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China’s Legal And Business Differences. A Multi-Disciplinary/Multi-Media Approach.

Posted in China Business

The other day, I spoke with a North American company that was seeking to get its tooling back from its former Chinese manufacturer.  This company’s domestic American lawyer had drafted a manufacturing contract with the Chinese manufacturer that was completely silent regarding ownership of the tooling/molds.  When the American company started getting bad product from its Chinese manufacturer, the American company requested the manufacturer return the tooling/molds.  The Chinese manufacturer claimed to own the tooling/molds.  The American company claimed that was not possible because it had the tooling/molds made by someone else and it had proof of payments that would prove this.

On top of this, the American company kept telling me that its lawyer insisted that it owned the tooling/molds.  He stopped saying this when I asked whether the lawyer claiming this was the same lawyer who had represented them when it contracted with the Chinese manufacturer.

I told the American company that it essentially had three choices.

  1. Get new tooling/molds made.  The American company told me that would take months and was unacceptable.
  2. Sue the Chinese manufacturer to try to get the tooling/molds back.  I said that would take months and since the American company did not have written and signed proof (preferably in Chinese) making clear that the tooling/molds belonged to it AND not to the Chinese manufacturer, I did not know who would prevail.  Either way, this would take many months. The American company told me that this was not acceptable.
  3. Try to negotiate a purchase price for the tooling/molds from the manufacturer, maybe at half their value.  The North American company let me know that having to buy its own tooling/molds back from its Chinese manufacturer was incredibly unpalatable, as compared to its other options, this was its best one.

What should the North American company (or more particularly, its lawyer) have done to prevent this horrible situation?  They should have explicitly (because if it isn’t explicit it pretty much doesn’t exist when it comes to China) put in their agreement with the Chinese manufacturer that the tooling/molds belonged to them and they should have explicitly put in the contract that the Chinese manufacturer would sustain liquidated damages of $10,000 for every day that it failed to return the tooling/molds. And they should have done this in Chinese and they should have gotten the contract sealed/chopped by the Chinese manufacturer.  This is what Chinese manufacturers understand and, more importantly, this is what Chinese courts understand and will enforce.  And because of this, as far as I know, we have never had a client whose tooling/molds have been held for ransom.

Early this evening, I listened to the last two minutes or so of a BBC radio show that seems to have been about a book writing anthropologist who writes about Papua New Guinea’s hundreds of tribes.  I got to hear him essentially sum up by saying that the tribes of Papua New Guinea deal with modernization/materialism one of the following three ways:

  1.  Seeking to reject it entirely and stick entirely to their old ways;
  2.  Seeking to integrate it into their existing ways, creating a synergy between the two:
  3.  Seeking to have it replace their ways, whole hog.

The North American company and its lawyer are not too dissimilar from the Papua New Guinea tribes that insist on sticking to the old ways no matter what they face.  Both essentially insist on going on with their lives as though nothing new had been introduced to them.

I received the following email this morning:

Your blog is interesting because it talks about project failures at the operational level. I bought couple of books you reviewed on your blog and the anecdotes of success they contain have been interesting and inspiring. Now, I am more interested in some material (in addition to your blog) that will provide insight on spotting major flaws in the operationalization of a project.

I’m in consumer research and I often tell clients how they should target a specific segment, what they need to do next. I have never been able to educate them on what NOT to do, and what major mistakes they need to look out for. That’s because I’ve never actually worked in their position (ie. actually executing a specific strategy).

It would be great if you write your own book or post more about failures. Case examples are much more insightful than ideological or CEO-level visionary “stuff”.

Seems this person realizes that China is different and that learning comes from this recognition.

The South China Morning Post recently ran an aptly entitled article by INSEAD Professor, Micheal WittBusinesses often fail overseas because the world is much less ‘global’ than they assume. The article is subtitled, “Key decision-makers often underestimate just how big, and important, global differences are.”

Its premise is that “many companies do not reach their full potential abroad” due to “incomplete preparations.”  It states that “surprisingly, many companies, even large multinationals, do not analyze the competitive landscape of the local [Chinese] market to determine whether it is possible to operate profitably.”  Foreign companies end up being surprised by the level of competition in China simply because they went into China without ever analyzing it.  Sort of like the North American company/lawyer who were surprised at losing their tooling/molds simply because they never even considered seeking to determine whether the rules on such things might be different in China than in North America.

The article notes the irony that “the tendency to fall for the fallacy that the world is indeed ‘flat’ increases with corporate seniority.”  Though the reason for this is “natural, as senior executives extrapolate from their own experiences within a confined international elite,” it also is ”highly problematic, because it leads key strategic decision-makers to underestimate just how big the differences are. And as the international business literature has shown time and again, what kills companies abroad is their inability to handle these differences and deal effectively with the attendant ‘liability of foreignness.’”

It goes on to discuss how institutional variations occur between countries and at “the most fundamental level, they show themselves in what a society accepts as the legitimate purpose of doing business.”  Western business schools generally teach that firms exist to maximize shareholder value, but the writer’s

But according to Professor Witt’s research, few societies and senior managers outside the Anglo-Saxon world accept this view:

To simplify very crudely, Hong Kong firms exist to produce family wealth; German firms, to produce needed goods and services for society; Japanese firms, to provide benefits to their employees; and South Korean firms, to keep highly conflictual demands by controlling families and hostile stakeholders in balance.

Few companies ever pause to consider these issues and their implications when expanding abroad. Many an international partnership was, foreseeably, doomed from the beginning because fundamental objectives did not match.

