Running a Successful Business in China

Johan Bjorksten (pictured) is an entrepreneur who built a consulting business with over 100 employees in China. Anders Hagglund is a seasoned manager who set up high-growth and highly profitable operations in China for a major industrial multinational. Together, the two men wrote the book How to Manage a Successful Business in China (World Scientific Publishing, 2010), which aims to dispense advice to business people on actual experiences in different industries, including but not limited to those of the authors. Below are excerpts from the book:

 
Joint ventures
China usually offers a wide range of partnership choices. Search the market for possible partners and start negotiations with the most suitable candidates.
 
  • Understand the decision-making structure: Who is really calling the shots? This can be a fiendishly difficult question, and one that may come back to haunt you if it is not dealt with upfront. In a local state-owned enterprise, for example, the real power may lie with the Party secretary rather than the President or General Manager; if possible, you should also try to involve the relevant officials for the city or region in question. But the complex networks of informal guanxi of Chinese organizations can also introduce decision makers with influence way out of proportion to their formal titles. What is more, balances may change, sometimes rapidly, in the fast-moving Chinese environment.
 
  • Make sure agreements are realistic: It is not uncommon for business partners to make promises that they cannot keep, whether because of lack of experience or simple wishful thinking; sometimes even because of pure desperation.
 
  • Make sure agreements are enforceable: You may feel satisfied that you have ample contractual guarantees, even including penalties for breaches of agreement. But what if the partner simply has no money to pay? What if he has excellent guanxi with local utilities that can block production by cutting off energy or water? Local tax authorities? Banks? Courts? The written contract cannot necessarily provide protection - agreements in China must always be structured so that they make sense for both parties, and so that they punish both parties equally in the event of disagreement.
 
  • Beware of relatives: In joint ventures, it is common for both parties to appoint not only Directors, but also to contribute senior management positions. It can be challenging to manage persons with strong connections, perhaps even family ties, to the joint-venture partner. This is a not a problem of the past - it keeps haunting business partnerships in China to this day.
 
Wholly foreign-owned enterprises
Nowadays, thanks to more liberal investment regulations, more and more foreign companies have started their own wholly owned companies in China without having a Chinese partner. These are officially called WFOEs (wholly foreign-owned enterprises). WFOEs are now the first choice for most foreign investors in China, the major advantages being the ability to manage the operations in a focused way without having to take into account the desires of a local partner.
 
  • Try to buy the assets rather than the company: Chinese companies often have hidden liabilities and other legacy issues. These risks can be reduced by purchasing the totality of assets: not just production facilities, buildings, inventory, and so on, but even accounts receivables and existing personnel structure. This approach makes all explicit.
 
  • Let the seller handle legacies: For example, companies can suffer from overstaffing and bureaucracy. The selling party will often be in better position to handle such issues than you are; it is therefore usually better to let him solve perceived problems as a precondition of you acquiring the company.
 
  • Wait for the right opportunity: Business cycles are beginning to affect China in the same way as other countries. This means that there will be times, when a company is cheaper to buy. 

 

Managing Partner Relationships

It is not only in forming joint ventures that you will need business partners; you will need to form relationships with suppliers, distributors, and other local companies. Probably the single most prevalent cause of business failure in China is the wrong choice of partner, particularly in setting up joint venture or distribution deals.
 
Problems with partners can take many forms besides failure to comply with stated codes of conducts. Fraser Mendel [a lawyer friend of the authors] lists a few typical scenarios that keep appearing in his practice:
 
  • Suppliers pirate your products or produce extra quantities that are siphoned off for sales elsewhere, including for export.
 
  • Suppliers produce products for your competitors despite non-competition clauses in your purchasing agreements.
 
  • Distributors offer to register your trademarks in China, and with the signed affidavits in hand proceed to register these trademarks in their own name, something which may only be discovered years later.
 
  • Suppliers may have impressive offices in a place like Hong Kong that do not reflect their actual operations in China. There have even been cases where such storefront companies have solicited orders from Western customers and farmed these out to third-party vendors. When the customer was satisfied with the quality of the first shipment and placed a larger order, the supplier simply took off with the money.
     
    Some businesses in China are started to obtain finance, rather than obtaining finance to start a business. This is done by launching a basic production business, borrowing factory buildings, and renting equipment from the government with the collusion of friendly officials. The company then carries out low-level business for a period of time (e.g. a year) so as to establish a basic track record and persuade Western business partners to provide credit, for example in the form of advance payments for goods.

    Using the credit from the Western business partner as a seal of credibility, the company can then persuade a local bank to offer it loans. The management often repeats this process several times; when the Western partner and local bank have significant stakes in the company's survival, both can be persuaded to lend additional funds to overcome "short-term financial difficulties". When the financiers lose patience, the funds will have been siphoned off through related party transactions and the owner will have gone on a "business trip" abroad.
 
Clearly, in a market as complex and fast-moving as China's, partners can make or break your business. It is therefore important to find the right partners, and to protect yourself against potential contractual or other legal conflicts:

 

  • Look around: Industries in China can be remarkably fragmented. At the beginning of the 21st century, there were still hundreds of independent auto manufacturers and dozens of refrigerator producers. When we did a survey of the market, we found that no company had more than 3% market share nationally in gas cookers and hobs. It pays to cast your net widely and to spend a lot of time comparing offers. 

 

  • Look inside: The sales office of your supplier may be nicely accessible, with pictures on the walls and a general professional feel to them. But you need to confirm that the supplier actually has the claimed staff and facilities as well as the necessary official documents showing their due incorporation, business license, possible industry-specific licenses, and qualifications. You also need to ascertain that the company has a serious track record of doing for-profit business.
 
  • Do not rely on intermediaries: As we have mentioned above, one of the world's largest automotive manufacturers lost over a hundred million USD and several years in the market because they depended on the recommendations of a self-styled government relations consultant who claimed access to senior officials. Intermediaries and consultants can be an invaluable source of information, but you must be on top of the decision making. Do not allow anyone to dictate who you should partner with. There is always a second choice in China.
 
Reproduced with kind permission from World Scientific Publishing Co. Pte. Ltd. and Eastwei Relations. Any other reproduction or transmission must be made with written permission from World Scientific Publishing Co. Pte. Ltd.


 

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