To JV, or Not to JV - How MNCs Choose Local Partners?

A interesting post fm Ceibs website. have fun reading

"In choosing a JV partner, some people may want [first] to make sure the partner has business experience. But if I am the person choosing, trust is very important. This basically means that we can share the same vision. Character is very important -- more than business experience. A JV is like a marriage."
Seiichi Kawasaki, Director and President, Sony China

Stay Single or Marry (to JV, or Not to JV)?
If your company does have a choice concerning partnering, the first rule in deciding which route to take is: don't rush. So says General Electric China's Steve Schneider. He advises foreign companies entering China first to spend time understanding the business environment. "If you don't know the market, it won't make a bit of difference whether you operate as a JV or WFOE," he says. "The reason we've been pretty successful [in China ] is that we spend a tremendous amount of time understanding our customers before we commit anything." Only after clarifying the areas in which your company may be weak can you determine whether or not a joint venture is the best choice. GE operates 12 JVs and 24 WFOEs in China . In determining which method to adopt, Schneider keeps in mind the three factors he considers responsible for the fact that each of GE's divisions is profitable: understanding the market, controlling costs, and building cost effective facilities.
Another test for whether a JV makes sense for an MNC is the scale of the planned China operations. BP China's Dr. Gary Dirks, who leads 22 JVs and one WFOE, explains how he determines whether or not to form a partnership. "It all depends on the complexity of the [operations] and how it fits into the notion of national interest or provincial interest. For something that is deeply fundamental, with far-reaching consequences, I still feel much better having a Chinese partner." Of BP's large-scale chemical complex in Shanghai , he says: "Frankly, I wouldn't even conceive doing a project of that scale and of that complexity without a Chinese partner." The domestic partner company, which owns 50% of the venture, helps in handling special interest groups, working with PRC government officials, and providing insight into the market and the industrial environment in Shanghai . For such a massive project, Dirks says, "You just need a Chinese partner."
But smaller-scale ventures, he says, are often best undertaken alone. For example, BP China prefers to operate its LPG terminal and distribution points as independent entities that are managed directly by BP's global operations. For LPG operations, he says, "I would choose 100% owned by us every time. It's so much simpler and so much easier to be on our own. There is nothing a partner could offer strategically to assist in that activity."
Unilever China's Alan Brown uses a simpler method of determining whether or not to form a joint venture. "If you are working in a highly regulated industry, then JV partners are almost essential," he says. "If you are working in a highly de regulated industry, they can be a damn nuisance."
One helpful characteristic of today's business environment is that many MNCs can now alter the structure of their existing partnerships. International managers advise monitoring regulatory changes constantly to see if you can, and should, adapt your business structure.
A look at Alcatel China illustrates the value of adaptability. One of the first foreign investors to enter China after its economic reforms, ITT (acquired by Alcatel in 1986) began negotiating with the Chinese central government in 1977. Six years later, the company won approval to form one of the earliest foreign?Chinese JVs: Shanghai Bell, minority owned. Today, Alcatel has regrouped the majority of its operations into a company limited by shares, Alcatel Shanghai Bell, in which it owns 50% +1 shares. Ten-year China veteran Dominique de Boisseson says Alcatel's primary strategy is: be adaptable. In some instances, companies still face stiff restrictions. For example, one interviewee explained that for his operations in central China , his company was forced to
form a JV with a government-recommended partner. "The government said, 'You either choose this company or forget it'," the CEO says. "The location wasn't ideal, the partner wasn't ideal, but that was the only chance. We accepted the JV; otherwise, we would have lost the market."
But Alcatel has been able to restructure its operations in China . The company has switched at least one JV to a WFOE and another JV to a company limited by shares. The new structure better suits the telecom business, says de Boisseson. "Before, all the decisions in the JV had to go to the board. It was far too slow, especially for fast-moving products, as they are out of the market in one year. If we lose time, we lose the market."
The overriding advice from our interviewees on JVs is that international managers should assess each China venture case by case against current regulations. In addition, China operations should be reviewed regularly, and perhaps restructured, as regulations are constantly changing.
Partner Selection, Partnership Terms
If you have decided to (or must) form a joint venture in China , the challenge is to find the perfect partner. As Sony China's Seiichi Kawasaki points out, a JV is like a marriage: selecting the right mate is the most important step.
The advice of our international manager interviewees on finding the ideal match can be boiled down to five messages:
Choose a weak, silent partner, or
Choose an active, value-added partner
Know your partner
Align your goals
Set the correct "marriage" terms
The process of forming a JV begins by determining which type of partner best suits your needs in China . Our profiled top executives described two ideals: (a) a weak, silent partner that won't interfere with operations; or (b) a stronger, more active company that brings to the venture valuable government-relations savvy, business connections, and/or industry knowledge. Our interviewees were divided on which type makes the best Chinese JV partner, but the tide seems to be turning away from weak partners toward stronger, value-adding ones.
