Bribery In China. Does Your Home Country Even Care?

Posted by Dan on July 29, 2010

Transparency International just came out with its most recent report on country enforcement levels against foreign bribery (h/t China Bystander). In other words, this is a report on how actively various countries enforce their laws against engaging in bribery overseas. Examples of these laws would be the Foreign Corrupt Practices Act (FCPA) in the United States and the United Kingdom Bribery Act. 

The report groups the 36 largest countries in terms of foreign trade into three categories: Active Enforcement, Moderate Enforcement, and Little or No Enforcement. Denmark, Germany, Italy, Norway, Switzerland, United Kingdom, United States engage in active enforcement.  Argentina, Belgium, Finland, France, Japan, Korea (South), Netherlands, Spain, and Sweden engage in moderate enforcement. Australia, Austria, Brazil, Bulgaria, Canada, Chile, Czech Republic, Estonia, Greece, Hungary, Ireland, Israel, Mexico, New Zealand, Poland, Portugal, Slovak Republic, Slovenia, South Africa, and Turkey engage in "little to no enforcement."

I had no idea there was such a disparity between countries like the United States (active enforcement) and Canada (little to no enforcement).  I am also surprised to see Italy in the active enforcement category and new Zealand and Austria and Australia in the little to no enforcement category. 

How advantaged in China business are those who come from little to no enforcement countries as compared to those who come from active enforcement countries?

Giving Gifts In China. Giver Beware.

Posted by Dan on July 27, 2010

The China Law Insight blog did an excellent post a few months back on the legal perils of gift giving in China. The post is entitled, "Offering Gifts of Travel and Entertainment in China - What if the Recipient is a State Functionary," and it nicely sets out the risks of giving business gifts.

The post starts out by noting how in the last decade, almost two thirds of the corruption cases that have resulted in penalties investigated by Chinese authorities have arisen from international trade or involved foreign business entities. Since I do not for a minute believe foreign entities engage in these sorts of illegal activities any more than Chinese entities and since the number of Chinese entities dwarfs the number of foreign entities, I view this as just another example of how foreign companies in China have to toe the legal line more closely than their Chinese counterparts.  

It is illegal in China to give "money or property" to a state functionary to obtain an "undue advantage." In large part, the risk stems from China's defining state functionaries to far more broadly than we typically think of that term in an everyday context in the West. State functionaries "includes persons who hold office in state organs, employees of state-owned companies and others who perform official duties according to the law. Foreign companies supplying infrastructure, teaching materials and hospital equipment in the Chinese market are examples of，those which deal with state functionaries on a regular basis.

Note however, that China's definition of a State functionary for corruption purposes may not be all that different from the definition used by the United States government for Foreign Corrupt Practices Act (FCPA) purposes.  For more on that, check out, "Understanding China FCPA Risks. Who Is A Foreign Official?"

China's courts define property as anything "that can be quantified with a monetary value."  This definition includes reimbursement of travel expenses and meals, so long as the provider had the requisite intent to obtain an undue advantage. Though the China Insight post did not mention this, the definition of property no doubt also includes paying for a government official's son or daughter to attend college in the United States or England, as is so often done.   

Though there is a minimum threshold amount for criminal prosecution, going under this amount does not guarantee you will not face a Chinese judge: 

In reality, there is a monetary threshold for criminal prosecution. According to the Threshold for Criminal Prosecution in Bribery Cases issued by the Supreme People's Procuratorate, the "property" offered as a bribe must be at least RMB10,000 for an individual or RMB200,000 for a unit, to justify criminal prosecution. However, these amounts may be taken cumulatively so that if meals or entertainment of a low value are provided on a regular basis (and for the purpose of obtaining an undue advantage), it will progressively attract criminal liability to the provider and eventually justify criminal prosecution.

However, according to Article 10 of the 2008 Opinion, prosecutors and judges must comprehensively analyze relevant information in addition to the value and purpose of giving a "property interest". The factors which they must consider include the past contacts between the provider and the recipient, whether provider and recipient are relatives or friends, the reason for and the occasion on which the "property interest" was given, whether the provider made any request in connection with the recipient's post, and whether the recipient actually rewarded the provider by using his or her post in a corrupt way. The purpose of this analysis is to differentiate, on the basis of the facts of the case, between legitimate gifts and bribes, both to state functionaries and otherwise.

There is an exception for small value gifts given as part of common commercial practices and "low-cost meal treats and related hospitality is unlikely to trigger an investigation ... if it is part of normal commercial practice. However, the provision of conspicuous or unusually expensive entertainment, such as a golf trip or a sightseeing tour, might attract attention."

Be careful out there.  

Shanghai As Global Financial Center, Or Just Another Seoul/Tokyo?

