Western Joint Ventures in China

23 February 2011.

Two weeks back, we took an extensive look at the process by which "Team China" has had over various Western corporations.

Today, we look at the other side of the Western / The far east corporate interface: the experience of Western companies with joint ventures in China.

It’s been ten years since multinationals [ MNCs ] first began turning away from joint ventures in China as the preferred way to play in the world’s hottest growth story.

Many joint ventures failed to endure,

and as multinationals gained experience in China, and foreign investment restrictions loosened,

many found it easier in lots of sectors to start a business from scratch—or to acquire an existing 1 outright—

than to negotiate, establish, and run a joint venture in the long term.

No longer.

China’s hot growth has boosted valuations and increased competitors for outright acquisitions associated with Chinese companies that are often much less interested in being acquired.

That makes joint ventures a more attractive option, and so does an increasing pool of healthier prospective Chinese partners.

All this is prompting some MNCs to reconsider the joint-venture approach as an alternate avenue to get a stake in the continuing strength of China’s economy.

But as the dynamics have changed, the fundamentals have not:

companies pursuing joint endeavors would do well to reflect around the lessons of past deals to improve the chances of success.

In China, some of those lessons are especially critical, such as

• choosing partners that can make concrete business contributions,
• safeguarding intellectual property,
• ensuring functional control of the joint venture, and managing talent.

Others are crucial for joint ventures in all geographies, this kind of as

• aligning strategic priorities,
• creating a structure that permits rapid responses to change, and
• preparing up front for eventual reorientating.

When China first opened its doors in order to MNCs in the 1980s,

some undertook combined ventures with local companies that appeared to be safe bets

because of their access to and influence with the nearby or national government.

Even today, many foreign executives prefer to engage with large, well-established Chinese companions.

Yet that preference hasn’t always benefited joint ventures,

typically because the parent companies didn’t reveal the same strategic or industrial interests.

Multinationals, for example, have stressed profitability, even when growth is slow,

while their Chinese companions have emphasized growth, even without profitability,

as we stated in our piece on Chinese takeovers of Western companies.

The result has been different priorities for investments and a lack of cooperation,

both between the parent companies and inside the mixed management team.

Instead, multinationals should pair with local firms that explicitly share their proper goals.

This doesn’t eliminate large, well-established Chinese companies.

But it does open up the door to faster-growing, privately owned, and smaller companies

that bring a powerful commercial mind-set and tangible company assets to joint endeavors.

The global pharmaceutical corporations GlaxoSmithKline and Novartis, for example,

chose such partners in 2009 for their joint ventures in the vaccine market.

Thanks to partnerships along with smaller local companies —

Shenzhen Neptunus Interlong Bio-Technique Company

and Zhejiang Tianyuan Bio-Pharmaceutical, respectively —

both joint ventures had the actual access they needed to government vaccine-procurement programs,

as well as a talent pool, R&D know-how, and an entrepreneurial management mind-set for further rapid growth.

One disadvantage that foreign companies may not have encountered in China before:

as Chinese executives grow more and more confident, many of these smaller gamers themselves hope to become nationwide, regional, or even global players,

a factor that, again, we have analyzed in some detail.

That aspiration can make it difficult to agree on the scope of the partnership if it’s to become limited to China or to particular products.

One approach is to outline the extent of co-operation both domestically and globally—for instance, whether it includes

• access to overseas sales channels,
• noncompete clauses for specific marketplaces, and
• agreement in principle on the possible evolution of the partnership into additional product lines.

MNCs still find it difficult to protect their intellectual property within China, and joint ventures are particularly vulnerable.

Protection in most developed markets occurs mainly through legally binding agreements enforced in courts of law.

But the concept of intellectual-property protection continues to be new in China,

and option to the legal system can be lengthy and inadequate.

Companies have had some success with more pragmatic, operational efforts, including the following:

• Bringing only older technology to China. This approach works for products that may have been available in developed markets for a while but are still competitive in China’s market. It also works in industries—such as bacteria channels for fermentation, vaccines, and particular motor engines—where innovation cycles are short.
• Leaving the plans at home. Multinationals can protect their ip by delivering equipment or technology ready to be installed, without detailed design specifications. Negotiating agreements to do so can signal a lack of trust in the local partners, however, and can increase costs if spare parts as well as maintenance must be provided from overseas.
• Keeping critical intellectual property totally out of a joint venture. Some companies have set up joint ventures that are restricted to individuals steps in the value chain that involve limited intellectual property, like putting together, packaging, or tailoring. This kind of approach is feasible only when local innovation lags behind global standards and, obviously, when the critical intellectual-property component can easily be separated into a step of the value chain.
• Charging with regard to intellectual property up front. Some multinationals have chosen to sell their intellectual property in order to joint ventures, either through up-front cash payments or licensing fees. This approach can be challenging to execute, with regard to while it resonates well with nearby companies, they generally are willing to purchase technology up front only at a significant discount.

In the past, foreign companies agreed to invest in joint endeavors as minority or equivalent stakeholders,

often failing to secure management positions that were meaningful enough to steer the development of the joint organization.

Such companies often found on their own relegated to providing know-how and capital, with little impact other than board voting rights.

In one extreme case, a global multinational had set up multiple joint ventures with leading nationwide players in China.

The organization was unable to exercise sufficient operational control over, for example, decisions around roll-out plans or product development.

Ultimately, it had to sell off its stakes in these ventures.

The capability to influence the course of a joint venture in China depends largely on the partners’ ability to build trust-based relationships

• at the working level,
• the joint-venture board level,
• and even outside the joint venture,
• with the federal government or other industry players.

