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Joint ventures in China require a lot of care and attention.
Janet Kersnar, CFO Europe Magazine
October 1, 2007
What is it about joint ventures in China? They're hard to set up, difficult to manage, and almost impossible to unwind if things go wrong. Just ask Emmanuel Faber, the former CFO of French yogurt and water company Danone, which has been running dozens of JVs with China's largest beverage company, Wahaha, in recent years. At the moment, as Danone's president of Asia-Pacific operations, Faber is in Shanghai sorting out a very public JV bust-up that erupted earlier this year.
As Danone and Wahaha accuse one another of breaching agreements, the tit-for-tat spat is playing out in courts in China, the US and Sweden, providing CFOs of other companies with yet more cautionary tales about the perils of running JVs in China. Ever since the Chinese government began letting foreign companies invest in the country through JVs in the late 1970s, these alliances have faced all kinds of problems, from lax governance and protracted decision-making to wrangles over intellectual property and excessive government interference. "The whole life of a JV [in China] can be blighted by a continuous negotiation of its terms," says James Burdett, a partner at law firm Baker & McKenzie.
There is growing evidence that the more experience foreign companies gather in China, the more they are eschewing JVs in favour of other structures, such as wholly foreign-owned enterprises (WFOEs). More than half (53%) of the respondents to an annual members survey run by the American Chamber of Commerce said that they have WFOEs in China today compared with 33% in 1999, while 27% said they have JVs compared with nearly 80% eight years ago. (See "Wish You Were Here" at the end of this article.)
For sure, more and more CFOs of companies will be reassessing their JVs and other business relationships in China in the months ahead. One reason is the heightened risk issues following the recent spate of made-in-China product recalls. (See "Chinese Checking," CFO Europe, September 2007.) Another is the new anti-monopoly legislation passed in China this summer, which could restrict M&A of local industries. It's clear that for any company that decides to continue down the JV route in China, more hard work lies ahead.
Amid all this, it might be easy to forget that JVs do indeed have a lot going for them. In sectors that exclude non-Chinese ownership, such as car manufacturing, JVs are the only way a foreign company can tap China's vast, growing economy. And particularly since China's entry into the World Trade Organisation in 2001, JVs allow companies in other sectors to build market share and brand awareness, and manage red tape, far faster than if they were going it alone. For Chinese companies, JVs promise access to new industry know-how, technology and more international networks.
The myriad problems that JVs in China encounter are largely "self-inflicted," asserts Patrick Powers, currently China vice president of a Canadian mining firm and a former vice president of the non-profit US-China Business Council in Beijing . "Many people come to China thinking they have to do things differently and that they can take short cuts. That's wrong," he says.
Out of Sight, Out of Mind
Like any new business partnership, extensive due diligence is required, including onsite visits, background checks into the other business relationships that a potential partner has, and a mapping out of the partner's current governance and decision-making structures. Introducing air-tight processes once a JV gets the green light is also critical, Powers says.
Indeed, keeping day-to-day management sharp is the area that foreign companies new to JVs in China often underestimate. According to Dane Chamorro, regional general manager of China and North Asia of consultancy Control Risks, "JVs require hands-on management, something not always easy in a country the size of China. If you think you can manage a JV by just sitting in Beijing, I can guarantee you that somewhere, somehow, someone is trying to pull the wool over your eyes. That would also happen in Nigeria; that would happen in the US."
This might seem obvious today, but it certainly wasn't back in the 1990s when China felt like the Wild West to many foreign companies. For the pioneering JV partners that are still around today, it's been a slow, steady learning process.