Posted by Dan on July 27, 2010

Excellent and thought-provoking article at Knowledge@Wharton, entitled, "Turning Shanghai into a Global Financial Hub: So Much to Do, So Little Time."  The article focuses on Shanghai's very public plans to become an International Financial Center by 2020 and debates whether that is going to happen: 

While Shanghai might be big, can it be international? A new Goldman Sachs report titled, “Shanghai in 2020: Asia’s Financial Centre,” argues that although the city will gain in importance, it is more likely to “become a large domestic market rather than a broader regional market.”

But that's not what city officials have in mind. They don't want Shanghai to be like Tokyo or Seoul, both of which are impressive and vibrant cities at the hearts of their respective nations but aren't -- as Shanghai wants to be -- at the absolute center of the global economy, whether in capital markets, trade or commerce.

For that to happen, Shanghai needs two things from the central government: The full convertibility of the RMB and the relaxation of controls allowing the free flow of currencies in and out of the country. 

Go here for more. What do you think?

Chinese Branding. From Moribund To ....?

Posted by Dan on July 26, 2010

As just about everyone knows by now, Chinese companies are generally not terribly good at marketing and sales, particularly in the United States. For every Haier or Lenovo, there have to be at least ten thousand Chinese companies with good products with no really differentiation from their competitors. How many of you living outside China can in two minutes or less name even five Chinese companies.

Those of us who do work for Chinese companies are constantly bemoaning the difficulty in getting Chinese companies to listen to us as to what it takes to do business in the United States. We see our Chinese clients failing to fulfill their promise in the United States and it greatly frustrates us. For some common reasons for these failures, check out this post, "Ten Reasons Chinese Companies Fail In The United States."  

So when I read today's Wall Street Journal article, "Chinese Firm Meets Global Branding," I was beaming for two reasons. First, with a bit of "hey I know those guys" pride, and second, with a bit of relief that there may in fact be some light at the end of the proverbial tunnel.  

The article is about a Chinese company called Changzhou Asian Endergonic Electronic Technology Company, which had the good sense to listen to its U.S. advisors and re-name itself Züuma(pronounced zoo-ma) for the U.S. market. Now before you laugh, let me stress this is no small feat. A few years ago, I worked on a joint venture deal that made complete sense but never took off because the Chinese company refused to market its home products in the United States using anything other than its own completely unpronounceable Chinese name, right during the zenith of the Chinese pet food scandal.  

Züuma (I have to confess I am not a big fan of the umlaot, but I'm guessing they are using it to convey German-ness/Swedish-ness) has been making GPS mounts and selling them to North American and European importers who market them under their own brands. Züuma makes about 40 cents off each mount, which typically sell for about $30 at retail.

Züuma's owner, Jack Yang, was smart enough to realize that if his company was to greatly increase its profit margins it would need to develop its own brand in the United States and, more importantly, that it would need to bring on top-notch American assistance to accomplish that. As Mr. Yang himself put it, he lacked the necessary knowledge of the U.S. market to conquer it on his own:  

"It's not that small- and medium-sized Chinese companies don't want to develop global brands," he [Jack Yang] said in a phone interview in Chinese. "We don't know how. We don't understand the U.S. market, culture or business model."

Yang ended up using Scott Markman of Chicago advertising agency Monogram Group, to help him "create his own brand and to get a richer margin." I have known Scott for years and we have spoken more than once about what Chinese companies must begin doing if they are to succeed in the United States.  

Markam pulled no punches with Yang, telling him, "You're very passionate about your product, your invention. Why make such a small margin?" Yang bought into the idea and Markham then brought on Michael Zakkour (with whom I have had similar conversations about Chinese companies developing as viable international businesses), managing director of China BrightStar, a China-sourcing company, to oversee marketing and distribution. To get around Mr. Yang's reluctance to pay full American rates, "Messrs. Markman and Zakkour reduced their fees and agreed to take a commission based on units sold."

The WSJ article then talks about the Americans jousting with Mr. Yang regarding the Americans putting long term goals over the short term profits Mr. Yang seems to crave, leaving readers to think the jury may still be out on this relationship. But hey, it is a start and I know that Scott and Michael have the U.S. expertise combined with the China knowledge to pull it out.

In my experience working with Korean and Russian companies, their willingness to do the right things to succeed in the United States pretty much went from "no" to "yes" without all that much forewarning. I always describe it as being like a light going from off to on.  

So maybe the light for Chinese companies has not yet been pressed, but this story at least lets me know that they at least realize they are in darkness.     

Why China Companies Are A Litigation Mark (As In Sucker), Part II.

Posted by Dan on July 26, 2010

The other day, in a post entitled, "Why United States Lawsuits Against Chinese Companies Are Trending Up. Just Follow The Money," I talked of how U.S. lawsuits against Chinese companies are rapidly increasing. That post posits various reasons why this is the case, focusing mostly on increased US-China trade and on an increase in Chinese companies with U.S. assets worth seizing.  

