Article

Resurrecting the China joint-venture

Joint ventures, once a necessity in China, are worth a second look.

By Michael Thorneman, Bruno Lannes and Nick Palmer

Published on October 17, 2008
min read


For decades the only way for foreign companies to do business in China was through joint ventures with Chinese companies. It was a perilous route—too often foreigners were kept in the dark about everything from costs to sales to who actually was running the business. Cultural conflicts flared. Exit terms were sketchy. The failure rate for joint ventures was more than double that of the success rate. Multinationals breathed a sigh of relief when the government finally allowed foreign players to acquire domestic companies in all but a few proprietary businesses like automobiles. Since then, the number of joint ventures between multinationals and mainland companies has dropped by an average of 25% a year since 2000. But rough as they can be, joint ventures provide a viable alternative for multinationals finding it hard to compete with the domestic businesses that are flourishing and proving to be efficient competitors. Joint ventures also make sense for multinationals shifting emphasis from exports to China sales—foreign companies can benefit from local networks and local knowledge. And for some restricted industries like car manufacturing and energy, joint ventures are the only way for multinationals to get a foothold. The fact is, despite the high failure rate, joint ventures—when properly planned and managed—can be the quickest path for multinationals in China. Boosting the odds of success rests on careful planning and management. What can multinationals do at the outset to avoid the pitfalls of joint ventures? We've identified three seemingly straightforward but often poorly executed factors: Overinvest in due diligence—both formal and informal. Due diligence is a difficult task anywhere; in the mainland it's often more daunting and more important. With unofficial payments and other hidden costs part of doing business, published accounts aren't as transparent as they are in many other regions. To compensate, overinvest in obtaining information from primary sources. For example, talk to customers and suppliers to help build a picture of your partner and the market they operate in to test key elements of the investment thesis. Track pricing at stores. Understand who is really pulling the strings at the potential partner company. "Analyze the shareholder register to understand control overlaps, who will vote in blocs, who's aligned," advises Richard Williamson, general manager, Asia strategy at Commonwealth Bank of Australia, which has joint ventures with two mainland banks. Discuss and agree on the detail around the economics. Be clear about your expected return on equity for the entity. This will also help anchor later negotiations, providing a hard-to-argue-with basis for a quid pro quo. Be explicit around key results areas at the entity level and one or two levels down. Firm up exit terms. In the mainland, joint venture exit terms typically are vague. But it's critical to have them clearly spelled out at the outset. Poorly defined rights of first refusal or valuation mechanisms are a sure recipe for drawn-out negotiations, missed alternative exit opportunities and mutual frustration. Managing a foreign joint venture in China once it is up and running requires developing common goals, forging strong relationships and establishing systems and controls that enable the partnership to ride out hot-button issues. Focus on building loyalty. Stable management starts by building strong personal relationships between multinational and Chinese partner employees. In many cases, personal bonds are a key reason locals stay and ignoring them will boost the already typically high rate of local attrition. Whenever possible, make sure there is a long-term expatriate commitment and a progressive transition plan. And begin the process of building a talented local workforce early. Recognize the importance of staying abreast of rising compensation levels. Be realistic—recognize and accept the limits of your position. As a minority shareholder or one of several parties, it's important to acknowledge your limitations. Influencing staffing levels is a case in point. China's tradition of long-term employment is hard to break. Consider the aerospace joint venture in Shaanxi that saw its orders drop by 50% after the 9/11 terrorist attacks on the U.S. When the foreign partner proposed a 40% cut in staffing, the Chinese team resisted. Fortunately, the multinational had a solid enough relationship with its partner and reached a compromise: Employees who agreed to resign were offered a buyout worth up to 30% of their salary. In many cases, it is normal practice for the Communist Party to make senior appointments. It's important to understand who is a party member but don't try to get involved. Maintaining relations means starting at the municipal level; going direct to Beijing with a complaint is typically counterproductive. Manage the home office. For the local head of a multinational, managing the home office can be a time-consuming but important exercise that entails two roles. The first is ensuring that realistic expectations for targets and timeframes are set and shared. The second is ensuring your messaging is well coordinated. This is especially important when senior officials fly in for a visit. Expect the typically more hierarchical Chinese counterpart to treat these meetings with a degree of formality. Off-the-cuff remarks or promises by uninformed senior executives can undermine the hard-earned authority of the local multinational chief. Joint ventures in China are a tough business. But following these guidelines can help a multinational master the tricky balancing act and make the most of the booming mainland economy. Michael Thorneman is managing partner for Bain & Company in Greater China. Bruno Lannes is a Bain & Company partner in Shanghai. Nick Palmer is a Bain & Company partner in Hong Kong.

