CONTENTS
1 INTRODUCTION
2 POTENTIAL AREAS OF TENSION WHEN SETTING UP
A JOINT VENTURE IN A LDC
Political Environment
Protection of Business Property Rights Economic factors
Cultural factors
3 SETTING UP A JV IN A SPECIFIC LDC - CHINA
Political Environment
Protection of Business Property Rights Economic factors
Cultural factors
4 CONCLUSION
1 Introduction
This report is concerned with the specific problems that might arise in joint ventures (JV) between western companies and companies from developing countries.
After a general introduction in the subject matter of JV this report shows main “problem areas” for these kind of JV and examines them on a specific developing country - the peoples republic of China.
By knowing of these pitfalls and taking them into account a company investing in a JV is able to avoid mistakes. JV in developing nations suffer from greater instability than those in developed nations1. The outcome of this paper is a practical hint for going into JV in China.
An often used way to enter a market in a LDC is setting up a JV. This report concentrates on equity JV which in contrast to contractual JV create a new entity (“the child”) through capital commitments by two or more parent companies2 where ownership and control are shared.
The advantages of JV are numerous. JV allow a lower level of investment, to share costs and reduce risks. The partner gain mutual benefits and synergies by sharing their assets. According to a study the major contribution of MNC in JV between developed and developing country firms is its manufacturing technology, product know how, patents, business expertise, technical training and management development. The main contribution of the local partner include capital, knowledge of the local environment, financial institutions, local suppliers and labor unions and local marketing capabilities3.
Joint ventures could provide an important stimulus to the growth of Third world economy and also their multinationals4.
2 Potential areas of tension when setting up a joint venture in a LDC
Political environment:
The regulatory environment for JV varies considerably among countries. Generally spoken in developed nations the JV regulation focuses more on the competitive effects of strategic alliances. In less developed countries, however, regulation is extensive, concerning for example the allowable percentage of foreign ownership, local and foreign management rights, necessary government approvals, percentage of local content in produced goods, import controls, royalty and dividend levels5.
In many LDC joint venture are the only legal way for foreign investment. JV with local investors are preferred instead of branches or wholly owned subsidiaries. Often the law allows the foreign investor to have no more than 49 percent[1] participation. Another possible government policy are “fade-out” agreements where foreign companies are forced to reduce their ownership to a minority position6. Both might result in a lack of control and decision- making power for the western company and complicates the integration of the JV into a wider international strategy.
Some contract, such as JV and import of technology, often require government approvals and/or authorized signatures. Contracts without these approvals are void7.
The political situation in some LDC is instable or changing. Furthermore there might be a tension between the relationship of that LDC and particular foreign countries. This strongly [1] In China, for example the average foreign equity ownership is less than 50 percent (Y. Pan; “The formation of Japanese and U.S. equity JVs in China”, Strategic Management Journal, vol. 18, p. 249)
affects the way of doing business for a JV with a western partner for example in getting governmental approvals.
Protection of Business Property rights:
Of special concern when doing business in LDC is the protection of intellectual property rights. LDC sometimes see intellectual property law as a unfair barrier for economic and cultural development and socialist legal systems have historically been less concerned with this issue.
There is no international law, only some multinational treaties affect the protection of intellectual property rights. The jurisdiction and the enforcement is generally local in scope. That means if someone infringes a intellectual property right the holder of the right has to bring suit under the law of the place of infringement.
The protection of patents is also local in scope and patent laws differ in length of protection, obtaining procedures, and scope of protection. Countries might not recognize patents in biotechnology products (genetically engineered animals) and especially LDC might not recognize patent rights in pharmaceutical products8.
The protection of patents is important in the case of technology transfer or licensing to LDC. Similar problems arise in the protection of copyrights, trademarks and trade secrets. Just as governments create property rights they also can destroy those. Especially in developing nations western companies have to watch out for this problem. Is private property accepted? How stable is a political system?
Economic factors:
Scarcity of convertible currency:
Many LDC are faces by a lack of convertible currency. That might arise problems for paying necessary imports for supply, royalty payments and the transfer of earned profits to the western partner of the JV.
Governmental regulations and barriers in currency exchange are very often the result. A way to come along with that problem is to substitute goods for currency (countertrade) and to substitute imports by producing goods locally (localization). Both, however, are faced with two threats: the product quality which is often not the one the western company expects and the delivery reliability9.