I just read a very thoughtful post that provides another really good explanation: Chinese companies do not hire the right lawyers. The post is entitled, "The Stakes Are Too High For China Not To Cooperate And Participate In Trade Remedy Disputes, And To Hire The Best Counsel," and though its focus is on anti-dumping cases against Chinese companies, its analysis has a much broader application.

The post talks of how Chinese companies that hire top counsel for their anti-dumping cases fare surprisingly well, while those who hire counsel based strictly on their low fees, virtually never win. The explanation for these disparate results is rather simple:

There is no guarantee, of course, that when a Chinese company spends more money on legal services it will necessarily get better results, but there are market reasons why some lawyers command higher rates than others: their time is in more demand, which means the market for services is recognizing their value. It may seem to a company an important savings to hire lawyers for $50,000 or even $100,000 less than lawyers from firms with greater reputations, but when a $100 million market is at stake, the savings on legal fees suddenly does not amount to that much and do not make sound commercial sense.

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Paying for the best available legal services is always better than trying to get through the case on the cheap, particularly when the cost is compared to what is at stake. It is always better to be flexible about fees because every possible contingency in the case cannot be anticipated in advance, and because there will always be unscrupulous lawyers (as there are unscrupulous businessmen) who will promise more than they can deliver, and will do as little as possible to earn their fees.

The post suggests Chinese companies employ the following tactics/metrics in choosing their United States counsel: 

How can Chinese companies win antidumping and countervailing duty cases? They first need to hire competent U.S. lawyers with experience and proven track records. The homework necessary to choose counsel is not simple, but again not impossible. They cannot listen to lawyers touting their own credentials without proof. They need to ask questions. Their focus, however, should be on the quality of the lawyers and their services, their reputation and their experience. It should not be only on price. Until recently, many trade remedy petitions were brought against merchandise from other countries. Respondents in other countries have never depended so much on the price of legal services the way Chinese companies have done, and there is a contrast in results that suggests powerfully that it pays to pay.

The post then talks of something else Chinese companies need to start doing to improve their chances before U.S. courts and administrative bodies; they need to start recognizing the seriousness of the proceedings:

Second, Chinese companies need to commit to cooperation with the investigating agencies and participation in every phase of the investigations. They need to commit resources and devote themselves to fighting hard to win. They need to consider the potential expense of defending their interests in the U.S. market against the potential value of losing access to the market. They need to think in the medium and long term, for once shut out of the market by an adverse outcome, it could take five years or more (the period awaiting a sunset review of an antidumping or countervailing duty order) to get back in. And they must know that, when their market access is challenged in the U.S., a challenge in Europe likely will follow, and vice versa. The global market means global challenges, and a problem in one place inevitably becomes, sooner or later, a problem in another.

All of the above is completely true. At this point, there is no doubt in my mind that Chinese companies (at least in my experience and that of my firm) generally handle United States litigation matters less effectively than companies from any other country, including those with less wealth and less international experience than China. There are many reasons for this, but until this changes, U.S. companies and lawyers are increasingly going to become aware of how Chinese companies have become litigation marks.  

For a somewhat related post, check out, "Ranking Creditors. China Comes In Dead Last," explaining how American companies put Chinese companies last on their payments list.

Why United States Lawsuits Against Chinese Companies Are Trending Up. Just Follow The Money.

Posted by Dan on July 23, 2010

I hate when I have to be vague for attorney-client reasons, but at the same time, I also hate not writing on something really pressing and important. The problem is that the times I have to get vague often correspond with those times when I have important and current information. This is one of those times.

There has in the last year or so, been an uptick in the number of lawsuits in the United States against Chinese companies. I do not have hard numbers to back this up, beyond the numbers of my own small law firm, but I have no reason to believe these are unrepresentative. This is happening for the following reasons, among others:

  •  There has been an increase in business between U.S. and Chinese companies;
  •  Lawsuits do not usually happen immediately after business relationships have been  established. They usually happen years after that, when business has reached a level  worth suing over, when the relationship has soured, and when it has become clear there  will be no resolution without court intervention. 
  •  Economic downturns tend to increase the likelihood of relationships souring and litigation  ensuing.
  •  More Chinese companies are doing sufficient business in the United States so as to  make collection of a United States judgment far more likely. I see this as the key  reason.  

Many of these lawsuits involve trade secrets and/or intellectual property. A good example is a lawsuit recently brought by Motorola against Huawei Technologies Co., "alleging a plot to steal the U.S. company's trade secrets." In an article entitled, "Motorola's Suit Poses Challenge for Huawei's Success," the Wall Street Journal talks of how this case "could complicate years of largely successful efforts by the Chinese telecommunications-equipment giant to demonstrate itself as an innovator in the industry."  Of course it could.

