Just read a highly relevant post by Ben Shobert (it’s sheer coincidence that I am having lunch with him today) on The Ethical Challenges of Doing Business in China’s Healthcare Economy. Though Ben’s post focuses on health care companies, it applies to virtually all foreign companies doing business in China. Ben’s post stems from an MBA class he taught at the University of Washington.

At one point in the article, Ben states that the “larger question” is “whether the incrementally different standards they [foreign pharma companies in China] must hold themselves to represents what amounts to a tax — both because their host country will look first at foreign companies and hold them to higher standards, but also because the standards in their domestic markets (FCPA, UK Bribery Act, etc.) are applicable regardless of where they might do business.” That is not a question, it is a fact. Foreign companies doing business in China have always been and for the foreseeable future always will be held to a higher standard than Chinese domestic companies.

Back in 2011, we addressed this same question and emphatically came up with the same answer, in When Should You Deal With Your China Ethical Issues? Yesterday:

All but one of these are great questions. The only one I do not like is the next to the last one, “Are foreign companies held to a higher ethical standard in our industry than local companies? The only reason I do not like this question is because I am of the view that one need not even bother asking it because the answer will always be “yes.” In that same post,

Similarly, In The Painted Veil On China Law, we talked of how China law enforcement differs between foreign and domestic companies:

There is one law in China for Chinese companies and that law has little or nothing to do with you as a foreign company. There is another law in China for foreign companies and that law does apply to you.  The laws that do apply to you are likely not all that different from the laws that apply to you in your home country and you are no doubt used to following the laws there.  You should view China similarly.

I cannot resist citing to one of my all time favorite comments, left here by one of the writers (Pipi) of the late great Sinocidal blog, on the differences between foreign companies doing business in China and domestic companies doing business in China:

When in China, do as the law says, not as the Chinese do. The laws are not intended to be enforced fairly – they’re their to be interpreted and enforced as local government sees fit to protect their clan, kin and cash-cows.

Does anyone really think that foreign companies (or at least Western companies) do not have to be just a little bit better than their domestic companies to survive in China? To the extent this “need to do better” can be called a tax (and I most definitely think that is what it is), foreign companies face higher “taxes” in China than domestic companies. And foreign companies that do not engage in bribery and corruption in China are likely at a disadvantage as compared with their Chinese competitors that are more likely to use such methods. And foreign companies that do engage in bribery and corruption are at a disadvantage as compared with their Chinese competitors because they are much more likely to be prosecuted (in China and at home).

Ben’s more interesting question, and one that was addressed by Ben and his MBA class, is “for life science companies like GSK, what really are their options?

Ben and the class saw the following five options (my comments are in italics):