SABMiller, the Anglo-South African brewer, first entered China in 1994, with a 49% stake in a JV — the maximum shareholding allowed to foreign brewers at the time — with China Resources Enterprise. Although the result, China Resources Snow Breweries (CR Snow), is now the largest brewer in China, there have been plenty of setbacks along the way. Over the years, SABMiller and CRE's relationship, has, fortunately, "evolved" for the better, reckons Wayne Hall, SABMiller's China finance director, who is a senior consultant to the JV's CFO, with a dotted line to SABMiller's CFO for Africa and Asia. "What we have managed to achieve is a business model that delivers autonomy and accountability for operational management and an independent 'share holder' structure," he says. "This is an area of interaction that has left many JVs in China lacking in terms of delivering on...business goals."
Good governance has been pivotal, says Hall. For example, CR Snow's board consists of ten members, five each from SABMiller and CRE, with the chairman rotating between the partners every two years. Equally important are the crystal-clear processes and procedures in place — some of which come directly from SABMiller's London headquarters (such as budgeting and planning), while others are adjusted to take local practices into account (such as productivity and performance management). And there are clear reporting structures that prevent either parent from excessive meddling in the JV's day-to-day management, something that's been the downfall of many other JVs. "This is important because accountability is then clear," Hall says.
Yet even as other companies hone their JV strategies over time, some finance chiefs reckon their companies will increasingly want to focus more on WFOEs while unwinding their JVs. "From a strategic point of view, we're constantly evaluating the efficiency of our JVs," says a Shanghai-based CFO of a large European electronics company with a number of both WFOEs and JVs. And because of that, "there's now a tendency to go out and buy back shares from JV partners, especially if the value-added role is not there because the joint venture has changed over time. By streamlining your legal entities, and by even dissolving them, and moving across into a holding structure, you're basically unlocking a lot of the equity that's been tied up in the JV."
But often "streamlining" JV arrangements is easier said than done, especially if either or both of the parent companies are unhappy. As Baker & McKenzie's Burdett notes, "When it comes to unravelling a JV, you can't necessarily go back to the terms set out in the original agreement, which may be largely superseded by subsequent discussions and arrangements between the JV partners [over time]. It could mean big, if not bigger, negotiations than when it was set up, and could quite easily involve lawsuits."
This problem nearly ensnared Jim Xue Jianmin of Shanghai Tire & Rubber. The year after he joined as CFO in 2000, the firm took a 30% stake in a JV to produce passenger-car tyres with French tyre company Michelin, which very quickly began stumbling over one hurdle after another. Rather than the co-operation that Xue expected at the JV known as Shanghai Michelin Warrior Tyre Company, he sensed rivalry between the partners and growing suspicion among his colleagues that Michelin wanted to dilute his firm's shares in the JV. Disagreements, including about how much capital the partners should inject in the JV and whether it needed to undergo an independent audit, were frequent.
He grew more concerned when financial information was not forthcoming, fuelling his unease as sales at the new venture dipped to levels lower than when Shanghai Tire ran the unit on its own. So exasperated and wary had Shanghai Tire's management team become that Fan Xian, the company's chairman and the JV's vice chairman, fired off a letter voicing his concerns to Michelin chairman and CEO Edouard Michelin, just months before Michelin died in a boating accident.
Since hitting that low point a few years ago, the JV has turned the corner. "Both sides are upbeat about China's tyre market prospects and expressed wishes to expand co-operation to create a win-win situation," says Xue. Communication, for example, between parents and the JV has been vastly improved — largely because of new investments in training and the appointment of a new CEO at the JV, says Xue. Recently, he adds, the relationship was given a big boost when Jean-Dominique Senard, Michelin's CFO and managing partner, made a point of meeting with senior executives of Shanghai Tire, including Xue, when he was in China in early July.
But Xue is not entirely happy. The JV has yet to turn a profit, losing 75m renminbi (€7m) last year alone. and Xue doesn't see that changing any time soon. As an aside, Xue also points out that Michelin's own wholly owned tire maker in China, Michelin Shenyang Tire, is making money. What's more, while rival tyre makers in China have been scaling up capacity, the JV has been standing still — its annual capacity is still the same at 5m tyres, as seven years ago.