A Virginia Federal Court appointed my firm (really, one of my partners, Steve Dickinson, who lives and works in Qingdao, in Shandong Province) as a sort of special counsel to assist a Shandong, China, with its document production. I just learned today that the Virginia Court ended up finding that Chinese company liable for USD $26 million in damages, based on a finding of copyright infringement. For more on that case, go here. 

In one way or another, my firm is also involved in a number of similar cases involving Chinese companies being sued for breach of contract or IP infringement. Just last week, we filed a U.S. federal court case against a Chinese company, asking the court to recognize and enforce a Chinese court judgment here. That's right, we filed a case in the United States asking a U.S. court to enforce a Chinese court judgment against a Chinese company. 

Our judgment enforcement case probably best crystallizes why there has been (and will continue to be) such an increase in cases against Chinese companies in the United States. We brought this case in United States because we deemed the likelihood of success to be more favorable here than in China because the Chinese company against whom our client has the judgment ships millions of dollars of product into the United States every month.   

In many respects, the United States is a great place to bring a lawsuit. Though cases here can be expensive, our federal court system usually works very well and reasonably quickly. Many years ago, the Yomiuri Shimbum interviewed me for their story on the "Americanization of International Law," and I had this to say about the popularity of American courts:

The Americanization of Global law is also leading to a huge increase in foreign companies seeking to have their disputes resolved by using American lawyers or even bringing lawsuits in American courts. Dan Harris, a Seattle, Washington, based international lawyer told us about a case he recently successfully handled on behalf of a Russian Far East helicopter company. This Sakhalin Island helicopter company retained Mr. Harris to bring a lawsuit on its behalf in a Seattle Federal court to recover three helicopters taken from the Russian company in Malaysia.

"I am constantly contacted by foreign companies wanting to pursue their lawsuits in the United States," says Mr. Harris. I think the reason for this is that the American courts (along with those in England) are probably the most respected in the world. People know American lawyers are well trained and they know the American justice system is fair." Mr. Harris, whose firm's work is about 90% international (Russia, Korea, Japan, China, Vietnam, etc.) says he is most frequently asked by companies in emerging market countries to bring their lawsuits in the United States. Mr. Harris attributes this to the belief that they will be treated more fairly and get a quicker resolution in the United States than they would in either their home countries or in the countries of their adversaries.

Chinese companies have become relatively easy marks in United States litigation because they typically have no clue how to handle a United States litigation matter. Just as these companies so often run their businesses outside of China just as though they are in China, so too do they tend to handle their U.S. litigation.

American litigation is nothing like litigation in China and here are some of the salient differences:  

  • Litigation moves fast in China. Really fast. It is not uncommon to file a lawsuit and have the trial and verdict within three months. In the United States, it is more like three years.
  • Generally speaking, in the United States, everything hinges on the witnesses. Documents are, of course, critical also, but you generally need a witness to get a document into evidence. In China, documents pretty much completely trump witness testimony. 
  • In the United States, one often files a lawsuit and then garners evidence through discovery from the other side to help prove it. In China, you are to a large extent stuck with the hand you have before you file your lawsuit.  
  • Forget about trying to bribe a U.S. federal court judge. Forget about it. In China, one always has to at least consider the "influence" of a particular party. 
  • In China, collecting on a judgment can be very difficult and once the court issues its decision, it does not have a lot of power to aid in collection. China Hearsay just this week did a nice post on this, entitled, "Enforcing China Court Decisions, Help Is On The Way?" This is not true of United States courts, who do not take at all kindly to defendants they believe are skirting their obligation to pay. United States courts have all sorts of powers to enforce their judgments and they do not hesitate to use them.  

All of these things tend to cause Chinese companies to throw up their hands and treat U.S. litigation as they treat Chinese litigation, which means they tend to engage in the following conduct, which can be detrimental to their cases here:

  •  Failing to understand the time and money needed to engage in litigation in the United  States.
  •  Failing to understand the importance of complying with the discovery rules.
  •  Failing to understand that just because you have a well-known lawyer, you are not  necessarily guaranteed to prevail.
  •  Failing to understand that U.S courts enforce their judgments and that engaging in    convoluted efforts to avoid paying on a judgment is a great way to bring down the wrath  of the court against you.

The bottom line is that if Chinese companies are going to be doing business internationally, they are going to have to get used to the idea of being sued outside of China and they are going to have to start realizing they are not in Canton (I know Canton is now Guangzhou but I wanted to pick a place that sounded as much like "Kansas" as possible) any more.  

What more can I say....

Ten Reasons Chinese Companies Fail In The United States.

Posted by Dan on July 22, 2010

Had a piece published yesterday on the Forbes China Tracker, entitled, "Ten Reasons Chinese companies fail in the U.S." I reprise the Forbes article below and then I add to it by discussing a very insightful e-mail exchange I had in response to it.  

