Strategic Options for Foreign Investors

 

Ownership Optios

 

Where a foreign company wishes to buy a stake in a Chinese operation, the main alternatives are:

• Joint venture with the foreign partner having majority shareholding;
• Joint venture with a foreign partner having minority shareholding;
• Wholly owned by the foreign company (known as a wholly owned foreign enterprise or WOFE).


Need for Local Partner: HR


There are several reasons why a foreign investor would need a partner in a joint venture. Western companies with little experience in China are likely to be reluctant to take on the management of a large Chinese workforce. Apart from the obvious problems of language and culture that can occur in virtually any country, the level of social provision for workers in China is much higher than many foreign companies (e.g. including housing) would normally be used to providing. A local partner will generally be much better placed than the foreign investor to handle the human resources aspect of the business. On the other hand, the foreign partner would probably be keen to avoid adopting some of the working practices associated with some traditional Chinese businesses, for example:


»Iron rice bowl«: a job for life;
»Eating from the common pot«: equal pay regardless of merit;
»Iron chair«: guaranteed promotion.



Need for Local Partner: Contacts


In some market sectors the local partner will have essential contacts with potential customers. This is usually important where the main customers are large Chinese companies, especially ones that are state-owned. Without such contacts it would be very difficult, if not impossible, for a newly established foreign company to gain market share reasonably quickly. This is the main reason that most of the foreign investment in power cables, for example, has been in joint venture with local companies. Typically, the local company already has a market presence and wants to expand its product range with the support of a foreign partner. The need for a local partner may be encouraged by pressure from the government, for example through withholding approval of investment proposals.

 

WOFE for OEM or Export


If the Chinese operation that is to be set up by a foreign cable-maker addresses other foreign companies in China (e.g. OEMs), then the need for a local partner is limited. When the Chinese OEM is a subsidiary of a group with a global organisation, the foreign cable company will already have established relationships with the procurement department of the group. The key task for the Chinese cable operation will be to achieve the stringent quality and delivery requirement of the OEM in China, and a local partner is unlikely to make a major contribution to this. The same consideration applies even more strongly if the Chinese cable-making operation is aimed at export markets, as in this case many of the customers will already be served by the cable-maker from operations outside China.

 

Minority Stake Carries Risks


Buying a minority stake in a joint venture requires less commitment in terms of the investment required by the foreign company, but carries more risk in terms of the foreign investor’s inability to control key decisions. Even if the objectives of the partners appear to be aligned when a joint venture is established, the interests of the parties may diverge as time goes on. A carefully constructed shareholders’ agreement may reduce, but cannot eliminate, the risk. Even where foreign investors have majority ownership, they would probably feel nervous because the local partner has a strong influence on key areas of the business. Foreign commentators often state that the Chinese legal system cannot be relied upon to make unbiased judgements in case of disputes between Chinese and foreign companies; more realistically, if a dispute between joint venture partners escalates to the point where it reaches the courts for settlement, then the joint venture would in any case already be doomed to failure.

 

Gradual Approach


There are some instances where the foreign partner has started with a relatively low share of a cable-making joint venture, then at a later date increased its share, either by buying out part or all of the shareholding owned by a local partner or through injecting more equity. This step-by-step approach has the advantage of limiting risk at the early stages, when the success of the operation may be in doubt, but allows the foreign company to take a higher share (or even 100% ownership) once confidence has been gained that the business can operate successfully in the Chinese market.

 

Partnership with Customer


In some cases cable-making joint ventures have been established that involve not only a local cable company but also a potential customer. Instances of this approach have occurred when electricity utilities have become a shareholder in power cable joint ventures. The motivation for this approach is more likely to be from the Chinese side than from the foreign investor, as it echoes the earlier times when there would have been a network of state-owned enterprises, closely integrated at a provincial level. This approach is not common elsewhere in the world, though there are some other examples (e.g. Malaysia and Vietnam) where power utilities are involved in manufacture of electrical equipment.

 

Equity Contribution from Plant


With markets outside China at times affected by deep recessions, one option that has sometimes been available for foreign companies has been to reduce surplus production capacity elsewhere by transferring cable-making equipment to China. The value of the second-hand plant may form part of the equity contributed by the foreign company into a joint venture, if this can be agreed with the Chinese partner. Chinese partners may, however, be reluctant to accept second-hand imported plant, as they will generally prefer to buy in the best technology, which usually means new equipment. Furthermore, new equipment is often available much more cheaply from Chinese producers than plant made by international equipment suppliers.

 

Location Critical …


As much of the recent economic development has taken place in the eastern provinces of China, most foreign cable companies have set up operations in these areas. Location close to customers is clearly important for producers who need to supply OEM customers on short delivery timescales. Consequently, manufacturers of products such as auto cables and winding wire are located close to their customers, and these are mostly based in a few major cities in the eastern part of China. To minimise delivery times and reduce transport costs, cable-making businesses with a strong export orientation are also likely to locate in areas close to the major ports of eastern China.

 

… Or Not So Critical?


There is not such a strong need for cable manufacturers whose main market is infrastructure development projects to be very close to their customers, but it is clearly still an advantage to be reasonably close. As transport systems in China have improved greatly in recent years, especially with construction of major new highways, it is possible for cable-makers to supply power cables, for example, to utility customers in distant provinces.

 

Location also Affects People


A foreign company locating in China also has to consider the impact that location has on the ease of managing the business. It would be difficult to recruit foreign managers to work in remoter or less developed locations unless the duration of contracts is short or very high incentives are offered. This issue is less of a problem now than it was a few years ago, as second tier cities in China have developed, with much improved amenities. In addition, the increasing availability of good Chinese managers has reduced the need for foreign expatriates.

 

Supply Partnership Agreements


There may be alternatives to buying into an existing Chinese cable manufacturing operation or establishing a new one. In some circumstances, where the main objective of the foreign company is to have a cheap source of cables or accessories, it may be sufficient to have a supply agreement with an existing cable manufacturer. There is no investment risk in this approach, but the downside is that the supply chain needs to be very tightly managed. If this type of relationship can be sustained, with benefits to both sides, it may not be necessary for the foreign company to have an equity stake in the Chinese operation.

 

Technical Assistance Agreements


International groups may choose to set up technical assistance agreements with Chinese companies without necessarily taking on any commitment in terms of investment. The foreign company would get the benefit of technique fees, while the Chinese company would receive technical know-how and sometimes also management support in improving its business. As one of the aims of the technique transfer is to improve product quality, the foreign partner also has the potential to develop a supply partnership the Chinese company with some confidence that the latter will be able to avoid major quality lapses.