Risk Strategies for the Chinese Market

Risk Strategies for the Chinese Market

Kedl, Kent

Although foreign companies have had a presence in China since the mid-1980s, China's reputation as a risky place to do business has not abated. Rather, in some ways, it has increased over time from the regulatory changes in the 1990s through today's concerns over the quality and safety of Chinese-made products.

Certainly, there are legal and financial tactics that companies use to manage risks in China, and companies should take every precaution to insure that they are on solid ground. There are some broader risk management imperatives, however, that companies should also consider as they establish their China strategies.

Strategy before Structure

In the early days of the Chinese economic boom, foreign companies looking to enter China were required to establish joint ventures with Chinese companies. The Chinese government established these requirements in order to facilitate the transfer of technology and management practices from more experienced foreign companies to fledgling Chinese start-ups. While some of these early joint ventures were successful, many of them were very poor "arranged marriages" in which the foreign company's desired strategy did not fit the structure forced upon them by the Chinese partner. These ventures were inherendy treacherous and rife with internal challenges that required considerable attention before the wider challenges of market could even be addressed.

In recent years, the Chinese government has changed its investment regulations to allow - and even encourage - a variety of other arrangements, from strategic (nonequity) partnerships to wholly foreign-owned enterprises (WFOE) to full acquisitions. Having this range of options is beneficial, but it means that each option needs to be fully explored and vetted. To do this, companies coming to China must first ignore the "how" of structure and first focus on the "why" of their strategic intent for China: What products will have the most play? What segments of the market should they target? What distribution channels should they use? Who will be the major competition and how can they structure a defensible and sustainable value proposition?

Once these strategic questions are answered, the foreign company's management can decide which structure will provide what they want. Can they establish a WFOE and grow organically? If they need special assets and access to market segments, are diere companies they could acquire or align with that will provide speed-tomarket? Aligning strategy and structure will go a long way to establishing a venture that starts from a lowerrisk position.

A U.S. manufacturer of medical equipment, for example, met a Chinese company at a trade show and started discussions about a strategic partnership. An assessment team later determined that the manufacturer actually had no idea what opportunities were there for them in the China market, and it turns out that they were simply responding to the overtures from the potential Chinese partner.

Instead of moving ahead with the partnership talks, the company backed off and did a deeper assessment of the Chinese market and where they should play. They discovered that, while there certainly were good opportunities for them in China, they would not be able access them through the Chinese company they initially consulted. That Chinese company had neither the reputation in the market nor the proper distribution structure required to access the niche target market. The U.S. company looked for other options and avoided a potentially disastrous partnership.

Get Close to the Market

Over the past year, the Western news media has been full of stories about bad products - from toothpaste to toys to tires - being manufactured in China and sold to Western consumers. Too often, the blame is laid squarely on the quality-management problems of Chinese manufacturers and the whole nation is deemed a risky place for outsourcing. Clearly, there are Chinese factories that have quality issues, but the fact remains that there are millions of products coming out of China every month, most of which have no problems whatsoever. Maybe, then, the question should be how best to manage product quality because someone is doing it right.

Too often, foreign companies do not manage their vendors on an ongoing basis. Some hand over vendor management to traders through whom they find the vendors, assuming that the traders have the skills - and interest -to monitor product quality. Others simply assume that once they start getting acceptable product from Chinese vendors, they will always get similar quality.

One consumer products manufacturer had faced serious quality problems from its China sources, even to the point that it faced litigation for faulty products. As executives dug deeper into the supply chain, they found that, although many of its suppliers had been working with the company for many years, not once had the manufacturer met with them and validated its supply chain. Nor had the company ever involved its suppliers in the product development process. Instead, it treated its suppliers like machines and simply developed the designs and told the suppliers to produce them. The only worries were price and on-time delivery, and both of those were eroding. After a lot of work repairing relationships with its suppliers, the company became much more confident in its product quality. The suppliers even pointed out some potential flaws in product design, saving the company money and avoiding potential lawsuits.

Companies sourcing from China should put their own people on the ground to manage their supply chain, establish and monitor their own quality systems, and maintain ongoing relationships with thie vendors. This approach will raise a company's fixed costs but, in the long run, will greatly lower the risk associated with having products made in an emerging market.

Relationships Matter

Very often, Western business people deride China because "everything is based on who you know; it has nothing to do with product quality." There is a kernel of truth to this stereotype. A famous Chinese maxim says, "If you have a relationship, you have a road." In thousands of years of Chinese history, family and community relationships have been important, and one's success in life has depended on how one works these relationship networks. That foundation still exists in China, and such "social capital" - or guanxi (gwan-shee) - is crucial to building a successful business in China. Early successful foreign entrants to China worked hard to build this network for themselves.

As China has developed a more credible legal framework and a more predictable market environment, however, foreign companies too often believe they no longer need that social network and that, instead, they can do it on their own. But guanxi is still necessary; one needs both a solid business strategy and good relationships.

Another company established its manufacturing operations in a small town in central China. It worked closely with the government to set up this facility and to find ways to benefit the community through employment, education and other initiatives. Soon after getting up and running, a competitor moved in across town and began copying the company's technology. The company filed all sorts of injunctions against the competing firm, all to no avail. The competitor kept operating.

One evening, a mid-level manager at the company was at a meeting of local government officials, and afterwards she pulled aside one of the key officials that she knew. The manager explained the situation of how this competitor was harming her company and, eventually, would derail many of the good things that they had worked so hard to establish with the local government. The official told the manager not to worry and that he would take care of it. Within days, the competing factory was shut down. An entire team of lawyers could not do what a mid-level manager accomplished through her excellent guanxi.

Kent Kedl

"Risk Strategies for the Chinese Market" pg. 54

Kedl is general manager of Technomic Asia, a market strategy consultancy based in Shanghai.

Copyright Risk Management Society Publishing, Inc. Jun 2008
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