Not that long after the fall of the Soviet Union, I, along with others in my law firm, had to spend considerable amounts of time in fairly remote places in Russia like Vladivostok, Petropavlovsk-Kamchatsky and Yuzhno-Sakhalinsk. Things were very uncertain in that part of Russia back then and we developed certain rules to protect ourselves. For instance, we always made sure that each person had at least enough cash to buy a last minute flight to Moscow and then from there back to the United States. Before leaving, we also would contact our Russian friends (including the spouse of a Russian Federal Marshall and a couple of Vice-Governors) to ascertain where they would be while our people were there (most did not have cell phones or email) and to confirm that we could contact them if anything would happen. In other words, we planned our escape route before we even went.

A few years back, I went to Papua New Guinea to recover helicopters for a Russian client. PNG (for the conoscenti) was in the throes of various insurrections at the time (I think this is nearly always the case) and I would be going to Goroka, which was fairly near at least one of them. I spent days planning the trip and set up all sorts of contingency plans. I even grew out a beard and bought a backpack to look like a hiker, not a businessperson.

When I was a kid, I lived in Istanbul, Turkey, for around fifteen months. At the start of my stay there, everything was great, but during our last month, there was a military takeover and it was a bit jarring to see two blank-faced 17 year olds from the villages on my buses holding machine guns. i can remember my parents meeting with consular officials to plot out an exit strategy if things turned for the worse.

One of the things I have always liked about China is that none of these sorts of thing are really required.

Or are they?

It seems like every time I talk with serious China people these days, they want to talk about what is going to happen in China regarding treatment of foreigners and governmental oversight (a euphamism). I have no idea, but I do get the sense that both the media and foreigners with a business stake in China are downplaying things. In fact, I think this almost has to be the case. I say this because the media are overwhelmingly in Beijing and Shanghai and because cognitive dissonance or sheer self-interest would cause the businessperson to have those views.

Be that as it may, I am not sure one needs to believe in some sort of imminent change in China to believe it at least makes sense to be ready for it. I can tell you that virtually all companies big enough to retain risk consultancies are doing so. Frankly, I am always amazed people do not think about these sorts of things more often.

Many years ago, I had a long-time client call me to ask for my assistance on an Iraq deal he would be doing. This was not long after the fall of Saddam. I told him I wanted no part of it and that I thought he was crazy to be planning to go there. I strongly suggested he would be better off staying alive for his children than making a few more million dollars. He was initially irritated with me but called me back a couple of weeks later to tell me I had been right and he was done with Iraq. I swear it was only days later that I learned of American businessperson Jeffrey Ake (who I had heard speak in Seattle only days earlier) go missing in Iraq. Mr. Ake remains missing.

The greater the risk, the greater the money. But the greater the risk, the greater the risk.

So good for Joseph Sternberg of the Wall Street Journal for writing this article (the title to which I dare not mention) on the need to be aware of and prepare for China risks. It is just wrong to assume and act as though things cannot and will not change. As Sternberg notes, “four months ago, no one would have predicted imminent mass unrest in Tunisia, Egypt, Syria, Bahrain, Yemen or Libya” and he warns companies to “consider managers trying to evacuate staff, safeguard physical property or keep supply chains operating as smoothly as possible.”  He then provides “a brief guide to keeping your business afloat if China goes kablooey”

  • First, “recognize that it really could happen. Human nature is to assume the status quo will continue indefinitely.”
  • “Understand where your vulnerabilities lie.” You may already have “a detailed list of expat staffers in China, their addresses and dependents, to aid in a worst-case evacuation” but you should also “track executives who might be visiting, in case one of those should happen to be in town” when something series goes down.
  • Think about your specific risks. “Are your factories identifiably ‘foreign’ and is that likely to be a sore point in the eyes of local residents? Have you previously stirred controversy for hiring lower-wage workers from other regions instead of locals? Are you in a controversial industry, such as a heavily polluting one, that could make you a target…?
  • What about China’s role in your supply-chain? “The key is to diversify supply chains, a practice some—though by no means all—companies already have adopted. This is not necessarily cheap. But those companies that invest in a little excess factory capacity in another country or buy insurance against supply-chain disruptions may one day find the additional expense a price worth paying.”
  • Think ahead as to how you will “respond to varying degrees of disruption. What events would trigger a factory closure for a couple days, or a reduction in factory hours, or moving workers’ dependents to another area, or in the worst case an evacuation of expat staff entirely? Who would make those decisions, based on what sources of information, and how would the decision be communicated down the line. And so on.”