Lack of control:
The character of a JV is to share ownership and control. Often the ownership is even limited by law below 50 percent. But for some firms it might be necessary to retain control (information, decision making). In this situation differences in opinion often lead to a fail of the JV10. But despite these laws, control with a minority ownership is still feasible by means of a management contract in all or specific areas (e.g. filling key-position in the firm by own manager).
Product selection:
The selection of a suitable product is a key factor for the success of the JV. Even more in LDC where the western company entering a JV is confronted with an uncommon environment. Main factors in this context are government policies, availability of local supplier, localization possibilities and the technology level of the partner11. But also the customer demand and taste has to be considered (production for export versus local sells)
Technology transfer:
The selection of the used technology for the JV is determined by several factors. For example skills of the available workforce, possibility of maintenance, laws protecting intellectual property rights, governmental regulations concerning imports and the used technology influence the planning of JV much more in LDC than in DC.
The transfer of technology, patents, know how and trademarks may be covered by license agreements and is often depending on government approvals. An area of tension is regularly that approvals for licensing of “outmoded” technology (reasons: lack in intellectual property protection, maintaining, skills of available workforce) are less likely to achieve than for current technology.
Additionally western companies are sometimes concerned that the foreign partner could develop to a potential concurrent after the transfer of advanced technology.
Finally payments (royalties, imports) are often forced with the problem of hard currency scarcity in LDC.
Cultural factors:
Culture is a characteristic of a collection of individuals who share common beliefs, values, rules, ideas etc12. It influences a business in every business field (marketing, production etc.) because everywhere there are individuals involved (employees, customer, supplier etc.). However, culture is so broad that it is impossible to give a complete overview about every aspect that has to be considered by a successful company. But it is important to be aware of differences in culture. It is always recommendable to ask for experienced advise before and during doing business in unknown cultures.
3 Setting up a JV in a specific LDC - China
Political environment:
China’s economic system is a mixture between market economy and centrally planned economy. A huge amount of companies is still state owned and are protected from market forces by the state13. Probably also the JV partner might be state owned.
China’s bureaucracy system is very complex and reach in almost every aspect of economic life. Furthermore the structure of the Chinese bureaucracy is changing rapidly14. Additionally the Chinese government is decentralizing the power to local authorities for facilitate the market. Without locally experienced advice it will be almost impossible to see through the extensive system of regulations, bureaucracy and competencies.
Most activities that are related to foreign investment projects (including JV) need governmental approvals. There are several regulations existing. The “regulations for the implementation for the Law of the People’s Republic of China on Chinese-Foreign Joint Ventures”, for example, rules that products of JVs can be sold within Chinese territory only if they are urgent for the country, if they provide important technological advantages for the formation of sophisticated products or/and if the products are of high quality and competitive15.
Besides getting a fast government approval, the fulfillment of these criteria is important for obtaining low tax rates, guaranteed supply or arrangements for marketing and forex. In general, the Chinese government gives more importance to the JV which can contribute for example advanced foreign technology, a large export contribution or import substitution benefits. However, an investors has to be aware of possible changes in the Chinese industrial
policy which are regarded to specific developments. For example an approval for assembling TVs in China will not be given after the production capacity rose to fast except if advanced technology will be introduced16.
An further example of change in the Chinese industrial policy is the introduction of the tax reforms for foreign projects in 1994. With this new system the Chinese government wanted to create a more equal tax basis for the local firms and JVs, to simplify the tax system, to increase the share of taxes for the central government and to have a better instrument for central control and for steering economic development. This reform means that some of the former favorable regulations for JVs have been ended (e.g. now JVs have to pay duties and VAT on imports of capital machinery)17. So for some industries tax advantages for investment in China might not be available anymore.
There are also changes in the way the property of companies is governed. Many former state owned businesses get privatized. It is important to assure in the contract that the Western partner has the preferential right to buy shares. If not, other parties could buy shares and could get influence in the JV18.
An actual factor of political uncertainty is the trouble between China and Taiwan after the elections in Taiwan. China is threatening with military violence in the case of further independence ambitions of Taiwan. There are several possible influences on a JV in the case of a conflict including sanctions.
Protection of Business Property rights:
China introduced a patent law in 1985 but there is still doubt if this law offers an effective protection. In particular, it is practically impossible to sue the state; a state owned business or someone who has good political relations19 20.
