Multinationals looking to tap enormous potential offered by market

China has become a key destination for multinational companies looking to establish and outsource their research and development (R&D) centers, driven by an expanding customer base, large talent pool, excellent infrastructure and favorable government incentives.

More than 340 of the Top 500 enterprises in the world have already set up their own R&D institutions in the world's second-largest economy and this number is steadily increasing.

According to Ministry of Commerce, China had more than 1,200 R&D centers set up by multinationals by the end of 2009, with technology firms taking the majority spot (40 percent), followed by automotives (20 percent).

China accounts for 13 percent of total global R&D spending in 2011 to date, according to recent published articles. This is an increase of almost 2 percentage points from 11.2 percent in 2009, making China the second-largest global R&D investor in 2011. Along with a rising number of R&D centers, spending by foreign-invested enterprises on R&D has seen an increase in annual growth rate of 21.2 percent from 2002 to 2008.

These numbers demonstrate the trend for multinationals to consider China as a place to establish R&D and shared service centers.

An increase in the number of multinationals based in China has also in turn led to the recent spurt in the number of R&D centers. From an operations perspective, it makes sense for firms to locate R&D centers close to their manufacturing platforms and head office. The localization of R&D efforts also enables companies to develop products for the China market, which in itself is one of the largest targeted markets for companies around the world. It also provides them with an opportunity to employ human resources personnel from within China.

Although there is a gap between China and developed countries in terms of top tier talented professionals, the cost of middle- to low-tier talent is only one-tenth to one-sixth that of developed countries, so there is a huge difference in HR costs from a business operations perspective.

We see another new development emerging, as the salary levels offered by top foreign and domestic companies start to converge, factors other than compensation are starting to drive competitiveness in recruitment. Meanwhile, some companies are also stepping up efforts to localize their teams by hiring rising numbers of local and overseas returning professionals. Companies used to hire expats, which in turn increased challenges in order to obtain the right level of talent, at the right location and at the right price. As a result, we now see a rising number of firms looking to increase the number of local hires to balance out the management experience and staff costs.

The government is encouraging foreign invested companies to set up R&D operations in the country via various initiatives. For example, the government has granted an exemption on import tax on technology development products by foreign R&D centers. Value-added tax can also be refunded on domestically purchased equipment by both domestic and foreign R&D centers.

In terms of intellectual property rights issues, the government in China has boosted its efforts to protect IP rights over the last few years. The number of ISO27001 certifications - an international security accreditation - in China has now risen to 494 from 140 in 2008, according to official data, which has seen China rise to the third rank in the world after Japan (3,939) and India (527) in terms of the number of certifications. An increase in the number of data security regulations and compliance requirements has also in turn helped to drive increased take-up of data protection standards by service providers and financial institutions amongst others.

To conclude, China is on its way to establishing a sophisticated R&D business. Multinationals are increasingly looking to tap into the enormous potential offered by this market and enjoy the benefits.

The author is partner-in-charge, shared services and outsourcing advisory, KPMG China.