Finally, a word on the importance of financial health in potential partners: one difference in searching for a JV partner in China is that the criterion of financial strength (or at least financial stability) is not generally considered to be as important as it would be in a developed economy. In China , other qualities are very often more important -- and more available. Even so, several interviewees did warn against working with a partner that is in serious financial trouble. They also stressed that MNCs can and should demand to see full financial records of any potential partner.
Strategy #1 : Choose a Weak, Silent Partner
From the mid-1980s to the mid-1990s, when most foreign enterprises were forced into JVs, international managers assumed that their Chinese partner could not contribute much to the partnership. Thus, the best match was a company that would at least not hinder business operations.
One option was to form a short-term partnership that could be dissolved after its initial mission was accomplished. This was the modus operandi used by L'Or??al's Paolo Gasparrini in setting up operations in China in 1997. L'Or??al formed a partnership giving 5% ownership to the Suzhou Medical Hospital . Gasparrini says the hospital was "not an active business partner" but did allow L'Or??al to "understand China better" and to acquire some useful relevant expertise (medical information on the characteristics of Chinese skin). After three years, L'Or??al bought back its 5% shares, the JV was dissolved, and both partners had accomplished their goals. Gasparrini sums up the situation this way: while foreign companies entering China in the early 1990s tended to "feel more secure with a JV," such a need is diminishing now. Today, he says, MNCs generally benefit from operating independently.
Other MNCs have maintained long-running partnerships in which the domestic company is not directly involved in the JV business. The Shanghai Hilton, for example, operates with a local partner that owns the property but does not interfere with day-today operations. Hotel general manager Volkmar Ruebel says the primary means of communication is via a monthly report issued to the property owners. Only rarely does the Chinese partner want to approve decisions. "The owner trusts us as an international
company; we are the custodian of the property," says Ruebel. "It is relatively smooth. We don't have any operating problems." He adds that the partnership gives Hilton "relatively strong autonomy in the way we deal with personnel and quality standards."
Carrefour China's Jean-Luc Chereau also partly attributes the successes of the hypermarket chain to its policy of choosing relatively passive local partners. The company entered China in 1995 and now operates 19 JVs and one WFOE. Chereau oversees local ventures according to Carrefour's corporate-wide policies -- some of which have evolved over 40 years of trial and error. During the chain's first 20 years of international operation, Chereau says, Carrefour "made a lot of mistakes" in selecting business partners. In the last 20 years, the company has followed a policy of not "sharing" the management with a local partner. "In China , when we establish a new JV, we share the investment but never the management," he says. "You cannot have two bosses." Even weak partners can bring value to the JV, insists Chereau, who demands several characteristics from the Chinese side, "First, all of our partners in China must have a long-term view. If they just buy shares and sell them within two years, what's the use? Second, the company must have some cash. Third, the company must have a very good network at local level. To succeed in Shanghai , your partner should be Shanghainese. To succeed in Guangzhou , your partner should be Cantonese."
( Note: In December 2004, WTO-related regulations opened up the retail sector and many aspects of distribution to WFOEs. Despite the fact that relatively few MNCs were approved to enter these sectors during 2005, and many were frustrated by the government's slow approval pace and confusing procedures, retail and distribution are two of the most promising sectors formerly closed to direct foreign investment.)
Strategy #2 : Choose an Active, Value-added Partner
Not all MNCs seek meek and mild local partners. In recent years, more MNCs are forming partnerships with active domestic companies that bring real value to the partnership.
A look at the JVs formed by Bayer China illustrates this trend. Company CEO Dr. Elmar Stachels says that in years past, Bayer had little choice but to form JVs with government-selected partners. "The contribution of this partner to us was very often just the land and the building -- no real contribution to marketing, services, technology, or production," he says.
Today, Bayer selects its partners according to its own criteria and standards. "We not only look at the activities, assets, and performance of a company, but also at the management, the people," says Stachels. He points out that, in recent years, Bayer has begun recruiting management personnel for the holding company directly from the top executives of its Chinese JVs. Thus, if the management of a potential partner company does not impress Bayer, Stachels keeps looking. Also, following deregulation, Bayer has recently (for many reasons) restructured some of its JVs into WFOEs.
At British Petroleum China , which operates 22 joint ventures, Dr. Gary Dirks looks for JV partners that truly contribute toward the corporate goals. "No matter where you go in the world, the key to success for partnerships is the alignment of your strategic interests, your ability to maintain the alignment over a significant period of time, and making sure your partner can contribute to those strategic interests. If both parties are perceived to be contributing as well as expected, then it can go very well."