  1. You can choose to maintain western standards of compliance. “The implications of this are that your domestic competitors, and, it should be noted some of your less scrupulous foreign ones as well, will not hold to this approach. So, you cannot simply hold to a high standard, you have to put in place strong sales and marketing tactics that work to stay front of mind in the consumer and healthcare professional.  But, in an emerging economy such as China’s, is this even a realistic strategy? Do consumers have enough discretionary income that they can realistically value the intangibles your therapy is going to offer, or is the decision the consumer will make no different than that the doctor or hospital administrator is going to? If your product is positioned based on an economic rationale that is inconsistent with that of your market, can you compete?”  Right, but you have failed to address a much bigger question: are you willing to risk jail time and public humiliation and reputational damage by engaging in bribery/corruption?
  2. Hold to the status quo. “Here’s what that means:  essentially, you assume the crack down is short-term, and inherently political in nature. ‘This too shall pass’ becomes the phrase you hear executives saying just under their breath as they count rosary beads during weekly management calls. If you believe that the crackdown on GSK was largely a political move by Beijing to accomplish two goals – lower prices and divert the public’s attention away from the government’s own culpability in the dismal state of China’s healthcare system – then you might take the slap on the wrist and move on. Companies that make this bet likely believe that the rules in China are not really in flux; that in twelve months practices in China’s sales channel will look basically like they did twelve months before the GSK scandal. Implicit in this conclusion is that China’s decision is inherently political, and companies who hold to this view would do well to remember that future responses to crises along lines of affordability and access are going to result in similar actions towards foreign companies.”
  3. Fundamentally change your sales strategy.  “This assumes the sort of tactical re-arrangement of how you sell and market like was mentioned earlier, but it also forces companies to bring newer drugs to China earlier than they had originally planned.  For most of the last three decades, products brought into China from all sorts of sectors have tended to be more mature. Much of this has to do with the China market’s inherent IP issues, but also the sense that Chinese consumers were not ready for the more current products. Pharma has been no different, but this approach might have to change for companies that now feel they have no choice but to accelerate their product life cycle plans that originally called for more mature products to migrate to China in an effort to hold off the anticipated IP and price pressures more sophisticated therapies would encounter.”
  4. Exit China. “Don’t laugh. The world’s second largest generic pharmaceutical company, Actavis, just did. My most recent Forbes column touched on this, and made an effort to remind people that there are multiple reasons for Actavis to have left, and that the company’s timing may be designed to take advantage of a moment when they could leave China without questions being asked about why they were not further into the Chinese market versus their competitors. GSK threatened to leave China if the fine from the Chinese authorities was too large, a threat the CEO quickly rescinded. But, neither company would be the first to come to the conclusion that they could not operate successfully in China and that they needed to deploy capital elsewhere.”
  5. Mitigate compliance risk through a very strategic use of distributors. “At its worst, this approach is designed to hide non-compliant behaviors from auditors; at its best, using good distributors is a strategy that forces compliant behaviors into parts of the supply chain that previously were not visible to manufacturers. Typically this involves competent distributors taking over, or managing, the efforts of small dealer networks around China that had previously little to no supervision, simply because of the highly fragmented nature of the dealer networks that service China’s hospitals.”

This is one of those situations where being a China lawyer is much easier than being a manager of a foreign company doing business in China. When my clients ask about how they should handle corruption in China, I tell them that they must never engage in it and that they need clear policies and training sessions to make crystal clear to their own people that corruption simply will not be tolerated. I then tell them that if they do not have a corruption plan AND a corruption policy in place, they have increased their chances of being in a world of pain at some point. I then usually put it to them directly: which of the following do you want to be able to say to the Chinese authorities/US federal prosecutors if your company is ever accused of having engaged in corruption?

  • Oh, sorry, I didn’t realize that corruption might be a problem.
  • We did everything we could to try to prevent this. Here is our policy manual which we require our employees to sign when they join our company and re-sign to acknowledge every year thereafter. And here is a record of the full day mandatory anti-corruption training we give to our employees every six months and the written materials we provide to them each time.  As you can see, the employees implicated in this case each attended x number of these sessions. I really do think we did everything we could do as a company to try to stop this sort of thing and I think you will find that we do take stopping corruption very seriously.
I then tell them about the compliance attorneys at my law firm who can help them sort out their FCPA and China corruption issues and the costs that will entail. They then usually call us back a few days later….
Corruption and bribery?
Don’t worry about the taxes.
Just don’t do it.

Lawyers copy.  Let me expound on that.  Lawyers proudly copy.  If I am writing a joint venture agreement on a coal mine in Western China, the first thing I will do is send out an email to everyone in my office asking for our most recent China joint venture agreements, preferably involving a mining operation, even better if it involves coal mining.  I will also go online to various specialized law sites and run a google search seeking out China joint venture agreements involving coal mines.  And hey, believe me, if I see some good provisions in any of those, I will co-opt them (and seek to improve them) for the joint venture agreement I am doing. This is what lawyers do.

And this is what I have done in running my law business.  I do not have an MBA and I do not have time to read MBA type books to get the equivalent of one on the cheap.  So I borrow from what I read/hear and like.  I read once about how Ford Motor Company emphasized standardization because it saves time and money in that it allows for familiarity and swapping out.  All of the desks in our firm are the same.  All of the desk chairs are the same.  All of the guest chairs are the same.  Everyone has either a MacBook Air or a MacPro Desktop or both and an iPhone.  This means if someone forgets a cord or a cord breaks or whatever, we are covered.

