China: Joint Ventures In China: What Every CEO Should Know

Introduction

In China, as in any foreign market, it is difficult to succeed alone. Business practices, language, culture, legal environment, and other obstacles make success in China elusive. In addition, Chinese law requires a foreign company to have minority ownership of enterprises operating in certain industries such as banks and insurance companies. For these reasons, joint ventures in China are common. It also is widely known that the failure rate of joint ventures in China is high, and joint ventures in China have achieved a reputation for being difficult to manage. Parties will come together, usually after lengthy negotiations, and celebrate the formation of the joint venture — and only a short while later, after millions of dollars of losses, wonder what went wrong. There are a number of reasons that few joint ventures in China succeed while most fail, including differing expectations, overestimation of the Chinese partner's market position, and conflicting management styles. This article sets forth a number of best practices that, if followed, may help increase the likelihood of success and avoid millions of dollars of losses.

Carefully Select the Joint Venture Partner

L ike other ventures, one should take great care in selecting the Chinese joint venture partner. The foreign company must establish a list of criteria for selecting the partner, including experience, integrity, guanxi (a network of relationships designed to provide support and cooperation), expertise, quality, and other factors. In addition, a foreign company must make the investment in building a relationship with the potential joint venture candidates. This usually requires the foreign company to locate an executive or team of people on the ground in China, which demonstrates a commitment to China. As well, there are just some things that cannot be learned from afar; there is no substitute for being on the ground in China.

In addition, the foreign company must conduct thorough due diligence of the short list of potential partners, their management, and major shareholders. The due diligence should include, among other things, (i) criminal background checks; (ii) civil lawsuit checks; (iii) interviews with customers, suppliers, and others that have done business with the potential partner; (iv) interviews with parties active in the target industry; and (v) interviews with employees. There are a number of qualified companies that excel in assisting with the due diligence process. However, notwithstanding the above, the most reliable method of selecting a joint venture partner is to start with a party known to be honest with a proven track record of dealing with parties known by the foreign partner.

Always Allow the Chinese Partner to Maintain Face

B usiness relationships in China are complex, and disagreements between partners are common. Generally, the Chinese believe that the parties can take different positions on an issue and both be right. Although this concept may seem strange to foreign executives, it is fundamental in China. At the root of this belief is the concept of mianzi, or "face." Generally, China is a hierarchical society, and one's position in that hierarchy is very important. Any actions that undermine that position can result in disastrous consequences. In addition, the ability to build the "face" of your partner is an important part of building and maintaining relationships in China. Accordingly, although it is important for a foreign joint venture partner to be firm and protect its interests (being too accommodating creates its own cultural problems), the foreign partner must avoid words and actions that could embarrass, diminish, or undermine the authority and standing of its Chinese partner. Accordingly, solutions to problems and interaction with the Chinese partner must be calculated to allow the Chinese partner to save face and avoid embarrassment. These solutions and actions must avoid a sense of condescension or lack of respect. Many foreign managers believe that the Chinese are not sophisticated and lack modern management skills and experience. Taking the approach that the foreign partner is arriving to show the locals how international business is conducted — which is more common than one would believe — is a recipe for failure.

Develop Relationships With the Personnel Working in the Joint Venture

A Chinese joint venture cannot be managed through periodic board meetings. Although such meetings are important and the relationships with the Chinese representatives on the board of directors must be developed and maintained, the foreign-partner executives with responsibility for the joint venture must have frequent contact and develop relationships with the managers and executives who are actually managing the day-to-day operations of the joint venture in China. The relationship must be based upon respect. This cannot be circumvented, and there are no short-cuts in this process. This relationship-building requires frequent business and social meetings. As mentioned above, this is one of the reasons why a presence on the ground in China is so important. The foreign joint venture partner must invest time and energy in these relationships. Foreign managers must not ignore or fail to listen to local managers. They must avoid being perceived as arrogant.

This relationship-oriented approach is instrumental in identifying problems early and being in a position to solve them. As mentioned above, in order to avoid losing face, managers of the joint venture are likely to downplay, avoid, or even hide problems with the business operation. The best way to overcome this tendency is for those responsible for the foreign partner to have very frequent social and business contacts with those running the day-to-day operations of the joint venture, ask many questions, listen, and understand the Chinese indirect communication style.