Dirks rejects the JV model based on a say-nothing, do-nothing Chinese partner. "Where you tend to have problems is when there is a perception on the Chinese partner's side that their contribution ends the day the JV is formed -- you contribute your technology and your know-how and the Chinese partner just sits around."
Today, companies that do form JVs advise looking for partners that offer these benefits: skill at negotiating with the Chinese government, business connections, insight into the local business culture and environment, an established workforce and operations, or a strong existing client base.
Our interviewees explained that many Chinese partners can offer real value to a JV. Thus, if you are going to form a partnership, it is possible -- and often beneficial -- to demand that the local company contribute toward your goals.
Strategy #3 : Know Your Partner
No matter what type of partner an MNC is seeking, it is critical to fully assess potential partners before committing. International managers warn that while MNCs often face pressure to establish in China quickly, spending more time up-front can help to avoid serious trouble later. Says GE's Steve Schneider: "Part of the learning I would offer for folks coming in [to China ] and setting up JVs is: spend a tremendous amount of time getting to know your partner first. It's better than any due diligence on the financial records."
Charles Browne of Du Pont China gives similar advice. "The key for a successful JV is that you spend a lot of time in partner selection," he says. "Some companies rushed in and picked what was available without doing enough research about the value of the partner -- whether their interests are aligned with yours, what they can contribute to the JV. We put a lot of time in partner selection to make sure the values are there."
Knowing your partner entails reviewing detailed information and records, making site visits to see the operations and facilities first-hand, and spending time gathering impressions from industry insiders.
Strategy #4 : Align Your Goals
International managers warn that many JVs fail because they fall victim to the Chinese idiom, "same bed, different dreams," which refers to a husband and wife with divergent hopes and ambitions. Du Pont's Charles Browne says that many failed JVs are victims of "split vision" between partners -- for example, if the MNC's primary objective is to build market share for its goods within China , but the domestic partner expects to focus on overseas sales. Browne has seen several of Du Pont's China ventures end in failure. "In many cases, the major reason was that we had different interests and different ways of doing business," he says.
Most problems that arise are innocent misunderstandings rather than malicious efforts to cheat an MNC, stresses Ekkehard Rathgeber of Bertelsmann Direct Group Asia. "Ninety percent of [Chinese] JV partners are very serious with their time," he says. Still, problems arise simply because the two partners have "very different targets, different ideas, and different mindsets," he says. As an example of the gap, Rathgeber explains that while many MNCs focus their operational goals tightly on profits, the Chinese partner may place a higher priority on other goals, such as impressing government officials by adopting advanced technology. Problems can also arise when the MNC introduces the Chinese partner company to operating procedures used globally. One common rough spot: the domestic partner may balk at the salaries offered to foreign managers in China . Working through such issues can be extremely time-consuming, Rathgeber warns.
Strategy #5 : Set the Correct "Marriage" Terms
Setting the best terms of the partnership is, of course, extremely important in alleviating problems once the joint venture starts operating. During negotiations, both sides typically struggle to obtain the largest percentage of ownership possible, and to protect their rights while limiting their obligations. Our international managers offered several bits of advice on surviving this process in China .
Microsoft China's Jun Tang, who oversees two JVs and one WFOE, advises establishing the JV as an entirely new entity. "If you do want to set up a JV, it is better to start from scratch," he says. Starting from zero allows both partners to adopt a new mindset, rather than continuing operations according to established methods. For example, in staffing, both partners can choose key personnel to send to the new company. This avoids a mindset of "outsiders" and "insiders"; everyone is an outsider in the new venture. "With a new entity, you can create a new culture, a new business model, a new atmosphere," Tang says. "To change an existing organization is very difficult. That is why we see a lot of JVs fail." Tang insists on establishing a new company even if nearly all members of the partner companies are hired into it.
One rule of thumb which attorney Norman Givant of Fresh-fields Bruckhaus Deringer shares with international clients in China : steer clear of 50?50 joint ventures. "That just builds gridlock into the structure," he says. Unless regulations require 50% Chinese ownership, Givant encourages MNCs to demand a majority share.
Givant also advises considering alternatives to straight joint venture models, as more options are opening for MNCs as regulations liberalize. Givant expects MNCs to undergo more mergers and acquisitions in the future as foreign companies take equity interest or procure stakes in listed Chinese companies, or buy companies outright. He also predicts that foreign companies will become more active in China's financial markets as regulations are liberalized. "You will see a growing sophistication both in terms of acquisition and participation in financial markets," he says.
Meanwhile, two of our international managers mentioned the benefits of establishing as a joint stock company (or "company limited by shares") in which the Chinese partner company is given a minority interest in the company. This allows the MNC to retain management control. Both Unilever and Alcatel have used such a method. Regulations were changed in 1994 to allow MNCs to register as joint stock companies, although relatively few have been approved.