I have a tendency to do the same with China.  I see who is succeeding and figure that they are to be emulated.  Despite its recent blip, I still border-line worship what KFC has done in China. I marvel at its ability to provide decent and safe and cheap food at a profit throughout China. That is no small feat and I assume KFC is doing a lot of things right. And if I were to start a fast food company in China, I would read as much as I could about how KFC did and does it, rather than try to re-invent the wheel.

I used to write a lot about individual companies in China, back when newspapers and magazines contained a lot more than they do now in the way of articles setting forth what various companies had done to succeed in China.  I loved those posts because I always have figured that one can learn more (and better copy) from specific examples than from bromides on how to do things.  I am labelling this post “Part 1” because I am planning on this being the first in a long running and irregular series of posts highlighting China success stories/who to copy in China.

So I was delighted to see on my Facebook today that my friend, Ben Shobert, just came out with a two part interview series with with Marie Han Silloway, Starbucks China’s chief of marketing. Starbucks is succeeding in China in many ways.  They are profitable and they are constantly growing. Their stores feel very much like a Starbucks anywhere, and yet they also have Chinese characteristics.  Amazing to me is that their service is so good and pretty much matches the service of Starbucks in more service-oriented countries like Japan and the United States.  In other words, if you doing business in China or thinking of doing business in China, Starbucks would be a good company to copy.  And for that, I recommend you read Will China be Starbucks’ Cup of Tea and Will China be Starbucks’ Cup of Tea, Part 2.

Read ’em and learn.

What do you think?

As you can tell, I am a big fan of The Rule of Threes.

Back in September, 2011, I wrote a post regarding a China deal that appeared to have badly soured. The post was entitled, China FDI, Whatever Happened To Show Me? and it was on a China deal that went bad for the small Missouri town of Moberly. The point of my article was to emphasize the importance of conducting due diligence before entering a China (or any) deal:

So why am I writing about this and how is this relevant to you? 

I am writing about it because it appears (having only “seen” this from afar I do not know) that the government fell into three classic traps. First, it appears that various governments got overly excited about the possibility of getting Chinese money. It appears it fell prey to the classic “China is rich. We want money. Therefore this is a good deal” syndrome. Second, it appears nobody conducted adequate due diligence. Were the very valid suspicions of my e-mailer ever checked out? I doubt it. I have no idea if my e-mailer ever raised her/his suspicions with City Hall, but having dealt with governments, I can only imagine how they were treated. Can you say groupthink? Third, the deal was rushed. The Columbia paper noted how it all went through in “73 days, far less than the six months or more usually needed to conclude such a deal.” Rushing a deal does not mean it will fail, but it certainly increases the chances.

I had no idea our post would thrust me into a political firestorm half a country away.

Almost immediately after our post ran, I started getting phone calls and emails from the Missouri press and from individuals in that state, wanting to talk to me about Moberly’s deal and wanting to talk to me about a potential China Eastern Air Cargo terminal in St. Louis. It seems that those who opposed the St. Louis terminal were using my Moberly post as new ammunition for why that unrelated deal should be terminated (loose pun intended).  

I ended up giving an interview on St. Louis radio and to a few Missouri journalists and got quoted a few times (here and here) regarding the Moberly deal. I also ended up talking with a someone down there (whose name I cannot recall), who talked of flying me to St. Louis (which never happened) to explain how just because one Missouri town had been ripped off by mercurial “Chinese Investors,” that alone has absolutely no meaning when analyzing a completely separate deal involving a legitimate and well funded Chinese company like China Eastern.

I thought again of Moberly this week after reading an absolutely fascinating Business Week article by Susan Berfield recounting what happened there. The article is entitled,  “A Missouri Town’s Sweet Dreams Turn Sour” and appropriately subtitled, “Bruce Cole persuaded Moberly, Mo., to help him build a sucralose plant. The town’s sweet dreams of jobs and opportunity soon became a nightmare.” To sum up a long and detailed and thorough and fascinating (yes, I know I already used that word) article, it seems Moberly heard the words “Chinese Investors” and lost their heads after that. It appears Moberly got duped out of millions of dollars it did not have and now the town is going to be considerably poorer because of it. And all because of their lack of due diligence.

