 5

to 10 percent of domestic sales)

2) When the product has been specifically designed to meet the needs of a particular

customer, not a “stock item”

3) Expensive items such as high end or operating machinery

4) Items with short product life cycles

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5) Items that do not need much after-sale servicing

6) The exporter is not likely to develop into a dominating presence in the market, but

will continue to be a niche provider

7) When the exporting firm is equipped to deal with export sales

8) When the company does not demand a premium pricing strategy due to a top tier

market strategy

9) When the firm wishes to exert control over its foreign pricing, marketing and

delivery strategy.

Distributorship

The distributor, like the agent is located in the foreign market. Unlike the agent,

however, it will purchase the products from the exporting firm, therefore take title to the

goods, and resell them for a profit. Characteristics of a distributor is that there are two

sets of invoices, on e an international invoice between the exporter and distributor, and

one from the distributor and final customer. Because the distributor takes title to the

goods, it may decide to carry complementary as well as competitive products. A firm

using a distributor will make this decision based on several factors:

1) For a potentially substantial market share of growth potential (20 to 25 percent of

domestic sales)

2) When exporting a stock item of commodity

3) When exporting a moderately priced product

4) For products with a fairly long product life cycle

5) If the product requires frequent maintenance or servicing

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6) When the firm estimates it will not be more than a minor market presence

7) When the exporting firm wishes to deal in export sales with a single customer

8) If the customer does not require direct control over its foreign pricing, marketing

or delivery strategies.

Subsidiary

Finally, a market subsidiary is an option available to a firm that feels comfortable

in developing its own subsidiary in a foreign country to produce, market, and/or sell its

goods in the foreign market. A characteristic of a market subsidiary is that it is

incorporated by the exporting firm and the export invoice is generated by two legal

entities that are part of the same corporation. A market subsidiary is a good choice for

firms with the following options:

1) For potentially considerable sales and market growth (more than 25 percent of

domestic sales)

2) For technologically driven products with intellectual property considerations

3) For complicated goods to produce or sell

4) For firms that expect a long relationship in the foreign market with the

introduction of additional product lines or goods in the future

5) If the product needs sophisticated maintenance or after sales service

6) If the exporting firm expects to develop into a substantial competitive presence in

the foreign market

7) For products or services that demand premium prices

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8) When the company wishes to retain control of its foreign pricing, marketing, and

delivery strategies (Pierre & Stewart, 2008).

The previous definitions were provided to display the inherent risks in associating

similar properties to each group of samples. Those definitions as outlined, for example,

show that because of the characteristics of the different business entities, subsidiaries will

tend to have a higher revenue than either agencies or distributorships. It becomes

necessary, then to analyze other properties within the sample groups (strata). For example

as seen in the chart below, the mean revenue in and of itself will not give the full detail of

success of each of the strata. For this reason, we have also included profit margin, return

on assets (ROA), and return on equity (ROE). With the combination of the financial data

with stratified random sampling, we should be able to identify trends to aid in the goal of

this research.

Mean Revenue of Business Structure (2009)

$5,599,667
$6,000,000

$5,000,000

$4,000,000

$3,000,000
$1,778,787
$2,000,000

$1,000,000 $298,791

$0
Agency Distributorship Subsidiary

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Data

The table below represents financial data gathered for the samples in each strata,

agency, distributorship, and subsidiary.

Agency
Company Name Symbol Revenue Profit Profit Margin ROA ROE
Zhongpin, Inc. HOGS $829,700 50,740 6.12% 7.6 18.9 1
Golden Dragon Holdings, Inc. GDHI $12,605 -312 -2.48% 2.1 -1.2 1
Ocean Sky International Ltd. O05 $54,068 1,409 2.61% 3.6 6.7 2
Mean Total $298,791 17,279 2.08% 4.43% 8.13%

Distributorship
Company Name Symbol Revenue Profit Profit Margin ROA ROE
First Pacific FPAFY $4,280,000 427,400 9.99% 5.7 25.1 1
Multi Chem MULT $504,000 -423,000 -83.93% -3.9 -72.3 1
SiS Technology 0529 $552,360 13,400 2.43% 2.9 8.2 1
Mean Total $1,778,787 5,933 -23.84% 1.57% -0.13

Subsidiary
Company Name Symbol Revenue Profit Profit Margin ROA ROE
Compellant Technologies CML $1,368 26 1.89% 0.6 2.3 1
EMC Corporation EMC $155 15 9.59% 5.7 9.8 1
Ace Limited ACE $157 29 18.39% 3 15.2 1
Mean Total $5,599,667 231,667 9.96% 3.10% 9.10%
1=financial data gathered from Yahoo Finance
2=financial data gathered from HKEx

How to Determine the Success of Business Structure

As we can see, as predicted, the subsidiary strata not only have higher revenue,

but also seems to have a higher profit margin. Based on this data, our question is can the

revenue and profit help determine the success of the business structure? To do this we

will calculate the coefficient of correlation and coefficient of determination to identify if

statistically there is any difference between the business structures.

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Company X Y X-X̅ Y-Y̅ ̅ ̅
(X-X)(Y-Y)
Zhongpin, Inc. $829,700 50,740 136987.46 42994.83 5889752820.37
Golden Dragon Holdings,
Inc. $12,605 -312 -680107.54 -8057.17 5479739836.85
Ocean Sky International Ltd. $54,068 1,409 -638644.54 -6336.17 4046558274.36
First Pacific $4,280,000 427,400 3587287.46 419654.83 1505422519279.92
Multi Chem $504,000 -423,000 -188712.54 -430745.17 81287016408.81
SiS Technology $552,360 13,400 -140352.54 5654.83 -793670246.74
Compellant Technologies $1,368 26 -691344.54 -7719.37 5336742031.57
EMC Corporation $155 15 -692557.24 -7730.27 5353652181.49
Ace Limited $157 29 -692555.94 -7716.37 5344015604.51
Total $6,234,413 $69,707 1612022310586.62
Mean $692,713 $7,745
sx, sy $3,905,169 $603,172

The scatter chart below shows the correlation between revenue and profit for the samples

with the calculations for the coefficient of correlation and coefficient of determination.

Correlation Between Revenue and Profit

500,000
400,000
300,000
200,000
100,000
0
-100,000 $0 $500,00 $1,000,0 $1,500,0 $2,000,0 $2,500,0 $3,000,0 $3,500,0 $4,000,0 $4,500,0
-200,000 0 00 00 00 00 00 00 00 00
-300,000
-400,000
-500,000

Coefficient of Correlation 0.09

Coefficient of
Determination 0.00732

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Summary

As we can see, even though there is a positive association between the revenue

and profit of the subject companies, the association is very weak. This weak relationship

indicates that independently, there can be no determinant factor of success based on

export business structure in Hong Kong.

Resources

Hong Kong Exchanges and Clearing. (2010). Retrieved September 5, 2010, from

http://www.hkex.com.hk

Pierre, D. & Stewart, R. (2008). International Logistics, The management of

International Trade Operations. Cengage Learning: Singapoe

Russ Thai Consulting, LTD. (1998). Retrieved August 6, 2010, from

http://home.swipnet.se/~w-10652/Hong_Kong_business_FAQ_1.html

The Heritage Foundation. (2010). 2010 index of economic freedom. Retrieved August 6,

2010, from http://www.heritage.org/index/country/hongkong

Yahoo Finance. (2010). Retrieved September 5, 2010, from http://finance.yahoo.com/

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