 

A couple of years ago, I did a post on my blog listing my 10 reasons why Chinese companies were failing in the United States.

In response to that post, Nina Ying Sun at the Plastics News Blog did her own post entitled "Why Chinese Companies Fail the US Market," explaining, agreeing on and challenging the items on my list.

I then did a new post, entitled, "Why Chinese Companies Fail in the U.S., Part II," responding to Ms. Sun. Someone just tweeted on this post and when I followed the link and read it again, I realized nothing has changed.

Chinese companies are still failing in the United States at what I see as an alarming rate--and the reasons I see for that have not changed a bit.

Here is my list, with Ms. Sun's comments and then my comments on Ms. Sun's comments:

1. Chinese companies focus on a Chinese consumer, not an American one.

Ms. Sun's comment: "Chinese companies would like to find out more about their target American consumers, but they mostly rely on personal-level approaches to collect business information, lacking a systematic and scientific market investigation conducted by professional Westerners that understand the market."

My comment: Very interesting and, I think, accurate observation. Chinese clients have driven me nuts by asking my views on things that I know nothing about, and then completely ignoring my advice when I try to hook them up with real experts. The following are typical conversations:

Chinese client: How much should we pay for that U.S. trademark?

Me: I have absolutely no idea. I just do not know such business well enough to be able to help you at all on this. But, we have worked with a company that does nothing but value IP and I would be happy to give you their name.

Chinese client: But what is your best estimate?

-------

Chinese client: Should we start out selling our product just on the West Coast or should we start out nationally?

Me: Good question. Difficult question. It seems to me the answer to this will hinge greatly on the costs involved and on your ability to set up distribution networks. My firm does not handle questions like this (and even if we did, I do not think it would make sense for you to pay law firm rates for this information) but I would be happy to refer you to top notch business consultants who do.

Chinese client: Should we start out in Los Angeles, Chicago or New York?

2. Chinese companies fail to realize that one reputation-damaging mistake in the United States could doom them forever here.

Ms. Sun's comment: This one is dead-on. And how come they don't realize this common sense? Because they get by in China and assume it's the same in the States.

My comment. Exactly.

3. Chinese companies fail to realize it will take time for them to make an impact in the United States and they are unwilling to spend the time and money necessary to do so.

Ms. Sun's comment: Chinese people take such pride of the fact that industrialization, urbanization and modernization have happened in China in a much shorter period time than in the West that they believe, if you try hard enough, everything can be done fast and well. Why don't they invest enough money to lay the ground work for the new market? Well, they look at the exchange rate. The same exchange rate that makes the Chinese production cost in yuan seem so low magnifies the marketing cost in dollars in the States.

My comment: Okay. But see number two above. Haste oftentimes makes waste.

4. Chinese companies focus too much on the end result (making money), and by doing so, they sacrifice the professionalism that would allow them to achieve long- term success.

Ms. Sun's comment: The Chinese would ideally like long -term success. But the drastic social, economic and political upheavals and changes in the past century have paralyzed Chinese people's long-term thinking. Fill the pocket as full as possible before the next change hits, be it credit policy, industry standards or consumer interest.

My comment: Absolutely true. Why think long term if there may be no long term? This explains the reason for the problem, but it still needs to be resolved.

5. Chinese companies tell users what they want instead of listening to users.

Ms. Sun's comment: This obnoxious mentality is a hangover of the old Soviet-Union-style "planned economy" (1949-1978). That period of time featured insufficient supply of necessities and one-sided propaganda. Although it's hard to question about China running a market, capitalistic economy today, the country skipped some vital steps in the development of the Western countries.

My comment: Same as for number four above.

6. Chinese companies focus too much on making money in the short term, rather than on building the quality necessary to sustain themselves in the long term.

Ms. Sun's comment: What pops up in my mind includes: vicious and endless price wars, a business environment that has deprived consumers their say, and lack of technology and craftsmanship.

My comment. I agree, but what pops into my mind is that companies must be broad-minded enough to recognize that what makes sense in one country may not make sense in another. Indeed, one might even say this of China's regions and there are certainly plenty of Chinese companies that have managed to succeed in China as a whole by localizing their product or their marketing by region.

7. Chinese companies fail to understand how beauty and design might distinguish their product from that of their competitors.

Ms. Sun's comment: Traditionally, domestic consumers simply can't afford beauty and design. Price is the only distinguishing point. Plus, the companies don't want to invest much on design, because it's bound to be copied by competitors right away, thanks to the absence of intellectual property protection in China.

My comment: All true, but see my answers to Number four and number seven above.

8. Chinese companies rely too much on phone calls and face-to-face meetings instead of e-mail.

Ms. Sun's Comment: This is probably part of the Asian culture, underscoring personal communication instead of machine-generated and less interactive e-mail. I don't think it's necessarily a disadvantage though. Japanese companies have done well in the U.S. market, despite their preference for in-person meetings and phone calls rather than e-mail.

