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This is the follow-up post I promised to my last post on joint ventures, "The China Joint Venture. It's BACK!!!" I promised a follow up post because the first one received so many comments and a few of them raised issues I thought needed addressing.
That last post was really mostly a podcast I did with AmCham, which can be found here.
In particular, I wish to address when a joint venture with a Chinese company makes sense, and how best to structure it when it does. I will confine this post to when a joint venture makes sense and will write later in the week on how to structure them when it does.
I want to first go on record (again) as stating that my views on joint ventures have not changed one bit since I first started doing them around fifteen years ago. My experience is that they are always risky and that they should be thought through very carefully. I mention this only because some commenters seem to think that whereas I was once against joint ventures, I am all of a sudden in favor of them now because the economy has gone bad and American companies have no other choice. Wrong. My position has always been that it is my job as lawyer to explain the legal risks and the job of my client to figure out whether the potential rewards justify the risks. Now that more companies are unable to go into China without going in as part of a joint venture, the risk/reward equation has shifted to the extent that there is now more often no other, perhaps safer option.
Having said this, when exactly does it make sense to go into a China joint venture. The obvious answer is when the reward outweighs the risk and when a joint venture makes better sense than a Wholly Foreign Owned Entity (WFOE). But when is that most likely to be true?
Restricted Industries. It is going to be true in whatever industries the Chinese government prohibits foreign WFOEs yet permits joint ventures. These businesses are most commonly found in mining, fisheries, farming, energy, telecommunications, media, and finance. If the Chinese government prohibits foreign companies from conducting business in China as a WFOE, but allows it as a joint venture, the choice is clear.
Supply Chain Access. I hate to use a cliche, but it fits here. China is not one market. It is many and some parts of China are far more and far less developed than others. I suggest you read All Roads Lead to China's weekly China logistics wrap-ups blog to get a better feel for logistics in China. A few posts from that site ought to tell you that moving product within China can be very difficult. Add to that the fact that well established national retail distributors and chains are extremely rare and you can see how getting a product to market in China can be difficult and expensive. Being able to slide your company into an established supply chain on either a national or multi-regional or even regional level is one of the best reasons for joint venturing in China.
Ready to Go Factories. This is where I have seen the most change since the recession started. Whereas a few years ago our clients were mostly choosing to establish their own manufacturing facilities in China by way of a WFOE, they are now much more likely to opt for a joint venture so as to be able to take advantage of an already existing facility with workers ready to go. This is an area though where a WFOE would typically make better sense, but if a company is faced with the choice of having Chinese manufacturing via a joint venture or not having it at all, then certainly a joint venture must be considered.
We have worked on a number of these deals where the American company contributes its technological know-how (and some cash) and the Chinese company contributes its factory and its workers. On one level this makes sense, yet on another, this sorts of arrangements can be particularly risky because once the Chinese company has learned the technology and burned through the cash, the need for the American company may be over. Concomitant with our handling of these sorts of joint ventures increasing, our handling of these sorts of joint ventures having gone bad has also increased. These are the joint ventures that most require smart handling, which handling I will discuss in our next joint venture post.
Read more: Love The One You're With. When China Joint Ventures Make Sense.
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All Roads Lead to China just came out with a fascinating, but way too short, post on a few interviews of Shanghai's underclass. It is called, "It's All About Hope and Opportunity in China" and I urge everyone to read it.
All Roads' post touches on the sorts of things China Law Blog used to discuss a lot more often when when we first started oh so long ago.
I can remember writing a number of posts and comments where I would talk about how the Chinese are more like Americans than many realize. And how I have always felt far more "at home" in China than in what I see as for more hierarchical and formal societies like Korea and Japan.
The All Roads post brought back some fond memories for me of one of my longest and best China friendships. Excuse me for a rare burst of maudlin here, but it all goes back to a case I was handling in Qingdao where I and a Qingdao lawyer ended up spending the better part of two days together waiting for a ship to come in to Qingdao's port and then hunting it down once we heard it had arrived. We had a lot of time to talk and one of the things I will never forget about our conversation was how we both saw our countries so similarly.
We talked about how what we most liked about our country was how it was still possible for people from poverty to rise up and achieve just about anything. And of how this belief is so essential to the fabric of both our countries. This belief is our core. And this now very wealthy, exceedingly well educated Chinese lawyer knew of this from the heart as he is one of 13 children from a tiny village whose father had a 4th grade education.
We then talked about what most concerned us about our respective countries and we both again said that our biggest concern was how this was changing. We both talked of how the wealthy are starting to live in gated communities and send their kids to private schools and we both worried about the long term impact this might have on our countries' futures. Our two law firms eventually established a formal affiliation, but it has always been built more on our friendship than on any piece of paper.
All Roads' piece talks about the hopes of the financially downtrodden to do better by their next generation. CLB's Steve Dickinson is always telling me of conversations he has with waiters and waitresses and others in China's less respected jobs. And what he says reinforces what All Roads is saying. That these people believe their hard work will pay off in a better future, if not for them, than for their children.
When I was in college, I took a course on revolutions and the two things I best remember from that course (in fact, probably the only two substantive things I remember from that course) where that revolutions typically spring from the urban middle class (this is obviously less true of China than of most countries) and they spring from those who believe the elites have blocked the paths upward.
Rich, put me down as someone else who would love to see more of your street interviews.
Just a few random thoughts....
What do you think?
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The Transcript from my AmCham interview on China joint ventures is now online here. We are working on a post on how companies can best protect themselves if they do go forward with a joint venture in China, but in the meantime, this transcript does a nice job (thanks in large measure to Josh Gartner's interviewing skills) of teasing out the state of the joint venture in China today.
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Just finished the book, Chocolate Fortunes, by Lawrence L. Allen. It's a very good book.
