|
Don't
let inept due diligence bring tears to your China operations!
In
Western society, ulterior motives are like the skin on an apple, peel
it off and you've found the hidden motive. Not
so in China, now you're dealing with an onion, with many layers.
Does your company invest or donate its money? Street-smart Western
multinationals would no more invest in a company without due diligence
than give a blank corporate check to a druggie, or would they?
Not in the Western markets perhaps, but mention investment in China,
and all the MBA taught caution is caste to the winds. Company after
company are currently pulling out of China, usually with losses in
the area of forty to a hundred million dollars.
One
of the latest victims of the "Chinese Benefit Scheme", a World leader
in domestic white ware, is presently taking action to terminate its
joint venture investment in China after only three years, leaving
the Chinese partner with a world-class plant capable of competing
with post-WTO Western imports well into the future.
Why?
Well, the Western company invested US$70
million in the Chinese joint-venture, built a state-of-the-art
plant, and left the running to the local partner. The plant never
reached more than eight percent of capacity, supposedly because the
local partner couldn't operate it. Yet, Chinese are generally known
globally for their business acumen!!!!
Management
was left entirely up to the local partner with the foreign partner
providing only technical support and a financial supervisor. Only
in the third year did they put
in a Western manager. By that stage, the Chinese partner effectively
had control over the operation and was utilising the facilities for
their own business plans. Needless to say, after a great deal of frustration
and irreconcilable differences in business objectives and motives,
the Western firm decided it was easier to write-off a loss of US$42
million rather than pursue the lucrative China market in
their current form.
So,
was this necessary? Is investment in China, the World's biggest market,
something to be avoided?
Not at all, taking a calculated risk is what business is all about.
Note the word "calculated" is used advisedly, as business decisions
inherently should be based on sound information. The MBA courses may
quote this as a case study, but will anyone tell students how much,
or how little due diligence was done?
The truth is, that it is unlikely, as the mother-company's board will
rationalize everything into corporate history, citing the Chinese
as the bad guys. Perhaps they should cite them as the smarter partner.
Due diligence is much wider in scope than is generally realized. Making
a substantial investment in getting to know the prospective Chinese
partner, or the proposed market, is not money that should be begrudged.
It is imperative to seek answers to vital questions in areas such
as management, legal issues, overall concept, market, capital requirements
and financial statements.
Management. Who are the management team? Have they worked
together before and are their ideas compatible? What
experience does each member bring to the table, and is it relevant?
What is the focus of each member? Is the team complete?
Legal
Issues. Is the investment in China legal? Are there any restrictions
imposed on that particular industry within China? Is the company operating
within the scope of the business
(i.e. is the company acting ultra vires?)? Has the Chinese partner's
fixed assets, to be used as capital injection into the new company,
in fact actually been pledged to the bank? Have the land rights been
granted the appropriate land certificate? Are there any restrictions
on the company's land-use rights?
Concept.
What is the overall timetable for the project? Will the product have
a competitive advantage in the Chinese market? Are there Intellectual
Property or Patent and Trade Mark
issues? What are the local business regulatory issues, and does the
plan allow enough time for these to be resolved?
China
is not a country where the Rule-of-Law predominates. Many
regulations are contradictory and often rely on the goodwill of a
bureaucrat who may have other interests at stake. Although corruption
is widely believed to be endemic in China, it is often sublime to
outside observers and the Government is actively fighting to control
it from surfacing in the business community.
Given
all of that, time is a very real factor, and Westerners used to the
speed of business in developed nations are often frustrated by the
multiplicity, and the seemingly overly bureaucratic state of government
departments.
Market. And what about those cash
flow and production projections? What data are they based
upon? What are the estimates of the need for the company's products
or services? What market research has been done, and has it been analyzed?
What
are the competitive advantages
of the company's products/services in the China market? What are the
future marketing strategies? What is the pricing strategy? What
about the competition?
Capital
requirements. How much funding will
be required now, and into the future, and how will the
financing be structured? Will additional funding be needed and, if
so, when, at what stage in the project and from who?
Financial
statements. It is important to have three to five year projections,
and for established companies, historical records going back for the
same period. It is also imperative to understand the financial position
of the Chinese partner, including whether the statements are presented
in a "true and fair" manner. Similarly, are they in accordance
with International Accounting Standards? In other words ... "are
the books cooked?"
Investigate.
Last, but not least, investigate your proposed partner, using an investigator
who is able to check through different channels. This is in addition
to due diligence on the
proposed joint venture partner and its owners.
So
how do foreign companies sort out this Gordaean Knot?
Firstly,
by getting the right advisors. With
China's outdated accounting system, bureaucratic controls, lack of
legal transparency and its fast changing regulations to make improvements,
seeking sound professional advice is paramount in setting up any China
operation. In the post-WTO
China it is easy to be confused. Whilst it is certainly recommended
that you seek the expertise of international firms
for such advice,
it is also just as important that such advisors have
proven China experience and
market-specific knowledge.
Secondly,
by conducting due dilligence. The key lesson learned is that, in China
especially, it is imperative that an in-depth "Complete
Business Due Diligence" be conducted before any firm
begins the "Long March" to the China market.
Otherwise
it could end in tears!
George
Scott-Kerr, LehmanBrown - Beijing.
|