My comment. When in Rome..... But, I agree this may not be a disadvantage, so long as the Chinese company has the time and the people for it.

9. Chinese companies fail to use "simple and elegant designs."

Ms. Sun's comment: Unfortunately, they are trapped in between complicated traditional styles and a blank page of modern Chinese inspiration. Again, they can't justify investment on design, because it will be copied by competitors overnight.

My comment: See my comment to number seven above.

10. Chinese companies fail to realize their need to hire MBAs and those with local knowledge.

Ms. Sun's Comment: Call them cheap or arrogant. They don't trust MBAs or Western veterans unless foreseeable return is guaranteed. They also want everything under their control, not threats and risk brought by language barrier and different business values.

My comment: I don't know what to call this but I know it is not wise.

 

This morning, I received an e-mail from David Ho, a self-described Chinese American techie who did an excellent job flushing out some of the reasons for why Chinese companies are so reluctant to engage real experts to assist them in their United States market entry:

Really liked your article on the 10 reasons Chinese companies fail. Liked it so much that I felt compelled to give you my own personal feedback on #10 in which you claim Chinese companies fail to realize their need to hire MBAs and those with local knowledge.

I used to work for ... [a Chinese company] and from my first-hand observations, there are two reasons for this (failing to hire MBAs and those with local knowledge).

1. Many Chinese companies seem to place a high value on technical knowledge, smarts and ability. These company owners (or high level company managers) naturally continue to reinforce the value of technical, engineering or R&D and minimize the value of marketing, advertising (and other such “soft skills”).

2. When they do try to hire local market experts, Ms. Sun is absolutely correct that they simply do not trust the (often inflated) claims they hear from local business consultants. Due to either a language barrier or cultural barrier, they simply cannot evaluate who can provide results vs. who is selling snake oil. Invariably, they hire someone disreputable (but they don’t know it) and get burned by this experience which only reinforces their distrust of local market consultants.

Tied in with my observation #1, since there is no way to quantitatively evaluate the effectiveness of local market and business consultants, it just discourages them from even trying to hire those MBAs and local consultants you talk about and just focus on what they do understand and can accurately measure.

I agree with you when you say “I don’t know what to call this but I know it is not wise”, but until you can show your Chinese clients (in some kind of quantitative way) how to evaluate these local business and market consultants (so they know who is for real and who is just blowing smoke), it will be difficult to overcome the reluctance to hire local consultants.

I responded to Mr. Ho by telling him that I thought he was dead on and requesting I be able to cite him. He responded with the following:

Glad you liked the insight! I’m not one of those MBAs or marketing consultants you’re referring to (I’m an IT consultant, actually, so I’m squarely on the technical side of things), but I’ve had this issue come up several times when talking to various people (sometimes my own clients) why Chinese companies can’t do a better job at _branding_ themselves in foreign (i.e. non-Chinese) markets. When I saw your article talking about the exact same issue, I couldn’t help but chime in!

When I was at ... [Chinese company], their “role model” company which they strove to emulate was SONY. Here, they felt was an Asian company that somehow was able to create a globally recognized and admired brand. They understood that SONY had invested plenty of money into local marketing (and product design), but they ultimately felt that it was still product innovation and superior technical ability that allowed SONY to succeed.

So, really, what's next for Chinese companies trying to break into the U.S. market? Will they remain locked in the catch-22 of being unwilling to spring for high level assistance in the United States and thereby remain locked into being third-tier brands in the United States? Or will more of them break out (a few already have) and become legitimate international companies? What is it going to take?  What, if anything will be the catalyst for change?

What do you think?

Fear The China Joint Venture And Front-Load Your China Licensing Agreements.

Posted by Dan on July 22, 2010

The China Economic Review just published a piece on China business relationships by Andrew Hupert, a professor of negotiation at NYU in Shanghai. The article is entitled, "Trouble in commercial paradise," and its thesis is that Chinese companies usually view their relationships with Western companies as short-term. 

Hupert starts out by talking of how even the "big boys" have recently been complaining about being tossed aside by China:

Long term relationships are never easy, especially when one of the partners is a Chinese SOE. Until recently, many European and a few of the more patient & deep-pocketed US firms took upon themselves the role of a corporate Dr. Phil, offering easy, smug advice on how to woo and win the affection of a Chinese partner. But now even the happiest of Western partners – like GE, Siemens and BASF – are publically complaining that they are not feeling very significant in China in any more. If there’s trouble in commercial paradise for the most eligible suitors, where does that leave the newcomers?