Successful multinationals map out critical stakeholders in and around the partnership —

from local management to main regulatory bodies —

and assign relationship responsibilities at multiple quantity of a organization.

This approach requires creating interaction protocols—

the composition of any delegation, the amount of visits, the specific topics to be discussed, and so on,

depending on the relative importance of the stakeholders and their particular agendas.

The CEO of a leading global insurer, for example, often teaches management practices at the Central Party School.

His readiness to do so gives him trustworthiness with joint-venture partners

by allowing him to have interaction with current and long term decision makers

who directly and not directly influence the course of business within China.

Most leading multinationals learned from the first round of joint ventures in China

that obtaining the right managers in place had been critical.

Many of these companies had simply dispatched available executives—

often not top performers but rather average executives searching for new problems.

Most of these executives therefore had limited credibility with the corporate parent

and were ill-prepared to manage demanding joint-venture companions.

Today, experienced multinationals recognize that a successful joint venture

requires credible, high-performing executives supported by powerful local teams.

Yet with so many companies competing for the best local candidates,

those men and women can afford to be choosy,

and they understandably prefer leading companies that have a strong image and offer good prospects for career progression.

So today, joint ventures must not only invest in their corporate brands

but additionally partner with top colleges to sponsor undergraduate as well as graduate students

and to establish a training platform for current employees.

CEIBS, a number one business school in China, and itself a joint venture, has more than 80 company sponsors,

which provide funding as well as in return can recruit upon campus and send their executives on advanced training courses.

Finally, companies must continue their own commitment even after candidates are hired.

This means

• sending some of a multinational’s best people to the joint venture to create a strong team,
• compensating employees at or above relevant market rates, and
• fast-tracking the advancement of high performers—
• even breaking away from more tenure-based development systems.

Regardless of where a partnership is located, companies often invest too little time building a shared understanding

• of its future business,
• the marketplaces it will compete in, and
• how it will evolve over time.

Differences of opinion that are deeply rooted within competing expectations of long term performance

can affect the joint venture’utes strategy and focus and eventually result in its failure.

Take, for example, 4 life insurance joint ventures that failed in China in the last 18 months,

after an average of four to five years of unsatisfactory business development and shareholder disputes.

Chinese life insurance partners have been nonfinancial companies

accustomed to short breakeven periods of three years or less,

with an emphasis on top-line growth and earnings.

Foreign insurers, on the other hand, take a longer-term view

and emphasize sustainable growth in the value of the insurance coverage policies underwritten rather than accounting profits.

In the four failed joint ventures, the inevitable tension over strategic priorities led to disagreements about,

for example, the right channels for pursuing lower-profitability volume

or whether to scale up an agency workforce faster,

but with a lower level of abilities, or more deliberately, with a higher-quality labor force.

These failures might have been avoided when the CEOs of the parent businesses and the joint ventures’ future management teams

had spent time collectively developing business plans and preparing for changes in market dynamics.

In contrast, at one of the three most successful international life insurers in The far east,

a standing business-development group, and a part of the future management team,

went through multiple iterations with its joint-venture partner

to agree on key business priorities, such as

• volume versus value,
• channels,
• products, and
• target client segments.

Once a joint venture is up and running, multinationals should aspire to manage it as if it were their own,

putting in place short lines of reporting from the joint venture back to the parent company.

This move is important in any joint venture, to provide senior managers the well-timed information they need to assess it’s performance.

But it’s especially true within China, where the fast speed in many sectors requires each partner

to react quickly to changes in the marketplace or the regulatory environment.

In this respect, multinationals can be in a disadvantage.

Decision-making processes for Chinese mother or father companies might include more people,

but once decisions are made, managers execute them quickly.

In contrast, foreign companies are slower to respond,

often encumbered by layers associated with country and regional administration.

It is not uncommon for the foreign executives of a joint venture in order to report back to the MNC’s The far east head,

who reports to the mind of the international unit,

who then eventually reports back to the actual CEO.

Some of the more successful multinationals provide for direct reporting lines to their CEOs.

Others have assigned obligation for China to a person in their management boards,

sometimes having a dual-reporting line into the regional business.

When a European transportation company made China its second home market, for example,

it elevated its China president to the worldwide management board and

sent its global CEO to China a minimum of six times a year to meet with the joint-venture partners.

The result had been improved cooperation with government bodies and therefore faster approvals,

more regular interactions and deeper relationships between the senior management of the parent companies,

and closer alignment within the joint ventures’ mixed management groups.

Even in developed markets, joint ventures are often restructured within a decade of being set up.

But in a market as dynamic because China’s,

partnership terms negotiated today might be ineffective in a few years,

and actually strong partners may find it difficult to survive.

This dynamism and uncertainty mean that the partners in a joint venture

must include provisions for restructuring its contract when the competitive landscape changes.

HSBC, for example, in its credit card partnership along with China’s Bank of Communications,

agreed to very specific actions if a change in regulation managed to get possible

to convert the partnership into an independent credit card company.

These detailed steps included the resulting board structure and the consideration to become paid to the partners.

Lacking such provisions, some multinationals have had to enter into tough negotiations with their Chinese partners to reach agreement on exit conditions.

Some that haven’t done so, according to McKinsey, have languished in joint ventures

which continued as formal relationships while either partner went after other avenues for growth.

None of these guidelines, however useful both in general and China particularly, guarantee success.

However the centrality of China in the world economic climate, both today and in the near future, means an MNC can disregard them only at its own peril.

David Caploe PhD
Chief Political Economist
EconomyWatch.com