Do you think about such things?  I do all the time.  I mean, why do some companies seem to just coast into China while others stumble in and never recover?  What more should we be writing about to help those seeking to do business in China or to sell to China?  For what it is worth, I would say that the knowledge North American companies looking at doing business in China is both considerably higher today than it was even five years ago and considerably higher than the knowledge Chinese companies have about doing business in North America.  Do you agree on that?

  • http://twitter.com/theeastasiaco East Asia Co.

    Dan,
    I have been involved with China for 25 years now. I think why so many overseas
    companies “stumble” in China, as you say, is for precisely the reason that was stated in the ASEAD study: they just fail to understand that business in China – and just about everything else – is conducted differently than it is their own country. I have experience working for companies like this and the thinking on the part of US management on certain projects was, and you will have to excuse me for saying this, just plain dumb. There was no attempt on the part of US management at the onset of projects to gain a deeper understanding of China and to anticipate obstacles that might arise because of cultural practices or biases. The mentality was always that what the US office says, China does. Obviously,
    this mentality just does not work in China. At one time, soon after
    Reform and Opening, when China was just beginning its long march to development
    and was hungry for overseas investment it may have, but not any more.

    At the heart of it I think is a cultural arrogance. I have hosted or accompanied many colleagues over the years in China. Most couldn’t speak a word of Chinese,
    didn’t know anything about China, hated the food, looked down on the people, regarded China as a developing country and the whole time they were in China they just talked about going back to the US. These were rank and file colleagues. But
    management also thought this way.

    This is not to simplify matters and say that only the companies
    that are culturally sensitive and respectful of China are going to succeed there. China is far, far too complex for that. But I think it does reduce your risk in China considerably if you understand and respect the differences between your own culture and China’s.

  • Michael Lin

    A few random comments:
    When I give training programs and presentations I often use (simplified) “bad examples” of failures to make my points. While some may laugh at the parties being so naive and/or silly, I find that these bad examples tend to stick in peoples’ minds better. I think it is human nature – i.e., we learn more from a mistake than from doing something right the first time. This is why listing “watchouts” are so popular in business – you want to learn from others’ mistakes so that you don’t have to go through the pain yourself.

    I do agree with Dan that liquidated damages clauses are quite useful in China and almost always recommend to use them.

    A part missing from the above is that there is a distinct dichotomy in China between large companies and smaller companies. Large companies (typically either state-owned or state-influenced) are oftentimes focused on providing employment rather than maximizing profit/shareholder value. In contrast, smaller, private companies are oftentimes focused on maximizing personal (not corporate) profit.

    This leads to different incentives and different outcomes as compared to, for example, a US company. For example, a company I know was attempting to get a Chinese building permit for a building which was going to be a technological showcase – automated mail delivery, using robot-carts, advanced cargo elevators for moving materials, ID-tracking systems for employees security, etc. However, the local authorities simply would not give approval, giving various reasons why the building was not meeting code, etc. Once the advanced systems above were replaced with people performing the same functions, the permits were granted quickly. The reason was that the local authorities saw the mail system, cargo elevators and security system as decreasing the need for people in those positions. So this effectively increased local unemployment. By adding human mail sorters and delivery people to mailroom, cargo elevator operators (literally elevator-ladies for the cargo elevator), and human security guards, the building employed 30-40 more local people, and the officials were happy to approve the construction.

  • http://www.facebook.com/david.a.dayton.7 David A Dayton

    Dan, great content and questions (as usual). Got into answer the question and it went a little long–so I posted the response at SRI. Thanks for the starting point and all the good advice. http://silkroadintl.net/blog/2013/02/05/why-do-good-companies-stumble-in-china/#sthash.4hgNAsu2.dpbs

  • bystander

    I wonder about the question raised by this post all the time; that is, why do some people and companies seem to do well in China and so many others so badly?

    I’ve come to the conclusion that the answer is really complicated. For some companies — take Apple for example — it’s not so much that they “got” China from the outset, I think, as that their product enjoys very high demand in China (great brand name advantage), is next to impossible to knock off (full of proprietary chips that can’t yet be manufactured in China but are hard to copy anywhere), etc. Add to this that the company is famously protective of its IP — nothing to do with China, it’s just that way, from decades before it ever set foot in China. So the overall strength and culture of their business and product led them rather naturally to do things that added up to success in China.

    I’ve known lots of upper management folks from US high tech companies who have ventured into China, and as I see it there are three stages of understanding they generally go through. The first is the cultural arrogance mentioned by another poster: can’t wait to get out of this developing country etc. Then comes a period of cultural recognition and respect and trying to do things the Chinese way. This ends in stories like the $600million fraud that Caterpillar found itself in last week, or the Alibaba/Yahoo fiasco, or the untold IPO accounting fraud stories, or any number of less spectacular and not widely reported of small-timers getting taken to the cleaners.

    Anyone left standing goes into a third stage where they recognize that things are different all right (can say that again) but that it’s a rather treacherous environment for foreigners. I really wonder how many people reach a relatively deep and realistic understanding of the business environment over here without having gone through some kind of stinging episode. Not many I bet.

  • BB King

    It’s 2013 and still many foreign companies fail in the Chinese market ?!

  • http://www.facebook.com/tyler.cohen.9849 Tyler Cohen

    I think it would be interesting to hear your take on the last point you make – how Chinese companies misunderstand their Western partners. What misunderstandings frequently arise on the Chinese side? What suspicions or worries are frequently expressed that slow down negotiations/deals and could be relatively easily overcome?

  • http://twitter.com/LandedBook Christopher Dillon

    I heard the same radio broadcast, Dan. The speaker was Jared Diamond, of Guns, Germs and Steel fame. http://www.guardian.co.uk/books/2013/feb/03/jared-diamond-clash-tribal-peoples