Concerning government takings of private property the western partner has should watch out for treaties between his home country and China. For example in the case of Germany there is since 1983 a treaty existing which protects German owned property for governmental takings. One exemption is takings which “benefits the society”. Here the treaty rules compensations21.
Economic factors:
Scarcity of convertible currency:
A JV in China has several possibilities by law to balance its foreign exchange. They include earning hard currency through sells, compensation between JV and credit from foreign banks22. So, besides earnings through exports also localization can solve the foreign exchange problem. Other possibility will be a favorable government treatment via swap market, at least as a short-term strategy23.
Product selection:
There are several factors a company setting up a JV in China has to take into consideration when choosing a suitable product. Some important are: the market demand, the government police, the availability of local suppliers and the Chinese partner’s technology level. Huge parts of the population of China are not potential customer for industrial consumer goods, 80% of China’s population is living on the countryside. To reach them is because of the deficient infrastructure (communication and transport system, energy supply) quite difficult. Also the financial situation of these people might be weak24. So a suitable product for a western market might be not suitable for the Chinese market (e.g. price, maintenance ...). However on the other hand just the larger cities represent a total of 100 million households, and this is a market equivalent in size to that of the U.S.25.
Some facts about the Chinese governmental policy are already mentioned above (political environment). Additionally it should be mentioned that localization is stressed in the government’s rules (local content). The localization process is a very important factor for getting government approvals for setting up a JV in China26. Which percentage of the finished product is actually made in China? Here a JV is probably faced with the problem of finding reliable and suitable local supplier. The most important reason for the lack of qualified local supplier are: The high switch costs: Normally the local suppliers don’t want to shift from current customers to the new customers because most of the demand of a JV is for components and materials which are new for them, it also involves small quantities and costs are often higher than expected. An unbalanced price system: The local price system is not consistent with the international one. Although local sources are expected to be cheaper than the international market it is often not the case. The poor infrastructure: There is often a lack of communications facilities, insufficient energy supply and transportation. In particular the supply of electricity and water has to be obtained by extensive negotiations with governmental officials27.
Further the western company has to consider the Chinese partner’s technology level. In many cases the available equipment is not suitable for the new product. In China, the traditional process has a low degree of automation, and the ground plan and factories are not in line Western production methods28.
Even taking into consideration the market demand, the government police, the availability of local suppliers and the Chinese partner’s technology level, very often negative factors might arise. There is for example the problem that the local supplier cannot meet a JVs requirements, the forex is not in balance due to small export and slow localization and/or the Chinese partner is slower to assimilate the technology than expected29.
Technology transfer:
The western firm often hesitate to introduce the most advanced technology to their Chinese partner. At the same time, the Chinese often overestimate their ability in assimilating product technology and improving local supply. Also there is a doubt about the security of the technology property rights.
Some countries, like Japan, are worry about a possible technological grow of the China because they will be a very serious international competitor.
Further there is a shortage of suitable trained and educated workforce in China. Further more than 70% of the higher-educated people in China are employed in academic fields and it is difficult for them to move to JVs because of the rigid employment policy30. This problem is quite difficult to solve. And probably the western partner has to train the workforce. Applying advanced technology, however, might be a argument for getting the desired government approvals. But it has to be considered that the selection of the Chinese partner has great influence on the success of the technology introduction.
Cultural factors:
China is a non-western country with a culture often completely different from a western one. Instead for Japanese firms it is much easier to develop connections and work with Chinese counterparts because of the cultural similarities and the small geographic distance31. This phenomenon is also supported by a research which shows that Hong Kong partners have far less problems in China than American and European partners who always complained about external environment and Chinese partner32.
However the differences are a source for many possible pitfalls for a western - non-western JV. Taking cultural differences in consideration and being aware of them is the best way to handle with this problems (prevention instead of cure). Some quite important points are the following.
China has officially rejected religion, but still, like in Japan, the Confucian attitudes play an important role. In the Confucian tradition involving formal law is a step of last resort. Instead, the Confucian standards of honor involve the respect of hierarchy and relationships (the inferior honors the superior) and the people try to behave in a honorable ethical way33. That is reflected also by the way of solving disputes, which includes a series of steps to resolve problems out of court (consultation, mediation, and arbitration)34.