Hupert goes on to seek to reconcile the apparent "paradox" between the insistence that "Chinese dealmakers have a long-range, relationship-oriented view of business" and their consistently engaging in actions that bely this. According to Hupert, Chinese companies do think long term, but that does not mean that "they are looking to settle down with any long-term partner in general – and a Western one in particular." Be prepared for your Chinese partner to bolt when a more attractive partner comes along: 

Many Euro and American management teams that have been involved with a Chinese supplier for more than 10 months tend to congratulate themselves on achieving a win-win, guanxi relationship but the reality is that they are actually engaged in a series of one-off deals with the same people. Once a better opportunity presents itself, the Chinese side considers itself a free agent.

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Western firms that are getting a little more "mature" -- with a bulging pension liability and a thinning customer base – like the idea of settling down with the sexy young Asian firm that still has its best demographics ahead of it. Sure, the match may make sense on paper right now, but do the local Chinese targets share the same long-term hopes and dreams? The ugly truth is that established Mainland firms – the kinds with government support and resources of their own – tend to see a Western brand as a short-term partner, a medium-term customer and a long-term competitor.

Sure, the Westerners can be fun for a while. They have interesting technology, a new way of doing things and, oh – that intellectual property can be hot stuff. But once the assets have been transferred and the IP has been digested – well, that Western firm seems more appropriate as a customer, client or even a distributor. And in the longer term – say five or 10 years – the math changes completely. Now that partner is looking like less and less of a source of assets and growth and more of a liability – or even a competitor on the global stage. The Chinese firm knows that it is quickly outgrowing the maturing Western counter-party.

Sorry to say, but what Hupert describes is exactly what I have seen happen time and time again. Call me cynical, but every joint venture agreement my firm writes is written based on the assumption that we will be dealing with it again in a few years when the Chinese company is seeking to push our client out. It is a shame that my firm has garnered a reputation for not liking joint ventures because we actually love joint ventures for very selfish reasons.  We love them because they make us a lot of money in the drafting of the contract and then they make us even more money when they go bad, and they nearly always do.  

This short term tendency also frequently manifests itself in China licensing deals, of which I wrote previously: 

My firm has been involved in countless IP licensing agreements over the years where foreign companies have licensed their IP (be it a patent, trademark or copyright) to Chinese companies.

One of the things we cannot help but noticing with these agreements is the tendency of the Chinese company to stop paying the licensing fee as the licensing contract starts nearing its end date. By then, the Chinese company has made good use of the IP and the Western company has made a good chuck of money from the agreement.

I have always seen this as simply a cost-benefit analysis by the Chinese company. It has paid the Western company, let's say, USD $3 million for the IP and it simply does not believe the Western company will sue it in China over the remaining $200,000 due. So it just stops paying. At that point, we typically send a demand letter to the Chinese company, reminding it of its obligations, reminding it of exactly how the contract favors us if we sue, and telling it that it had better pay the $200,000 immediately or we will sue.

At that point the negotiations begin and a settlement usually follows.

Because of the above, our advice to our clients who license their IP to China is three-fold:

1. Base your pricing on the assumption that you will not get full payment on your final     payments;

2. Do whatever you can to make sure the Chinese company still needs you at the end of     the deal so that the Chinese company has no choice but to keep paying you;

3. Put in some killer provisions in your contract that deal with a situation where the Chinese     company stops paying at the end.

And for more on how to do a joint venture with China (or how not to), check out the following:

You might also want to listen to an AmCham podcast I did at the end of last year on the "return of the China joint venture."  

China Supply Agreements. Why The "Perfect" OEM Agreement Should Cost Less.

Posted by Dan on July 20, 2010

My firm virtually always uses flat fee billing for China OEM supply agreements. We have done so many of these that we pretty much know the range of time one of these will take, even allowing for the required customization and the normal back and forth negotiating that will go on between our client and the Chinese supplier. Our time estimates are nearly always dead on, except for those clients who want the "perfect" OEM agreement.

Those take us less time.

Let me explain.

I am always saying it is easy to write the "perfect" contract and it is. The perfect contract does everything possible to protect your client. At least in theory.

By way of example, the "perfect" OEM agreement would contain something along the lines of the following:

  1. The Chinese supplier cannot raise its prices during the three year term, but the Western buyer has no minimum purchase requirement.
  2. Deliveries more than 10 days late, for any reason, result in a $100,000 cost reduction penalty.
  3. Buyer does not pay for 30 days after goods have arrived, been inspected, and been approved. No time limits imposed on buyer to do the inspection. Buyer pays nothing for non-conforming goods and need not return them to supplier.
  4. Chinese supplier is penalized for a defect rate of more than 1%. 
  5. Arbitration shall occur in Topeka, Kansas (buyer's hometown).
  6. Chinese supplier cannot sell similar product to anyone else. Buyer is free to buy from anyone else.

Okay, you get the picture. This is obviously a great/perfect contact for the buyer.  

