Cablegate: In the Zone: Companies Tell Us Their Dalian

DE RUEHSH #0194/01 3092328
R 052328Z NOV 09



E.O. 12958: N/A

1. (SBU) Summary: The October 26 ) 27 visit of officers from
the U.S. International Trade Commission (USITC) to various
development zones in the port city of Dalian, Liaoning
Province, provided an opportunity to visit several
U.S.-invested and Chinese companies, including Intel, Epoch
International Enterprises, Neusoft, and Genpact. The visits
suggest that Dalian's unique location, highly educated
population, and infrastructure play the most important roles
in the decision to invest in one or the other of the port
city's well-developed zones. Intel, for example, has
long-term expansion plans within the zones themselves.
However, with increased competition for labor, diminishing
'other benefits,' and aggressive courting by other cities,
Dalian's natural advantages have already begun to wane, and
some companies have begun to look westward. This cable
provides a ground-level snapshot of operations at these
companies, which were reluctant to discuss important details.
Septel reports on the views of the zone administrators. End

2. (U) October 26-27 ConGenOffs accompanied USITC officers
Alexander Hammer, International Economist at the office of
Economics, Country and Regional Analysis Division and Michael
Anderson, Chief of the Advanced Technology and Machinery to
Dalian to find out more about the differences between
economic zones in China. Dalian, the major port in Northeast
China, is replete with a hodge-podge of development zones
that house a number of foreign and domestic companies.


3. (SBU) At Fab 68, Intel's new wafer fabrication facility
located in the Export Processing Zone (EPZ) James Zhang, head
of PR and marketing, listed six reasons for building this,
their first 12-inch wafer fabrication facility in Asia.
First and foremost was Intel's interest in China as a
long-term growth market. Second, Dalian has sound
infrastructure, including a steady electricity and water
supply. In fact, the Dalian Development Authority (DDA) built
a special power sub-station for the Fab 68 to prevent any
supply fluctuations. Third, Dalian's skilled labor pool and
potential recruits from the 22 colleges and universities
located in Dalian played a role. Intel's recent donation to
the Dalian Institute of Technology, an 8-inch fabrication
tool worth USD 30 million, is a bid to further attract and
train promising students in the semiconductor field.
Fourth, Dalian labor costs are half those in Beijing or
Shanghai, with the average software-related job being RMB
2,000-3,000 (USD 293-439) per month. Fifth, twenty large
Intel suppliers have already set up branches in Dalian, and
Intel believes that this is a good base from which it can
build up a semiconductor 'ecosystem.' Finally, the EPZ has
provided Intel with numerous preferential policies. Noting
the policies are strictly confidential, Mr. Zhang said the
EPZ has been "very supportive and responsive" to their needs.

4. (SBU) Currently, the Manufacturing Support Building
houses 800 employees, but by the end of next year, Intel
plans to have 1,500 employees, including 800 assembly line
workers and 700 managers and office staff. Of those 1,500
employees, roughly 250 will be Americans. Intel is awaiting
the conclusion of the tool installation and equipment
debugging process in its Essential Utility and Fabrication
Processing buildings to complete what it calls Phase One of
their operation. U.S. suppliers will ship 12-inch wafers to
Fab 68, which will then process the wafers and ship them to
Chengdu, where they will be tested and assembled. During
Phase Two of construction, slated to begin after 2010, Intel
will build a testing and assembly facility in the EPZ,
thereby eliminating shipments to Chengdu for
after-processing. Zhang offered no word on Intel's plans for
the Chengdu plant.

5. (SBU) Intel is the sole occupant in the 1.1-square
kilometer Zone B of the EPZ. In this EPZ, set aside for
manufacturing companies that export 100 percent of their
product, no duties are levied on goods exported from the zone
and manufacturers receive a refund on any import duties
charged on materials used for exports. If the goods are sold
in the domestic Chinese market, however, all related import
duties are levied. Despite this incentive to export, Intel
plans to sell about 80 percent of the wafers domestically.
One reason Fab 68 will still be cost-effective is because of
another benefit conferred on companies located in the EPZ:

SHENYANG 00000194 002 OF 003

it is not charged customs duties on capital equipment imports
(chiefly from Japan and the United States). (Note: During
earlier conversations with Intel reps, the Consul General and
others were told one problem the EPZ and other municipal
authorities had helped with was in obtaining these
concessions on equipment that Chinese Customs might consider
"used," a problem frequently encountered by foreign investors
here who want to import rebuilt equipment from other