Say what you will, I say there is nothing wrong with being prepared.

Because of my need for excessive euphemisms here, I urge you to go read Mr. Sternberg’s entire article here. I also note that I am going to need to be doubly careful regarding comments and warn that we may have to edit some of them. That being said, what do you think?

One of my main duties as a lawyer is to minimize risk. Properly forming/registering a Chinese entity minimizes risk. A great contract minimizes risk. Registering a company’s intellectual property minimizes risk. Written employment contracts and a written employer manual minimize risk.  An FCPA compliance manual (usually part of the employer manual) minimizes risk. The list of how we help our clients reduce their risks goes on and on.

But there is only so much we lawyers can do.

There are certain risks on which we have little to no impact. We can write the world’s best contract, but if your Chinese counter-party is a crook without any real assets, he can breach the contract with impunity. Our registering your IP greatly reduces the likelihood of someone stealing it and makes it easier for you to sue them if they do, but it does not preclude anything. An FCPA compliance manual is not guaranteed to stop your employees from countermanding it.

Then there are the really big risks. We can tell you that doing something is legal today in China, but what is legal today may not be legal tomorrow. We had a client who purchased a relatively expensive building for a particular business and then within months, the local government made it illegal for foreigners to operate that particular business from a building they own.

And then there is the biggest risk of all: China itself.

Joseph Sternberg, the dead-bang brilliant and far too young (not sure he’s even 30 yet) Editor of the Business Asia column at The Wall Street Journal just came out with an article discussing China’s too-quick willingness to retaliate against whole countries or to act against their “own economic interests.”

The article is entitled, “Nobel Sentiments, Business Risks,” and its thesis is, essentially, that businesses should be taking lessons from China’s recent reactions to the way it has dealt with businesses from countries China perceives as having slighted it. These reactions give rise to “new questions . . . about policy risk in China.”  They sure do.

The article makes note of how China this week canceled a meeting with Noway’s fisheries minister in apparent retaliation for a tiny committee of private citizens. Sternberg then comments on how this sort of thing is taken too much in stride by businesses in China:

Exporters are optimistic that political disagreements won’t dent trade in the end. But it’s worth asking how they can possibly know. Conspicuously, the only basis for this conclusion is surmise. Norway is a big oil exporter, and China is a big oil consumer. Ergo, Beijing will understand that its self-interest lies in not antagonizing Norway.

No senior officials in Beijing have made any clear statements about whether they will retaliate against Norway. Beijing hasn’t formally said why it canceled that meeting with the minister. There has been no public debate on the matter, so there is no way of knowing how divided the leadership is on whether to pursue a more vigorous response or to let the whole thing blow over.

Everyone simply assumes Beijing will act “in its own best interest.” But absent democratic institutions like a parliament and a free media, there’s no way to know what Beijing thinks its self-interest is.

I could not agree more. Far too often I have had clients just assume the major goal of China and its provinces and its local officials is to bring in foreign business that can provide good jobs for the Chinese people, but that is just one of many goals. I am convinced the main goal is actually to keep the Chinese people happy in a political sense and though that goal can and often does include jobs, it can and does oftentimes include much more than that, sometimes even to the exclusion of that.

Sternberg goes on to describe the capriciousness of it all:

At heart this is a question of risk versus uncertainty. Policy risk is the ability to estimate with some degree of precision (the risk) the probability that government will do something stupid (the policy). Uncertainty is far more capricious, involving the completely unknown or unknowable. China may be more uncertain in this sense than some have realized.

