Beware The Potemkin Chinese Company.
Anyone and everyone who does business in or with China needs to read these two posts at The Black China Hand. "If I Build a Potemkin Village Will They Come?" and "How to Start a Chinese Company."
The first post is about a Chinese company that sought to hire the Black China Hand to make his company (within a few weeks) look like an American company so as to win a big contract from an American company. The takeaway from this is that cursory due diligence on a company with which you intend to do business is not enough. Let me give you some examples of cases on which I have worked:
1. Western company pays Chinese Steel company ~$2 million for steel rods. Chinese company has a really nice office but there is no company there and the $2 million completely disappears.2. Western company pays Chinese shipping company to ship food product from Russia to China. Problem was there was no Chinese shipping company and the food never arrived. Total loss was approximately ~$2 million.
3. Western company discovers that its China manager has been skimming about $5 million a year for ten years by charging its suppliers fees for contracts.
4. Western company invests ~$500,000 in project with Chinese aviation company that does not exist.
In all of the above cases, the Western company was invited to China to check out the company and did so. My firm has probably been contacted about one hundred times by companies who ordered product from Chinese companies over the internet and then either never received anything or else received fakes.
The point here is absolutely NOT that all Chinese companies are fake because obviously that is not the case. The point is that not everything (anywhere, not just China) is as it seems and it always makes sense to conduct due diligence.
The second post is about the same Chinese company and how it got its start:
He was hired right out of college to the sales department of a state-owned import-export company. After working there several years he decided he wanted to branch off on his own but he needed capital and clients. He solved that problem by basically poaching the clients he made working at the import-export company. As for capital: he basically ran his company from his desk in the import-export company drawing a salary, making use of the company's resources (cars, dinners, gifts) to fund his personal initiative. If company officials knew or cared they didn't make him aware of it. So with no risk (financial or legal) whatsoever, over several years, Mr. H was able to build his company until it could sustain itself without the "shield" that the import-export company unknowingly provided it.At that point, he simply quit the job at the import-export company … registered his own with the relevant authorities, rented a space elsewhere and continued doing what he had been doing over the last several years. Ten years later he's in the running for what I perceived to be a multi-million dollar contract with a top US company.
Again, this is just not that unusual:
1. A few years ago, I brought a lawsuit on behalf of an international fishing company against an employee who for years had been traveling the world in style on my client's dime to buy and sell fish products for his own company. In fact, this employee had set up a joint venture in Asia with one of my client's biggest suppliers.2. I am right now in the middle of a lawsuit on behalf of a Chinese company against an ex-employee who is alleged to have sold substantial amounts of my client's product, with payment having gone to his account, not the company, and which money this person used to set up a competitive business.
I do not for a minute think these sorts of things are peculiar to China. Not at all. In fact, I have seen similar things in wholly American companies. But, I do think linguistic and cultural differences make companies both less willing to investigate, less able to understand what is going on, and even less willing to challenge something that just does not seem right.
Nothing profound here, just a bit of advice to be on your guard.
Comments
Companies seem to use a bit more common sense in places like the ME, S. America and Africa. With China, they just dive in head first without looking. Then they expect the US to expend political capital defending their dumb butts. You'll even get more due diligence in the US, especially after Enron and Madoff.
But China has, ahem, cough, wheeze, sniff, 1 billion potential customers.
Posted by: dude | November 18, 2009 11:22 PM
I think you hit the nail on the head. It is not that these things happen only in China but my experience, and as you clearly pointed out, is that when it comes to China, firms and individuals are often lulled into a false sense of security without asking the hard questions whose answers should make them feel secure. I think that this is because people, like Mr. H, know so well how to play the game. China is a great many things, but it is most definitely not a place to forget your common sense.
Posted by: laosan | November 19, 2009 1:41 AM
One bit of extra information is that during the 1990's, China was trying to shut down massive numbers of state owned enterprises, and in a lot of them, starting your own private subcompany was not only tolerated, but even encouraged, as once you started your company and left, the state could shut down the SOE.
The thing about import-export companies is that in the central planning era, all trade with the PRC had to go through a state import-export company. You wanted wheat, you had to trade with the state wheat company. Once China liberalized trade, the reason behind a lot of these companies just disappeared. In some situations they were massively restructured. In other situations the plan was just to close them down.
Posted by: Twofish | November 19, 2009 1:02 PM
Dude - I disagree that companies use more common sense in the Middle East. There are way too many comparable messes out here, just more focused on sales commissions than on product sourcing.
Dan - do you really think language and cultural differences cause companies to neglect to investigate? Seems to me that the real culprit is misaligned incentives that reward excessive risk taking while shifting penalties for errors to someone else (sounds a bit like banking, no? well, no accident...). If a mid/senior exec at a Western company throws together a dozen hodge-podge ventures, he maximizes the likelihood of 1 triumph (with ample commission going to him personally), while the disasters "probably" won't fully materialize until well after he's moved up and on.
Way I see it, faulty due diligence is just a symptom. The real problem is that too many Western managers get paid for making the numbers work - not for making the relationship work.
Posted by: donzelion | November 21, 2009 12:09 PM