ZHONG GUO - THE MIDDLE KINGDOM

ZHONG GUO - THE MIDDLE KINGDOM
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Mar 20, 2008

The Joint Venture Paradox

Many companies view the joint venture as the only way to enter into the Chinese market. Little do they know how Chinese businessmen and the Chinese government view these supposed 50/50 arrangements. After Deng Xiaoping opened up China's markets in 1978, foreign direct investment (FDI) began to flood into the country. By the 1990's, roughly 60% of FDI was in the form of joint-venture agreements. Today, that number has decreased to 40%. The twenty percent decrease can primarily be attributed to the failure and complexities of many joint-ventures. The Chinese government generally requires just over 50% control in these types of arrangements. According to Western thinking, this translates to approximately equal control of the business, revenues, and control. Quite the opposite is expected for most Chinese partners.

China's aforementioned sense of humiliation contributes heavily to the perceived dynamic of how the joint venture should operate. Although there is a strong desire to work with Western companies in order to acquire needed tech know how, the fear remains. As a result, a power struggle can emerge making the joint-venture difficult to operate. McGregor's example of Morgan Stanley joint venture in China, China International Capital Corporation (CICC), demonstrates the risks a firm takes when entering a foreign market. There is a lack of infrastructure and social institutions in order to properly support and handle the issues that arise. Not to mention, the strive for personal gain, corruption, and politics further muddies the picture. The West's view of China, as the next BIG market and the subsequent potential gains, has created such fervor to enter and enter NOW. Greed, many times, overrules common sense and appropriate due diligence. Morgan Stanley entered with this attitude as it wanted to be the first investment bank in China and gain all the associated first mover advantages. However, the outcome exposed the challenges of being a first mover. It was impossible to learn from others and avoid their mistakes.

The Carrefour article demonstrates the idiosyncrasies involved in working with Chinese partners. Jean-Luc Chereau comments on his experience in entering the Chinese market:

"...I started talking with one of our Chinese partners who had signed those contracts, and nothing seemed to be happening. Finally, my assistant told me, "Just because he signed a 20-year contract 2 years ago with your former boss—a person who is not you—does not mean he will respect the contract." That was a big shock to me;
the contract was notarized and everything. But we started to renegotiate article by article. Five years later, during the Asian crisis, I invited this same partner to my office and said, "Just because I signed a contract with you does not mean I will respect it. We are in a crisis." So he said, "Fine," and we started to renegotiate, to reduce the rent."

The US legal system would run the Chinese partner through the ringer for violation of contract and sue until the company acquiesced or went bankrupt. In China, the legal system is not only not adequately prepared to undertake such a battle but also contracts are merely a starting point. As conditions change, everything is negotiable which again reiterates why relationship building is so important. Morgan Stanley learned this lesson in its CICC venture. As McGregor states: "China is not a legalistic society...If the Chinese want to do something, they find a way to skirt rules or laws." This notion refers back to the culture effect discussed earlier. The rules of the game are played differently in a shame-based society. Do whatever to be successful, but do not shame the family name or get caught.

Partnerships provide the necessary "in" into the market. They also give foreign companies a cultural road map and the grease to work within the paradigm of China's government and social institutions. Often the process is so different as well as the expectations on each side that both parties can or are sideswiped by reality. Ultimately, it is the relationship not the contractual piece of paper that holds ventures together.

The government's perceived role as judge, jury, and collaborator complicate business dealings even further. The CCP has two goals: to stay in power and to provide economic success so that it can stay in power. As a result, businesses must realize close relationships with officials are instruments to maintain the status quo. By "welcoming" joint-ventures, China is gaining unprecedented access to technology, know-how, and capital. All of which reinforce the CCP's role as benevolent dictator and economic driving miracle. While this arrangement will likely continue, as the gap between rich and poor and urban and rural widens, the CCP must be weary of their beloved proletariat (or peasants in China's case). Historically, dynasties fall when the power balance is tilted and the peasants become aggravated due to injustices. The unprecedented ability to move through the country and into one of six hundred plus unknown cities of 1 million plus will help to keep grievances at bay. The ability to move into an urban area allows for the possibility to earn well above the average annual peasant income of ~ 8000 yuan or roughly $1000. According to the Chinese Embassy's website (http://www.china-embassy.org/eng/xw/t268200.htm), as of August 2006, China's national per capita income reached $1740 or ~ 14000 yuan which represents an approximate 70% increase income just by moving to the city!

Joint-ventures and other FDI have in some ways fueled this wage increase by creating jobs in various sectors such as electronics, apparel, and other consumer products. A virtuous or not so virtuous circle (depending on one's viewpoint) is, therefore, continued. The government created an economically viable and prosperous environment; FDI continues growth in the environment; living standards are raised for all classes but at varying rates. All three are still forced to work within the guanxi paradigm governed by obligations and fake 50/50 arrangements.