6. (SBU) During their visit to Epoch, a wholly U.S.-owned
company located in the Free Trade Zone (FTZ) since 1988,
Epoch President Foad Ghalili explained how his contract
manufacturing business operates in a niche market in the
microelectronics sector. According to Ghalili, Epoch's
unique status as an American company means it has no direct
competitors in the China market: his clients expect and are
assured a level of IPR protection that Chinese companies
engaged in similar, small-scale manufacturing simply cannot
match. As the respect for IPR has not yet improved
dramatically in China, Ghalili expects continued growth. He
noted that although demand for contract manufacturing
decreased dramatically at the end of 2008, business has since
returned to normal and total year on year profits for October
2009 have increased.

7. (SBU) Epoch imports about 60-70 percent of the total value
of their materials; the rest is bought on the local market.
Although Epoch has to pay the 17-percent value-added tax
(VAT) on the locally purchased materials, any VAT paid on
materials used in exported products is later refunded.
(Epoch exports almost all of its products.) Sixty percent of
their products are shipped to Europe, 25 percent to the
United States, and 15 percent elsewhere. In addition, Epoch
can purchase components and raw materials from foreign
companies operating in other FTZs in China and ship them to
the Dalian FTZ, where they manufacture the final product,
without paying any duties or taxes. Ghalili added that his
company receives income tax benefits because it is considered
a "high-tech" company, whereas the corporate income tax for
other foreign companies in the FTZ is 25 percent. Epoch also
re-sells its used tools and equipment VAT-free on the
domestic market since no VAT is levied on high-tech tools and
equipment purchased from the FTZ. About 60-70 percent of
EPOCH's tools and equipment are re-sold in China; the rest
are re-sold internationally.


8. (SBU) The information fountain seemed to be closed during
a visit to Neusoft, a private Chinese software company
located in Dalian's High Tech Zone (HTZ). The USITC
delegation received a rather cursory introduction to the
company's founding and expansion plans, all of which has been
reported widely. Founded in 1991 at Northeast University in
Shenyang, Neusoft is the flagship company in the HTZ, which
contains Neusoft Park, a commodious campus styled like a U.S.
university. Phase One, as it is called, houses a domestic
business R&D center, an IT training center, an international
business R&D center, and a business processing outsourcing
(BPO) call center. After Phases 2 and 3 are completed, the
entire park will employ 30,000 people. Unlike other zones,
the park also includes optional housing, which Neusoft rents
to its employees for RMB 300 (USD 44) per month; the HTZ
administration built a residential area for Neusoft and then
rented these buildings to the company at a reduced price.
The discussion gleaned no information about the company's
import-export structure, tax benefits, or business
relationships with other companies in the HTZ, other zones in
Dalian or elsewhere, or its international clients.


9. (SBU) Established in Dalian in 2000, Genpact provided HR
support for GE's business development arm before splitting
from its parent in 2005. Now it operates a back-office
operation and supply-chain logistics company for the Asian
market. Director of Business Development Daniel Tong
explained that Genpact's reasons for being in Dalian mirrored
those of Intel. Lower labor costs; a large supply of educated

SHENYANG 00000194 003 OF 003

labor; and proximity to the Chinese, Japanese, and South
Korean markets far outweighed any special incentives, such as
tax breaks. Tong said, however, that one new challenge to
operating in Dalian was increasing competition for highly
skilled labor, which has driven up costs. This challenge,
along with a growing domestic market led Genpact to expand
beyond Dalian. The company has already opened a BPO center
up the road in Changchun, Jilin Province. Furthermore, in
response to Genpact's expressed interest in moving westward,
more than ten western cities, including Chengdu and former
Dalian Mayor and Liaoning Party Secretary Bo Xilai's
Chongqing, are vying for its business, offering aggressive
tax incentives for the company and its employees. In
anticipation of the move westward, Genpact is working with
western city governments to establish language training
centers at their universities.

10. (SBU) Although still exporting most of their services,
Genpact recognizes increased growth potential in a maturing
domestic market. The global economic downturn made stark the
need for increased efficiency at previously unchallenged
behemoths, such as China Mobile, PetroChina, and Bank of
China, which have seen increased competitive pressure to
streamline operations. These companies are looking to
outsource their back-office operations to BPOs like Genpact
as a cost-cutting measure, which Tong hopes will translate
into an ever-widening net of clientele.


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