There are some specifics in the Chinese way of decision-making. Controversial points are discussed, until a result appears, which is acceptable for the whole group (consensus principle). It is not advisable, in particular not during the JV negotiation, to shorten this process by democratically means (“vote is divorce”). Delays in the negotiation might be the result35.
If we look at the partner in a JV and their executives, then we see that these executives often bring their private considerations to the JV operations. Most Chinese top manager stay only for a couple of years in their position and therefor drive a short-term strategy with concentrating on short-term success without considering possible future loss36. A development in the attitude of Chinese is that people get more interested in making money and less interested in being involved in political affairs. The whole business climate is changing and gets more “realistic”. That supports the shift from a planned economy to a more market orientated one37.
4 Conclusion
Prevention is better than cure. Being aware of pitfalls helps avoiding them.
It can be said that the attitude of the Chinese regulatory system towards JVs in general has become stricter (e.g. JV approvals only for certain industries) and several aspects of the business environment in China are changing rapidly (e.g. Chinese competitors, tax benefits system). Further the culture and business environment in China is so different from the western one that a western company that wants to settle a JV in China should at first always ask for locally experienced advise for example by a consulting company. But also the Chinese business partner has to be chosen very carefully. He should know how to do business in China but he also should be able to perform with satisfying price, quality, services and products.
To still enjoy tax benefits it is advisable to start a JV in China as soon as possible, after making the investment decision, because it seems that several tax benefits will be finished soon.
For several issues there are governmental approvals necessary or regulations affect the way of doing business in China. So it is advisable to maintain a good relationship with government officials. Also therefor a locally experienced partner can contribute help.
Last but not least awareness of changes in the political and legal environment in China is necessary (e.g. trouble between China and Taiwan). Business strategies and organization must retain enough flexibility to allow for surprising changes in laws and government policies38.
[...]
1 Dr. X.F. Jia, “Joint ventures and wholly owned subsidiaries”, reader p. 26
2 Dr. X.F. Jia, “Joint ventures and wholly owned subsidiaries”, reader p. 16
3 Dr. X.F. Jia, “Joint ventures and wholly owned subsidiaries”, reader p. 25
4 Dr. X.F. Jia, “Joint ventures and wholly owned subsidiaries”, reader p. 21
5 C. Hotchkiss, “International law for business”, p. 276
6 Dr. X.F. Jia, “Joint ventures and wholly owned subsidiaries”, reader p. 25
7 C. Hotchkiss, “International law for business”, p. 94
8 C. Hotchkiss, “International law for business”, p. 306
9 Ball, McCulloch, “International Business”, p. 556
10 Dr. X.F. Jia, “Joint ventures and wholly owned subsidiaries”, reader p. 26
11 E. J. de Bruijn/ X.F. Jia, “Managing Sino-Western JV: product selection strategy”
12 A.W. Harzing & J.v. Ruysseveldt, “International Human Resource - an integrated approach”; p.127
13 E. J. de Bruijn/ X.F. Jia, “Managing Sino-Western JV: product selection strategy”
14 C. Hotchkiss, “International law for business”, p. 92
15 E.J. de Bruijn/ XF. Jia, “Managing Sino-Western JV: product selection strategy”, reader p.37
16 E. J. de Bruijn/ X.F. Jia, “Managing Sino-Western JV: product selection strategy”;reader p. 38
17 E. J. de Bruijn/ X.F. Jia, “JV in China face new rules of the game”; p. 52
18 E. J. de Bruijn/ X.F. Jia, “JV in China face new rules of the game”; p. 54
19 J. Zentes “Ost-West Joint Venture” p. 206
20 Prof. de Bruijn
21 J. Zentes “Ost-West Joint Venture” p. 205
22 J. Zentes “Ost-West Joint Venture” p. 204
23 E.J. de Bruijin/ X.F. Jia,”Managing Sino-Westerm JV: product selection strategy”; reader p. 39
24 J. Zentes “Ost-West Joint Venture” p. 207
25 R. Mills and G. Chen, “Evaluating Chinese Joint Venture Opportunities Using Strategic Value Analysis”, in journal of General Management, vol. 21; p. 1.
