The operational cost of positioning an export company to inland China may effectively double the overheads. The fact that it is more expensive in terms of additional transport costs is somewhat obvious, but the scale of the difference-wiping out all gains made in lower land and labor costs-and adding a significant burden on top, is a surprise.

First-tier city annual average operating expenses

Total: $272,150

Central provincial capital annual average operating expenses

Total: $171,525

Cost of additional container transportation: $400,000

Grand total: $571,525

Admittedly, we have only used the legal minimum salary as a figure, however even if we increase this amount by a factor of 50 percent to take into account managerial level salaries and so on, the cost of transportation still wipes out any gains made.

Essentially, the cost of transporting goods by rail in China makes the issue, for businesses wishing to export, an expensive one. Although the figures drawn upon to reach this conclusion are averages, and as such contain within them a huge amount of potential variation, the exercise does however serve a useful purpose in revealing the huge burden of having to transport goods across China via rail to reach a sea port. Possibly also a revealing statistic when considering two other aspects: Rail is a monopoly industry in China and is fairly expensive as a result; and a premium on usage makes transportation a cost barrier to the inland regions. (China still has a great deal of rail investment to make, and many routes are close to capacity.)

One exception may be Wuhan, on the Yangtze River, offering transport services by river, however even so, we have found that due to monopolies being in place even river transportation is pricey and to a large extent unreliable.

A basic simple conclusion then: Investors looking at export markets are still significantly better off staying in the coastal regions.

So what then of central China?

The high cost of exporting means businesses are going to have to look either at opportunities in the service sector, or seriously at selling to the local market. So let’s consider the demographics of doing so.

Opportunities--a huge market?

As we have already discussed, central China has a huge population-in fact it would be the third largest country in the world if it were independent. So what opportunities exist in the region to support this? One indicator is the level of per-capita income, the ability for people to buy non-essential items. Here is a breakdown:

Disposable income of urban residents in central provincial capitals (yuan per annum):

Hefei: 9,684 ($1,210)

Changsha: 12,434 ($1,554)

Zhengzhou: 10,640 ($1,330)

Wuhan: 10,850 ($1,356)

Nanchang: 10,301 ($1,287)

Taiyuan: 10,476 ($1,309)

We can also look at retail sales in each city:

Retail Sales (billion yuan per annum):

Hefei: 32.4

Changsha: 74

Zhengzhou: 70.7

Wuhan: 109.8

Nanchang: 30.7

Taiyuan: 38.4

This tells us two things: First, residents in these cities don’t have a huge amount of cash to spend on mid-range non-essential items, and second, retail sales have significant volume-a point not lost on the likes of Wal-Mart and Carrefour. To make a margin then-you have to think big and be in a position to trade on huge volumes.

The other issue facing international businesses in the region-especially those looking to introduce new brands-is that the domestic suppliers are well entrenched, with well known brands, long-established supply chains and sales channels, and are going to be difficult to compete with.

For this reason we predict that international investors will start to operate in this market only on bulk sales, and either through the time-honored method of having a local joint venture (JV) partner, or to make a local acquisition. Often, as a strategy, both acquire the JV first, then later on buy out the partner’s shares.

A prediction then, for central China:

1) A rise in JVs;

2) An increase in the numbers of acquisitions to improve management in existing businesses and access market share via an established brand that can also be used to parachute international originating products into the China market; and

3) An increase in acquisitions in commodities manufactured in the region that can be sold elsewhere on domestic and international markets under long term market buoyancy (such as Mittal Steel’s recent acquisition in Changsha).

Chris Devonshire-Ellis is the Senior Partner of Dezan Shira & Associates--www.dezshira.com