The book is about the competition between Hershey's, Mars, Ferraro Rocher, Nestle and Cadbury for the Chinese consumer. But it is really more about is what it takes to succeed in the consumer products business in China. And lest anyone ever thought China consumer sales would be easy, Chocolate Fortunes thoroughly dispels that notion while explaining exactly what it does take to succeed or fail in China. Lawrence Allen was himself an executive with both Hershey and Nestle and he clearly knows whereof he speaks in describing who among the Chocolate titans did well and why.
For anyone who is thinking of going into consumer products or food or retail in China (and who out there is willing to ignore 1.3 billion customers?) this book is a must read.
Based on my firm's experience in handling the legal aspects for all sorts of businesses going into China, I see the legal side of China consumer products/retail as relatively straightforward. But the "making money side of retail in China is no mean feat. For the most part, our manufacturing clients go into China, start making a product and then start making a profit relatively quickly. Our service sector clients go into China, get an office, and then start making money relatively quickly. Now I know it has to be more difficult than that, but from my perspective as a lawyer, it does seem that the call I get from these clients 3-6 months after we have set them all up usually involves them telling me how well things are going and how well they expect things to keep going.
Not so on the consumer products and retail side. Issues like where to sell in China, distribution, and marketing (all of which Chocolate Fortunes extensively discusses) are intensely complicated and can be fraught with peril. And then there is the issue of costs. Getting good retail space (either through renting one's own store or through distribution through existing stores can be shockingly high in China. We have had a number of very well funded clients decide to test out retail concept in a second tier city like Qingdao or Suzhou after finding out how much it would cost to do so in Shanghai or Beijing. Indeed, these days, places like Qingdao and Suzhou are not really bargains either. And my 3-6 month calls from our retail/consumer goods clients who are seeking to sell into china usually involve them muttering about how they had no idea "gaining traction" in China would be so difficult.
What are you seeing out there?
Read more: Chocolate Fortunes. China's Consumer Market Writ Large And It AIn't Easy....
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One of the misconceptions I am always fighting about China is that it has no laws. Even people who should know better are oftentimes guilty of just assuming there is nothing on the books to cover a particular business law matter. Their assumptions oftentimes stem from their having seen companies act in so many different ways, leading them to conclude there is no one right way.
There usually is and if you are a foreign company, your best bet is to follow the law.
If anything, one of the problems businesses face in China is too many laws, some of which are in conflict with others.
The Wall Street Journal just came out with a new site, entitled, China Real Time Report. It appears it will be free for the next couple of weeks and then require a subscription. Not clear to me if the subscription required will be to the newspaper itself (I think this is the case) or something separate. Anyway, it is billing itself as a "vital resource for an expanding global community trying to keep up with a country changing minute by minute," with its postings coming from "the wide network of Dow Jones reporters across Greater China."
Its post, by Sky Canaves, "Do Too Many Rules Erode the Rule of Law?" makes note of China's "too many rules" phenomenon and muses on the results:
It’s not a new revelation that China has a lot of rules.Last year, there were rules for Beijing residents during the Olympics, and also rules for foreigners who came to town for the games (57 of them!)
This year, in Hubei province, a county government infamously ordered local officials to smoke locally produced cigarettes, while civil servants in the southwestern city of Kunming were ordered to learn 300 English sentences and 100 sentences in Lao, Burmese, Thai and Vietnamese, apparently to promote tourism in the region.
Today’s New York Times looks at some even more bizarre manifestations of rules run amok, such as an edict requiring schoolchildren to salute all passing vehicles on their way to and from school, and the Chongqing rule that “forced unmarried women to pass a chastity test before receiving compensation for farmland appropriated by the government.”
A potential side effect of so many seemingly arbitrary rules is that people may feel more inclined to skirt rules that they disagree with, or are simply too cumbersome to follow on a regular basis, fueling a culture of rule-bending and ignoring.
Not only does China have so many rules/laws, but they change faster (by about ten-fold) than any other country. I previously wrote on this in "China And Doing It By Heart. One Day You Are In And The Next Day You Are Out" and in "China's Internet Censoring. Hate To Say I Told You So, But I Told You So...."
I agree that having too many laws that people skirt leads to a denigration of the rule of law, but I fear the government likes things pretty much as they are. There is a Russian story I always tell that illustrates why I believe China likes so many laws. Many many years ago, an executive of a well known company called me for my views as to how it should handle going into Russia via Moscow. I called a Russian client of mine for the answer. This client is Russian and this client has been doing business with the very top echelons of the Russian government for about 30 years. He definitely told me that this US company needed to win over Moscow's mayor or something would go wrong. He told me he assumed the US company would not want to pay a bribe and he said Moscow's mayor is not going to be interested in that anyway. But, he said this company needed to do something very public to let Muscovites know that the mayor had been looking after the people in allowing this company to come in. My client suggested this American company donate a large sum to a local hospital or orphanage and publicize it with a big ceremony at which the mayor would be the honored guest. He said if this company did not do something like this, they would surely find themselves bogged down in some sort of lawsuit involving noise restrictions or something like that.
I passed all of this information on to the executive, who told me his company had never operated that way anywhere in the world. When I pointed out that his company had yet to go into any place like Russia, he poo-poohed me. My client was right and the American company was wrong. The American company ended up getting bogged down in a lawsuit that my client insisted would have been handled within weeks not years had this company done what my client had prescribed.
Which gets me back to my theory on too many laws. The more laws, the more likely one is to be in violation of one of them. And if everyone is in violation of a law, then everyone is beholden to the good graces of the government to avoid being fined or jailed.
I agree with this WSJ post that the Rule of Law is coming to China, but only ever so slowly.
What do you think?
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