Except there is only one problem. Nobody serious is ever going to agree to this and, in fact, in our experience, contracts like this are automatic deal killers. Tthat is why we should charge less for them. Over the years, we have been asked maybe half a dozen times to write OEM agreements not all that dissimilar from that set forth above. Each time, we have counselled our clients against this sort of agreement, but a few times we have been instructed to go ahead. Once (or maybe even twice), the client remarked on how they bet Wal-Mart has this sort of contract. Our response was that we had seen a number of Wal-Mart's contracts and though they do tend to be pretty favorable for Wal-Mart, they also typically contain massive minimum purchase guarantees that make the contracts worthwhile for the Chinese supplier.

Now usually when we write a normal (as opposed to "perfect") OEM contract, we hear back from our client within a couple weeks, discussing potential changes to the contract suggested by the Chinese supplier. We then work for another few days to a week on modifying the agreement to suit both sides and then we are none.  

With the perfect contract, we get silence and then we eventually contact the client. Each time, the client has told us that they have been unable to find a Chinese supplier willing to do business "our way" and so they will be looking elsewhere for their supplies. We suggest they allow us to modify the OEM Agreement and they go back out there, but they say no, they do not want to do business under terms that will put them at risk.  We say okay and move on.

The funny thing about the companies seeking the perfect contract is that they almost always are of a particular type: old line, mid-sized (not small) businesses that have been in business for a very long time and have carved out a pretty good niche and strong brand name in their market. They are looking at China not so much because they have to, but because they believe it will allow them to cut costs and thereby increase their margins. 

In any event, the lack of subtlety in the initial OEM Agreement and the subsequent lack of negotiations and back and forth between the Western buyer and the Chinese supplier means these are the agreements that fall short of our estimated time range. So I guess the next time someone wants the "perfect" OEM Agreement from us, we will have to charge less than for one that will actually work.

What do you think?

For more on China OEM Agreements, check out the following:

On The State Of China State Secrets.

Posted by Dan on July 19, 2010

China Economic Review just published an article by CLB co-blogger, Steve Dickinson, entitled, "Chinese Walls."

Steve starts out his article by discussing the inherent tension between China's desire to manage "economic information" while at the same time wanting to move to becoming a "modern market economy." China has responded to this tension by overhauling its state secrecy system:

In recent months the State Council has promulgated an amended State Secrets Law and the state assets regulator has put forward new rules regarding commercial secrets held by state-owned enterprises (SOEs).

The idea is to limit the scope and amount of information classified as secret and improve the systems for preventing disclosure of classified information.

China's new approach to state secrecy focuses on the following three themes: 

Restricting the scope and quantity of state secrets. Only information classified in advance as secret by an authorized government agency qualifies as a state secret. And, under the Secrets Law, the number of agencies able to make classification decisions is strictly limited. The old system where virtually any government agency or SOE was authorized to arbitrarily designate information as a state secret has been eliminated.

Both Chinese and foreign observers have criticized the PRC state secrets system because of the overly broad definition of what can be classified as a state secret. This criticism reflects a misunderstanding of how the law works. It is true that the definition is broad, but information is only a state secret once classified as such by a relevant government authority. Thus, while the potential scope of secrets is vast, the actual quantity is limited by the requirements of the classification procedure.

Clearly distinguishing between state and commercial secrets. SOEs are owned and supervised by the government, which begs the question: Do SOE secrets automatically count as state secrets? If so, then an SOE could reasonably be classified as a government agency and not as a private commercial enterprise. This is contrary to the country's economic development policy and would cause enormous difficulties for SOEs in their international business dealings.

In order to prevent any confusion, on this issue the regulations provide clearly that SOE secrets are neither private commercial secrets nor state secrets. The companies themselves do not have the power to classify any information as a state secret. This clear separation between normal commercial secrets and state secrets is consistent with international law on the separation between SOEs and government agencies.

Protecting state secrets from disclosure in the digital world is the critical issue. The State Council estimates that in the past decade, over 70% of disclosure of state secrets has occurred electronically. Much of this disclosure was inadvertent, resulting from failure to adopt normal computer and telecommunications security measures.

The Secrets Law addresses this issue in two ways. First, it imposes an obligation on all agencies and persons with access to state secrets to follow data protection best practices such as use of secure networks. Second, it requires all telecom operators in China to cooperate with the relevant government agencies in monitoring the unauthorized disclosure of state secrets.

Steve then goes on to discuss how many foreign observers have wrongly concluded that telecom operators are now being asked to act as censors regarding state secrets. No operator has the power to define a state secret - this can only be done by the relevant government authority. The only requirement imposed by the new law is that they must cooperate with the government if a disclosure of state secrets has occurred.  

Telecom operators have no right to question the government's classification of something as a state secret so this "may be an issue for foreign investors in Chinese telecom operations, since they may not agree that certain information should be ruled secret."  

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