Business Risks in China. By Peter Macquart-Moulin, Control Risks, U. K.

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It seems that hardly a day goes by that we are not reminded of the spectacular development China has accomplished over the past couple of decades and the myriad opportunities that are still waiting to be captured by the savvy investor. Whether it is at seminars on how to do business in China or reading business journals, the statistics that leap out should be enough to get the pulse of any executive in charge with growing their business skipping.  “China’s GDP grows by 11.4%!; FDI inflow reaches USD80 billion!; Chinese internet users top 210 million!; China built 53,600 km of new expressways in just 17 years!; 131% year-on-year increase in wind power generation!; 100 cities with a population of 1 million or more!; 20,000 new cars hit the roads every day!; China to build 97 new airports by 2020!”; just to cite a few jaw droppers from recent memory. 

China’s sizzling economy – and 1.3 billion consumers - leaves little doubt over the importance of China for many businesses. Indeed, for some, not doing business in some way in China may result in not conducting any business at all. The majority of multinational companies already have a presence in China – more than 450 of the Fortune 500 – and SMEs continue to eagerly stream there in one form or other.

China’s business environment continues to improve as the government has sought to fulfil its WTO obligations.  Authorities are reviewing all laws, rules, regulations and implementing regulations in line with international norms. In general, it is easier to conduct business in China than in many other emerging markets.

However, China remains a complex and relatively opaque business environment. We continue to see companies rush in to take advantage of the seemingly limitless opportunities without clearly understanding the risks they face. Many of them will have thought that they could do things differently than in more familiar jurisdictions and many still are willing to cut corners. In these circumstances things are likely to go wrong and in many instances have had damaging consequences for profitability and reputation.

In the gold rush mentality to enter or expand a China presence even large multinational companies have run into trouble, as some headlines in the recent past have shown: massive recalls, breach of joint venture agreements, trade secrets stolen, Foreign Corrupt Practices Act violations and systemic commercial corruption uncovered, etc. Naturally, companies are reluctant to publicise their misfortunes – many more cases go unreported. In Control Risks’ own experience, the headlines outline the archetypical cases but many more companies face these challenges on a regular basis. 

In some ways the problem can be simplistically described as a gap between local business practices and the foreign executives who are expected to adhere to international best practices while meeting increasingly challenging targets. Another element is cultural. Commercial corruption, nepotism, conflicts of interests, kickbacks, bid rigging are still so commonplace in China as to be considered ‘accepted business practice’. For example, kickbacks are often seen as a socially acceptable way of earning a little extra cash and conflicts of interests can be seen as a competitive advantage rather than something unethical.

Even relatively simple issues such as client entertainment can create a host of headaches if not properly managed. For example, if your local staff are entertaining employees from a state owned enterprise or if a supplier is entertaining your own procurement personnel - which in China can involve paid outings to casinos, karaoke bars (where prostitution is likely to be featured) or rounds of golf –  how does this sit with your company’s policies on appropriate business conduct?  Or comply with laws against corruption of foreign officials? In this context, something as simple as entertainment can have an impact on your company’s bottom line and reputation.

If these issues weren’t enough to keep you up at night, the compromising of your intellectual property is also a considerable risk to consider. We all have heard of the counterfeit luxury bags, forged brand name watches and pirated DVDs openly available across major cities in China. There is no doubt that counterfeiting is a major problem companies have to face. However, they are more likely to be exposed to the theft of sensitive information – something that has the potential to put a company out of business altogether.

The theft of critical intellectual property will save a Chinese competitor the time and cost of research and development. One source of the problem may be employees themselves. A number of companies have woken up to discover that employees have set up a competing business across the street with critical information on their technology, pricing information, processes and client information. If attempting to address this wasn’t daunting enough, media reports indicate a growing trend of highly sophisticated industrial espionage.  According to these reports, the industrial spies are increasingly making use of technical means such as penetrating a company’s IT systems or planting listening devices and using social engineering techniques whether through subterfuge or extortion (remember the night at the karaoke bar mentioned above?).

The Do’s and Don’ts
While there may be a perception of what is ‘acceptable business practices’ locally, it is wrong to assume that one cannot enforce standards and succeed in China – a lot of companies have. Likewise, many companies are moving their R&D facilities to China and are successful in protecting their intellectual property.

The bottom line is - know your risks. China is not a bad place to do business and you may have experience operating in hostile business environments, but what applies elsewhere may not hold true in the Middle Kingdom.  Do not be blinded by seemingly endless opportunity and don’t cut corners.

A few words of advice:
You can never conduct too much due diligence. Understand the background, track record and company culture of the companies you do business with whether they are potential partners, suppliers etc.
 
Screen key hires. As much as a 1/3 of CVs screened by Control Risks in China contain at least one mistruth – ranging from simple exaggerations to serious malfeasance in their past. Identifying these and conflicts of interests early can prevent a lot of heartache later on.

1. Train employees. If you believe there is a cultural gap between the standards you want to instil and local views on acceptable business conduct - re-educate your employees.  Instilling your company culture from the outset will avoid many problems down the road.
2. Implement robust physical security controls, processes and procedures to protect your intellectual property.
3. Ensure that third parties holding your sensitive information are operating to the same standards. 
4. Audit & repeat. Due diligence, training and security programs should be a part of your ongoing business

Case Study
Danone’s high profile trials and tribulations in China over the past year serve as a good example of some of the pitfalls to be avoided.  Danone’s joint-venture (JV) partnership with Wahaha, once held up as a model of success, began to unwind when Danone discovered the existence of a number of Wahaha named businesses in which it had no stake – evidently in breach of contract. What became apparent is that although Danone owned 51% of the JV it had little to no control over the business. After the initial investment, Danone had effectively become a sleeping partner. In the ensuing legal squabble it also emerged that the rights to the brand name ‘Wahaha’ may not have ever been properly transferred to the JV. To make matters worse, Wahaha’s founder Zong Qinghou later became a member of the National People’s Congress, China’s legislature, making it an uphill battle to enforce contracts against him and his company in a Chinese court. The end result is tens of millions of dollars in lost revenue every month and a severely damaged reputation in China.

How it could have been avoided
Pre-acquisition - Danone should have performed due diligence to get a better understanding of their partner’s background, motivations and company culture. At the signing, ensured they owned the brand rights and post-deal, actively managed the operation beyond the initial investment. The case also highlights the value of including a dissolution clause in your contracts in the event that the partner takes up public office - a situation that could make one’s company a minority partner overnight regardless of equity share.  

Peter Macquart-Moulin
Account Manager, Global Client Services
Control Risks
London, U.K.

Peter.Macquart@control-risks.com
Web: www.control-risks.com

Control Risks is an independent, specialist risk consultancy with offices on five continents.
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