Netflix Venture Shows China Is Open to Foreigners -- at Least the Ones it Likes

TAIPEI, Taiwan (TheStreet) -- Netflix' (NFLX) attempt to enter the vast Chinese market is already generating a lot of skepticism.

And no wonder. Even 35 years after first opening up to the outside world, China remains a minefield for any foreign business to navigate. What's becoming clear, however, is that certain businesses are indeed being welcomed, while others are clearly not.

Even Netflix admits it's not quite sure what to expect. And it's starting out small. 

"We'll learn a great deal if we can successfully operate a small service in China centered on our original and other globally-licensed content," the video streaming service said in a Jan. 20 letter to shareholders. "That is our preference, for the next few years, if we are able to acquire the necessary permissions."

Netflix already has 62 million members in 50 countries (though that includes those signing up for the one-month free trial), so it makes sense for the company to tap the huge Chinese market.

In Netflix' favor is its scale. Large companies such as General Motors (GM) usually have procedures in place to find local partners -- required sometimes for investment in China -- and negotiate red tape to get permits. Smaller companies may lack the know-how or on-the-ground connections.

Netflix has been talking to a media group backed by Alibaba (BABA) chief Jack Ma about cooperation in China, news reports say, perhaps to avoid getting pushed off the set by local rivals or regulators. The company would not comment officially.

The task will certainly not be easy, analysts said.

"Netflix, to justify an investment, would need in a very brief time period to capture a dramatic market share, establish a powerful brand, disrupt existing patterns of purchasing entertainment and leverage their global content in China," said James Berkeley, managing director of the London-based management advisory service Ellice Consulting.

Netflix would see thin results unless it scaled up to a level that disrupted China's numerous local movie distributors, who have government relations and might protest the intrusion. China also restricts foreign investors in Internet content and mass media, both of which the Communist government controls to protect its public image.

"Venturing into a combo of both compounds entry and business stability issues in China," said Danny Levinson, a Beijing-based technology angel investor. Without licensing copyrights to Chinese companies, he said, Netflix is "going to be the latest foreign lemming jumping off the China cliff with their eyes wide shut."

Internet investors from overseas also face competition from China's own almighty content providers such as U.S.-listed Baidu (BIDU) and Tencent (TCEHY). Chinese-listed LeTV would compete particularly with Netflix. Those who make it work, such as Microsoft (MSFT), often partner with a Chinese peer.

Export manufacturers still have a clear channel into China, though against ever stronger macro-economic headwinds. Companies keen on protected industries such as construction, telecoms, Internet content or mass media should rethink their goals. That's the first clue to Netflix.

In the 1980s when China began shaking off suspicion of foreigners to open its doors, only the hardiest of foreign firms got in. They would form joint ventures with local partners, some of which stole technology or more, and quietly pay off government officials. Many then came from nearby Hong Kong or Taiwan, where investors quickly figured out Chinese business culture.

Foreign investment that started out mostly in manufacturing once drove China's growth, now at about 7% per year, which in turn became an incentive for other firms to enter the market that was still an inexpensive base to produce a wide range of exports.

Chinese officials hope consumption will someday lead the economy, a contrast to Western countries where demand has wobbled since the 2008-2009 Global Financial Crisis. The emergent Chinese consumer is motivating retailers to jump in.

About 441,000 foreign-invested firms operated in China as of September 2013 with registered capital of $1.98 trillion, according to state media.

A favoring of retailers offers business security to U.S.-listed, China-entrenched firms such as Apple (AAPL), Starbucks (SBUX) and luxury brand Burberry (BBRYF).

Foreign investors are also widely advised to choose a location that encourages their industries, for example production of cars or toys in the southern city Guangzhou. A receptive city government can fast-track permits or offer incentives.

Otherwise factories face pressure from rising wages and land prices, likewise increasing demand to control pollution and contribute to the rejigging of China's macro economy toward clean industry and consumption.

"There's some progress China could make in terms of setting up a company," said Jeff Walters, a principal in the Shanghai office of the Boston Consulting Group. "It can be a little bit slow."

Foreign investors should also mind nationwide restrictions on entry into energy, natural resources and telecom networks. All are dominated by state-invested giants, considered crucial to national security or both. Construction is also largely off limits, though major projects such as airports may sub-contract to foreign firms with special expertise.

This article is commentary by an independent contributor. At the time of publication, the author held no position in the stocks mentioned.

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