26 E. J. de Bruijn/ X.F. Jia, “Managing Sino-Western JV: product selection strategy”;reader p. 36
27 E. J. de Bruijn/ X.F. Jia, “Managing Sino-Western JV: product selection strategy”;reader p. 37
28 E. J. de Bruijn/ X.F. Jia, “Managing Sino-Western JV: product selection strategy”;reader p. 39
29 E. J. de Bruijn/ X.F. Jia, “Managing Sino-Western JV: product selection strategy”;reader p.40
30 E. J. de Bruijn/ X.F. Jia, “JV in China face new rules of the game”; reader p. 51
31 Y. Pan; “The formation of Japanese and U.S. equity Joint Venture in China”, Strategic Management Journal, vol. 18, p. 253
32 F. Ying, “Research on Joint Venture in China: progress and prognosis”; p. 79
33 C. Hotchkiss, “International law for business”, p. 88
34 C. Hotchkiss, “International law for business”, p. 94
35 M. Köhler / G. Wäscher “Erfahrungen deutscher Unternehmen beim Aufbau von Joint Venture in der VR China - Ergebnisse einer Umfrage”; ZFBF, vol. 41, no.2; p. 151
36 E. J. de Bruijn/ X.F. Jia, “Managing Sino-Western JV: product selection strategy”; p. 38
37 E. J. de Bruijn/ X.F. Jia, “JV in China face new rules of the game”; p. 51
Frequently asked questions
What is the report about?
The report is concerned with the specific problems that might arise in joint ventures (JV) between western companies and companies from developing countries. It focuses on equity JVs where ownership and control are shared through capital commitments by two or more parent companies.
What are the advantages of Joint Ventures (JVs)?
JV allow a lower level of investment, to share costs and reduce risks. The partners gain mutual benefits and synergies by sharing their assets. Major contributions of MNCs include manufacturing technology, product know-how, patents, business expertise, technical training and management development. Local partners contribute capital, knowledge of the local environment, financial institutions, local suppliers, labor unions and local marketing capabilities.
What are the potential areas of tension when setting up a JV in a LDC?
Potential tension areas include the political environment (regulations on foreign ownership, government approvals), protection of business property rights (intellectual property laws, patent recognition), economic factors (scarcity of convertible currency, lack of control, product selection, technology transfer), and cultural factors (differences in beliefs, values, rules, ideas).
What are the economic considerations regarding convertible currency in LDCs?
Many LDCs face a lack of convertible currency, which can cause problems for necessary imports, royalty payments, and the transfer of earned profits. Solutions can include countertrade (substituting goods for currency) and localization (substituting imports by producing goods locally).
How does the selection of the product influence setting up a JV in a LDC?
The selection of a suitable product is a key factor and consideration must be made for government policies, availability of local supplier, localization possibilities and the technology level of the partner as well as customer demand and taste (production for export versus local sells).
What cultural factors should be considered?
Culture influences every business field, because everywhere there are individuals involved (employees, customer, supplier etc.). It is important to be aware of differences in culture.
What are the specifics of setting up a JV in China?
China's economic system is a mixture between market economy and centrally planned economy. Bureaucracy system is very complex and reach in almost every aspect of economic life. Most activities that are related to foreign investment projects (including JV) need governmental approvals.
What are specific regulations regarding products of JVs in China?
According to “regulations for the implementation for the Law of the People’s Republic of China on Chinese-Foreign Joint Ventures” products of JVs can be sold within Chinese territory only if they are urgent for the country, if they provide important technological advantages for the formation of sophisticated products or/and if the products are of high quality and competitive.
What are the factors to take into consideration when choosing a suitable product when setting up a JV in China?
Some important factors are the market demand, the government police, the availability of local suppliers and the Chinese partner’s technology level.
What are specific cultural factors to be aware of in China?
China is a non-western country with a culture often completely different from a western one. Instead for Japanese firms it is much easier to develop connections and work with Chinese counterparts because of the cultural similarities and the small geographic distance. Confucian attitudes play an important role. Also, Controversial points are discussed, until a result appears, which is acceptable for the whole group (consensus principle).
What is the conclusion of the report?
Prevention is better than cure. Being aware of pitfalls helps avoiding them. If a western company that wants to settle a JV in China should at first always ask for locally experienced advice. Business strategies and organization must retain enough flexibility to allow for surprising changes in laws and government policies.
- Arbeit zitieren
- Steffen Zacharias (Autor:in), 2000, Joint venture between western countries and companies from developing countries - specific problems, München, GRIN Verlag, https://www.grin.com/document/98824
