JOINT VENTURES IN CHINA HOW TO DEAL WITH THEM?

INTRODUCTION:
China home to 1.3 billion people. In the eyes of a Marketer, China houses 1.3 billion customers. China is often referred to as the next big thing, right after Europe and North America. Hence, companies from all over the globe want to enter this huge market, which has remained a closed economy for almost 3 decades post Second World War. It is the worlds fastest growing consumer market. Hence, entering into this market is of prime importance to each and every firm which has met with success. There are 3 main types of entities in China which can be owned by foreign enterprises. These are Wholly foreign owned enterprises, Joint Ventures and Registered Offices. In joint ventures, we again have 2 types Equity joint ventures (EJVs) and Contractual Joint Ventures (CJVs). In this article, we would explore in detail about Joint ventures and try to develop a framework for starting a JV in China, apart from the all-important negotiation process.

JOINT VENTURES:
The Joint Venture statute was adopted by the Peoples Republic of China (PRC) on 1st July 1979. Although they established a set of procedures for the Joint Venture, they government didnt enact any criminal procedures to back up the Joint Ventures. In short, the legal aspect of enforcing the contracts seemed to be missing. So, before drawing up a joint venture contract, it is necessary to perform market intelligence and due diligence survey. Due diligence must be taken in two aspects namely legal aspect and financial aspect. The following table lists the important factors which must be considered in due diligence study. LEGAL ASPECTS Business Licensing Corporate Structure Land Use Rights Pollution Access & Utility Rights Intellectual Property Rights Valuations Background Checks FINANCIAL ASPECTS Accounts Overheads Related Party Transactions Staff Liabilities Receivables Company Bank Account Sales Audit

Table 1. List of Legal and Financial Aspects that must not be overlooked

There are two basic variables which determine the success of a joint venture in China. The first and foremost thing is the Chinese partner. It is important that the Chinese partner be on the growing list of industries that have been organized into national corporations. This will help a great deal in negotiation process, which is a key aspect in setting up a joint venture especially in China. The second variable would be the proposed location of the plant/facility. Joint ventures located in primary centers such as Beijing, Shanghai and Guangdong will have a smooth startup while starting in secondary cities will attract personal care from the local mayor/politician. Vijay Krishnan A| DM14257

JOINT VENTURES IN CHINA HOW TO DEAL WITH THEM?

TYPES OF JOINT VENTURES:
There are two types of joint venture setups that are practiced in PRC. They are

i. Equity Joint Ventures (EJVs) Equity joint ventures Or Gu fen zhi he zi qi ye involves the setting up limited liability company with a particular shareholding structure between foreign and Chinese parties. These were the type of JVs allowed initially after the enactment of Joint Venture Law in 1979. Ownership management and investment are shared by the EJV partners and the profits are distributes in line with the shareholding pattern. The foreign partner must own at least 25 percent of the firm. ii. Contractual Joint Ventures (CJVs) He zuo qi ye or Contractual joint ventures (CJVs) create an association between Chinese and foreign partners. In this type of JV, setting up a limited liability company is not mandatory. These came into existence in 1988 after the enactment of Law of PRC on Sine-Foreign Cooperative Enterprises. Even in this type of JV, the foreign investor must own at least 25% of the firm. CJVs are usually preferred over EJVs as they offer strategic and operational flexibility.

KEY ISSUES THAT ARISE DURING JVS:

1. OWNERSHIP As in any joint venture, the percentage of ownership is an important issue. According to earlier laws, more ownership was to be held by the local player. Nowadays, ownership restrictions are not seen. However, it is often seen that the Chinese would like to retain the majority stake. 2. FOREIGN EXCHANGE Foreign exchange is another key aspect in joint ventures. According to the joint venture law, Joint ventures must show a surplus in their balance sheets at the end of the contract period (usually 10 years). The primary reason for conflict is that foreign investors target the Chinese market while the Chinese partners target the export market. This creates a conflict of interest. Also, the Chinese investors do not like to spend foreign exchange. This creates an additional burden on foreign investors who end up accounting for the imports as part of their investment. 3. TECHNOLOGY TRANSFER Technology transfer is considered to be the most important point which can also make the foreign partner vulnerable, if not handled with care. The technology transfer laws are balanced and reasonable. The Chinese are concerned that the foreign investors do not dump any obsolete technology to them. Such transfer of outdated technology will be penalized. However there is always the fear of reverse engineering processes which may infringe the Intellectual property rights. The investor must understand that the JV is about China obtaining their know-how while maintaining Chinese control. Vijay Krishnan A| DM14257

JOINT VENTURES IN CHINA HOW TO DEAL WITH THEM?

4. MANAGEMENT & LABOR The characteristics of a western manager and a Chinese manager are quite contradictory. Chinese managers never associate themselves with cost and revenue. They are very cautious and they dont accept change that easily. There is lack of interdepartmental communication within the enterprise. And the relationship between managers and labors is poor. Also, the manager is not good at decision making because of the collectivism ideal. So, training a Chinese manager to run a profit oriented enterprise is a challenge. When it comes to labor, it is abundant. Since the economy is centrally planned, no laybacks have been done in the past. There is more number of laborers who work in China, but comparatively, their productivity levels are low. Workers in China are generally eager to learn. 5. SOURCING & PRICING Sourcing is often a problem in joint venture enterprises. Usually the foreign investor expects a high quality output, but the quality of inputs is not at par with the quality standards. Moreover, when a quality standard for raw materials is met, its demand shoots up and supply is also not so reliable. However, a continuous investment on infrastructure has improved the supply levels. Still, the quality standards are not met that often. Since the quality is usually low, premium pricing could not be followed. And the Chinese partners insist on low prices because they think it is the only way to promote their product. They do not understand the need for marketing strategy. Also, disputes arise in agreement of fixed component and royalty to the foreign investor.

KEY POINTS TO BE CONSIDERED:

i. Undertake your own due diligence and feasibility study. Do not rely on a Chinese feasibility study as it may not give the accurate details. Its sole purpose is to attract you as a customer. In a government Joint Venture, give more credit to your partners political power. Always get a majority stake in the joint venture and have your own CEO, CFO and HR director. The role of HR Director is very powerful is Chinese business environment. Developing relationships is more important than developing contract notes. It is very important to choose a vision and mission statement which syncs with your partners vision and mission statement. This will help the employees connect more.

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CONCLUSION
One has to agree to the fact that China has accepted the market economy model. However, there are a few things that hinder the success of a joint venture. A proper segmentation and targeting of consumers has to be taken. We cant assume that there are 1 billion people who would have breakfast daily, so Ill market breakfast cereal. Due importance to culture and demographic factors has to be taken before arriving at a decision. Also, it is highly recommended that Joint venture be adapted as an entry mode if it is the only option available. Vijay Krishnan A| DM14257

JOINT VENTURES IN CHINA HOW TO DEAL WITH THEM?

REFERENCES: 1. Creating and Managing Joint Ventures in China, William H. Davidson, California Management Review, 1987 2. China Foreign Direct Investment: Greenfield, Mergers & Acquisition, or Joint-Venture, JT Norris Jr, International Business & Economics Research Journal-January 2011 3. China's Laws on Joint Ventures, Peter Nehemkis, Alexis Nehemkis, California Management Review 4. One Billion Customers, James McGregor 5. Doing Business in China, kobus Van der Warth 6. CFO Guide to Doing Business in China, Ching Mia Kung

Vijay Krishnan A| DM14257