There are some promising plans on the drawing board, however. Discussions are under way for the JV to produce Michelin tyres exclusively — at the moment, only 30% of its capacity is used to produce tyres under the Michelin brand. The rest of the capacity has been producing tyres for the local Warrior label, which Xue hopes will be outsourced back to Shanghai Tire. Xue says Shanghai Tire is waiting to hear what Michelin thinks of that proposal.
Whether that will be enough to rescue the JV remains to be seen. Certainly, there are some CFOs in China who would argue that it's not worth the effort.
Janet Kersnar is editor-in-chief at CFO Europe. With additional reporting by Yang Jian.
The Telltale Signs
If they only knew then what they know now, companies with failed joint ventures in China must be saying to themselves. But China experts say there are a number of telltale signs that should have alerted them that their JVs were about to go off the rails before too much damage was done, says Jürgen Kracht, head of Hong Kong-based Fiducia Management Consultants. Here are his top three warning signs:
1. Management standards: If your JV partner cannot tell a balance sheet from an income statement, alarm bells should ring. Accounting principles can vary immensely within China and are not up to par with western standards. Further, key performance indicators are often not established concepts in Chinese companies.
2. Nepotism: If Chinese employees are hired by a Chinese manager, be alert to nepotism. This can have a huge impact on both the formal structure of your JV (who reports to whom) and the informal information flow (who informs and will be informed by whom).
3. Hidden agendas: Competition created by a JV's own staff is not uncommon in China. Be alert if your JV partner has access to core product technologies that can be used to create a little "side business" (which is what Danone is accusing Chinese JV partner, Wahaha, of doing).
Explore, Expand, Explode
It's not only veterans of Chinese joint ventures and wholly owned enterprises, such as those run by SABMiller and Michelin, which can offer important lessons about doing business in China. After running a number of franchising agreements there, Mitchell Presnick, chairman and CEO of Super 8 Hotels (China), has plenty of advice to offer.
The way Presnick refers to Super 8's strategy of introducing China to the budget-hotel concept seems straightforward enough: explore, expand, explode. Since opening its first hotel in June 2004, Super 8 (China) — under a master licensee agreement with US-based Wyndham Worldwide — now operates a chain of 53 hotels. About 70 to 80 properties will be opened by the end of this year, 20 more than initial projections set in 2004.
"We're relying on local partners and, like any relationship, it takes work," Presnick says. Turning a local property into a Super 8 hotel can take up to nine months, much of this spent performing due diligence. Presnick explains that Super 8 uses this initial stage to learn as much as possible about its partner, and vice versa. "Obviously there's an investment involved on the part of the local partner, and even more than that, there's a lot of co-ordination that takes place between them and us," he says. "We then see who is prepared to work with us and who's really just looking to use our brand to develop their own business."
Working with Super 8 means that partners will be under "continuous review." For example, the business development team works on finding ways to maximise the revenue potential of each property by, say, introducing a different pricing structure or special deals, while the quality specialist teams undertake a quarterly inspection of every property, collating, analysing and comparing data back at headquarters. "Usually there's a positive correlation between the positive trends in our performance indicators and the relationship itself," says Presnick.
To keep the performance indicators on track, there's also an advisory board made up of 12 franchisees who meet with Presnick several times a year so that he "can get a sense of where relationship and brand as a whole is heading." His work with the board is supplemented by regular phone calls between him and each franchisee.
Along with all these checks, Presnick says he has a less conventional way of monitoring Super 8's partners: "If there were no contract, no piece of paper, would there still be a desire on both sides that there should be a relationship? If the answer on both sides is 'yes,' then the chances are you will be among the most successful business partners in China."
Despite its enthusiasm for the idea, Super 8 isn't relying exclusively on franchising. The company announced earlier this year that it will begin investing directly in its own hotels, with franchises making up between 60% and 70% of its portfolio within the next few years. "That takes some of the pressure off of those partner relationships," says Presnick.