For decades the only way for foreign companies to do business in China was through joint ventures with Chinese companies. It was a perilous route—too often foreigners were kept in the dark about everything from costs to sales to who actually was running the business. Cultural conflicts flared. Exit terms were sketchy. The failure rate for joint ventures was more than double that of the success rate. Multinationals breathed a sigh of relief when the government finally allowed foreign players to acquire domestic companies in all but a few proprietary businesses like automobiles.

Since then, the number of joint ventures between multinationals and mainland companies has dropped by an average of 25% a year since 2000. But rough as they can be, joint ventures provide a viable alternative for multinationals finding it hard to compete with the domestic businesses that are flourishing and proving to be efficient competitors. Joint ventures also make sense for multinationals shifting emphasis from exports to China sales—foreign companies can benefit from local networks and local knowledge. And for some restricted industries like car manufacturing and energy, joint ventures are the only way for multinationals to get a foothold.

The fact is, despite the high failure rate, joint ventures—when properly planned and managed—can be the quickest path for multinationals in China. Boosting the odds of success rests on careful planning and management.

What can multinationals do at the outset to avoid the pitfalls of joint ventures? We've identified three seemingly straightforward but often poorly executed factors:

Overinvest in due diligence—both formal and informal. Due diligence is a difficult task anywhere; in the mainland it's often more daunting and more important. With unofficial payments and other hidden costs part of doing business, published accounts aren't as transparent as they are in many other regions. To compensate, overinvest in obtaining information from primary sources. For example, talk to customers and suppliers to help build a picture of your partner and the market they operate in to test key elements of the investment thesis. Track pricing at stores.

Understand who is really pulling the strings at the potential partner company. "Analyze the shareholder register to understand control overlaps, who will vote in blocs, who's aligned," advises Richard Williamson, general manager, Asia strategy at Commonwealth Bank of Australia, which has joint ventures with two mainland banks.

Discuss and agree on the detail around the economics. Be clear about your expected return on equity for the entity. This will also help anchor later negotiations, providing a hard-to-argue-with basis for a quid pro quo. Be explicit around key results areas at the entity level and one or two levels down.

Firm up exit terms. In the mainland, joint venture exit terms typically are vague. But it's critical to have them clearly spelled out at the outset. Poorly defined rights of first refusal or valuation mechanisms are a sure recipe for drawn-out negotiations, missed alternative exit opportunities and mutual frustration. Managing a foreign joint venture in China once it is up and running requires developing common goals, forging strong relationships and establishing systems and controls that enable the partnership to ride out hot-button issues.

Focus on building loyalty. Stable management starts by building strong personal relationships between multinational and Chinese partner employees. In many cases, personal bonds are a key reason locals stay and ignoring them will boost the already typically high rate of local attrition. Whenever possible, make sure there is a long-term expatriate commitment and a progressive transition plan. And begin the process of building a talented local workforce early. Recognize the importance of staying abreast of rising compensation levels.

Be realistic—recognize and accept the limits of your position. As a minority shareholder or one of several parties, it's important to acknowledge your limitations. Influencing staffing levels is a case in point. China's tradition of long-term employment is hard to break. Consider the aerospace joint venture in Shaanxi that saw its orders drop by 50% after the 9/11 terrorist attacks on the U.S. When the foreign partner proposed a 40% cut in staffing, the Chinese team resisted. Fortunately, the multinational had a solid enough relationship with its partner and reached a compromise: Employees who agreed to resign were offered a buyout worth up to 30% of their salary.

In many cases, it is normal practice for the Communist Party to make senior appointments. It's important to understand who is a party member but don't try to get involved. Maintaining relations means starting at the municipal level; going direct to Beijing with a complaint is typically counterproductive.

Manage the home office. For the local head of a multinational, managing the home office can be a time-consuming but important exercise that entails two roles. The first is ensuring that realistic expectations for targets and timeframes are set and shared. The second is ensuring your messaging is well coordinated. This is especially important when senior officials fly in for a visit. Expect the typically more hierarchical Chinese counterpart to treat these meetings with a degree of formality. Off-the-cuff remarks or promises by uninformed senior executives can undermine the hard-earned authority of the local multinational chief.

Joint ventures in China are a tough business. But following these guidelines can help a multinational master the tricky balancing act and make the most of the booming mainland economy.

Michael Thorneman is managing partner for Bain & Company in Greater China. Bruno Lannes is a Bain & Company partner in Shanghai. Nick Palmer is a Bain & Company partner in Hong Kong.