Understand and Maintain an Alignment of the Parties' Interests

Identifying the Chinese partner's interests in pursuing the joint venture is not an easy task. Unlike Americans, who, for example, tend to be straightforward in discussing their interests in a transaction or relationship, the Chinese tend to take a different approach. The Chinese tend not to reveal their actual interests prior to the establishment of some level of trust between the parties. For example, the Chinese partner may be interested in a quick, short-term profit or obtaining technical know-how through the joint venture so it can independently pursue the business on its own at a later date. It may desire to launch the product line under its own brand or just have the prestige of being partnered with a well-known foreign company. Too often from the initiation of the joint venture, the parties are pursuing different agendas at the expense of the other. Part of the challenge is to overcome the different communication and working styles of the parties. However, an emphasis on relationship-building, training, and management can help build workable communication channels.

In addition, one must be mindful of the "crouching tiger, hidden dragon" phenomenon. The "hidden dragon" concept represents myriad invisible vested interests. In some instances, the Chinese partner is just an instrument of those interests. These hidden interests can change the Chinese partner's priorities, affect the initial agreements, and change the dynamics of the joint venture. For example, one type of hidden dragon is local government officials, who often can be the real authority behind the Chinese partner. These local officials may control the appointment of key people, impose unreasonable requirements of local tax collection and job creation, and intervene from time to time to impose their will on the joint venture. However, the Chinese partner often has strong guanxi with the local authorities and may indirectly control the joint venture by using this power in the event of a disagreement, hence the reference to "crouching tiger, hidden dragon." The foreign partner must make an effort to understand the Chinese partner's relationships with local government officials and other hidden dragons and identify and understand the real decision-makers.

Balancing these interests and keeping them aligned is tough. As mentioned above, an on-the-ground presence is essential for keeping one's hand on the pulse of and developing relationships with the Chinese partner and local government officials. Constant contact is necessary to understand the others' interests and adjust as necessary to keep such interests aligned. Once these interests are identified, they must be translated into clear objectives. At this point, the joint venture has a quantifiable standard for measuring progress and satisfaction. For example, investment objectives should be agreed upon and continually re-evaluated jointly as the venture progresses. The partners should set clear corporate values, communicate them to the employees on a continuous basis, and monitor progress in implementing such values. The parties should make adjustments as necessary to keep the interests aligned as circumstances change. These corporate values would include such items as product design, product quality, and customer service. The foreign partner should often communicate the shared interests and mutual benefits. In this way, the parties can relentlessly pursue the achievement of the common objectives.

Always Have a Strong Legal Foundation for Business Relationships

The Chinese commonly use the phrase, "We know the law, but that is not how things are done in China." Cutting corners or circumventing the law based upon the belief of common practice is a "no lose" situation for the Chinese partner and a ticking time bomb for the foreign partner. It is common for a Chinese party to use the failure to comply with the law as leverage to get more concessions from the foreign partner later or even force the foreign partner out of the lucrative business arrangement. In this regard, the foreign partner must establish a means of self-protection from the beginning. All material business relationships should be documented. A strong legal foundation would include a majority position in the joint venture, both ownership and management; a detailed joint venture agreement; the ability to control key hires such as the chief financial officer, controller, and human resources managers; independent relationships and guanxi with local government officials; strong anti-bribery policies and legal compliance programs; and a strong internal and external trade secret protection program.

In addition, the foreign partner should negotiate control of the "seals" or "chops," as they are often called. The "chop" is a stamp indicating identity and is often required for authorizing actions by a company in China. In addition, the joint venture must ensure that it has all of the necessary permits to operate. In China, permits authorizing the conduct of a certain business are very narrowly drawn. In addition, the permitting regime is complex. It is not unusual for Chinese companies to operate illegally because of the lack of proper permits. The problem can increase as the company evolves and expands its business. Similarly, it is common for Chinese companies to maintain multiple sets of books, one of which is kept to justify the payment of low taxes. As mentioned above, the foreign partner's control of the finance function should prevent this type of business practice.

Conclusion
Although China is a very lucrative and attractive market, business success in China is difficult. Foreign companies can save themselves millions of dollars and reap great rewards by learning from those who have previously succeeded and failed in China. Being mindful of the best practices set forth in this article will be helpful as one expands in China.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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