We love to write about the China scams because  they make great cautionary tales for our readers. Just about whenever we write such a post, we get a comment and/or email or two from someone who seems to find it hard to believe that anyone could so “easily” have been duped. And/or they just want to let us know that whomever it was who was duped was “incredibly stupid.”  I disagree. What usually has happened is what always happens and what appeared to have happened to Moberly. I do not see these things as hinging so much on one’s intelligence. I think these sorts of things happen when the “making money portion of our brains” (help me out here medical people) takes over and overwhelms the deep thinking part of the brain and thereby renders it fairly useless. I am just not sure this process happens any more often with “stupid” people. But I do think it happens more often to those new to international business and overly exicited about its prospects. These are the people who “check their brains at the gate” when arriving in China. 

Unfortunately, we have written so often on China scams and the need to conduct due diligence before doing business with anyone in China that I am beginning to fear we have nothing new to say about it — but being lawyers that is not going to stop us. So it was a breath of fresh air to see someone else talk about it, especially when that someone is not a lawyer, but a highly regarded expert on doing business with China. I actually came across the Business Week article in a post on the Cross the Rubicon Blog, entitled, “Misery in Moberly” and it was that post by Ben Shobert that spurred me to write this one. In his post, Ben so effectively emphasizes the need for, and the benefits of, conducting due diligence, that all I am going to do is quote him:

It is such a simple insight, but one that bears repeating:  you will never, ever regret spending money up-front vetting a potential partner or running a deeper due-diligence process on a particular fatal flaw in your international strategy.  In the case of this sort of vetting procedure in China, or other emerging economies for that matter, the process you need to go through isn’t as clear-cut as we experience in the developed West.  In emerging economies, you are looking for reputational, not just financial, information.  You might be able to get a D&B or S&P report on the company in question, but in an emerging economy, it probably doesn’t reflect the set of books that you care most about.

Due diligence. It’s mandatory.

Do you agree?

For more on due diligence in China, check out the following:

I love it when I read something that tells me what I already knew, but simply had not realized. That happened to me today when I read  a post on the Asia Healthcare Blog by my friend and fellow-Seattleite, Benjamin Shobert, entitled, “Life Sciences Companies Go to China to Raise Capital” [link no longer exists].

Ben sets out the three main reasons pharmaceutical companies are going to China:

[F]irst, and most obviously, build market share in China’s high-growth market. Second, access China’s inexpensive R&D capabilities to complete drug discovery faster and less costly than what is possible in North America or the European Union. But, American pharmaceutical start-ups are beginning to take note of another opportunity in China: as a source of potential investors for their start-ups.

Though my firm has worked on/is working on a deals/potential deals involving Chinese investors in American tech (no pharma) companies, until I read Ben’s post, it had just not occurred to me that this is a trend. But it clearly is. Chinese companies are looking to put their money into United States based companies both in the United States and in China.

Of course, Chinese investing in foreign companies in China is nothing new as they have been doing that via joint ventures (JVs) for more than twenty years. What’s different about today, however, is that in the past foreign companies typically merely allowed Chinese investment when they had no choice. Today, foreign companies are actively seeking Chinese investment because they need the money.

Ben sets out the three key issues foreign companies face when taking in Chinese investment:

  • Losing intellectual property to the Chinese investor
  • Having to turn over the Chinese market to the Chinese investor
  • Eventually having to turn control of the company over to the Chinese investor

Absolutely true. It has been over one (or more) of these three sticking points on which most of the deals on which we have worked have foundered.

The tension is obvious. The American (in our cases) company wants to maintain full control over its IP and is concerned about the Chinese investor taking that IP to one of its other companies. Some of the Chinese companies are quite up front in saying that one of their reasons for investing in the U.S. company is to have full access to the American company’s IP. Most American companies cannot abide by that. The turning over the Chinese market to the Chinese investor is usually the easiest of the three issues because compromise is usually possible by agreeing on a timeline and/or a market sharing arrangement. Surprisingly enough, the same is usually true with respect to turning over the company to the Chinese investor because that too can usually be resolved by agreeing on the preconditions for any turnover and the terms for if and when such a turnover situation is triggered.

Chinese investment in your company. Are you ready for that?