The question is not whether China’s government will do foolish things. All governments do, as American businesses staring down the barrel of ObamaCare will attest. In the democratic world, however, businesses can see bad policies rolling in their direction like thunder clouds on the horizon. As a result, they enjoy ample time to estimate how bad the hit to the bottom line would be. Policy making in a democracy follows a certain logic of poll numbers, votes, media spin and the like. Because so much of it happens in the open, it is possible to make educated guesses about the outcome. As a corollary, understanding the logic—how congressmen think, say, or where the campaign money comes from—makes it easier to lobby effectively.

Not so in China. This comes up repeatedly as China increasingly asserts its political and economic might. Japanese companies have found themselves deprived of Chinese rare-earth minerals owing to a political spat over maritime sovereignty. Foreign executives like Rio Tinto’s Stern Hu have found themselves arrested, tried and convicted on corruption charges seemingly as a result of commercial disputes.

According to Sternberg, China is so random and the events that trigger China are themselves so random, that there is pretty much no way to know the odds of your company getting caught in a maelstrom.

So how could a Japanese executive relying on rare-earth minerals from China have estimated his risk from a politically motivated cut-off in supply? How could a Norwegian handicap the odds that a Nobel Peace Prize might adversely affect his business?

Already there are signs companies are realizing they’ve made mistakes. Google withdrew when it concluded it had wrongly estimated the upside policy risk of censoring search results in exchange for doing business in China. The company discovered Beijing’s internal logic evidently rules out allowing a foreign Internet search company to succeed no matter how accommodative it is.

Like it or not, China no longer feels terribly inclined to care much about the foreign companies in its midst and it will not hesitate to place big picture politics over economics. Those who believe otherwise are neglecting real risk. And sometimes, the impact of these things is so small and so subtle that I have suspected something is happening, but I cannot be sure. For example, in the last couple of months, as tensions between the United States and China have been rising on the economic and military fronts, I have gotten the strong sense that China is cracking down on Americans in China without work visas. I can tell you that the number of calls we have gotten on those has greatly increased. Is this random? Is this due to something else? Might this be happening to people from countries other than the United States? I don’t know, but I think there is something going on and this is not the first time.

What then is a foreign company to do? I am not a business expert, but if it were me, I would at least take note of the potential risks and at least be thinking of contingencies to try to alleviate it. If my product costs $1.00 to make in China and $1.20 in the United States, I would NOT shut down my entire U.S. operations and move it all to China. And I know it is not good form not to be all rah rah on China, but I will note that in my own portfolio right now, I own country funds for three countries: Vietnam, Brazil, and Turkey. I sold my China country fund a year ago. If I had to pick one country that is going to grow the most during the next ten years and do so in the best way possible for American companies, I would pick Vietnam.

Who’s with me?

Excellent post by Rich Brubaker of the All Roads Lead to China blog on his discussion with Neal Beatty entitled, “Identifying, Measuring, and Taking Action on the Risks of China.” It is the kind of post every company doing business in or even with China should read.  

The post sets out an amazingly comprehensive (yet blissfully concise) list of risks businesses face in China:

  • Compliance & integrity issues: internal fraud (kickbacks and conflicts of interest are most common)
  • Corruption & Graft: recognized by the government in Beijing as a serious issue in China. And now an increasingly serious issue in the US and UK with the growing impact of anti-corruption laws.
  • IP issues – counterfeiting, internal theft of critical information, and the protection of your trade secrets are major issues
  • Business partners: Who really is your prospective JV partner? How did they accumulate their wealth? Does your partner or key staff have undeclared family or business connections to a competitor or supplier?
  • Political and regulatory risks – this is largely more of a strategic, ‘big picture’ issue, but companies who lose touch with the prevailing political pressures affecting their industry can find themselves exposed to problems or shifts that they weren’t expecting.
  • Supply Chain risks – lack of transparency and controls along the chain
  • Natural Disasters – typhoon, flood, earthquake
  • Business disputes – the concept of “illegal detention” by business partners as a means to settle a dispute over payments due; threats by disgruntled former employees.
  • Restructuring & labour disputes – closing a factory, or dealing with the disgruntled employee who seeks revenge on a manager
  • HR risks – associated with the new HR law and the complexity of hiring & firing staff.

It goes on to note, absolutely correctly, that the extent of each of these risks varies with the companies. I did a post, entitled, “China’s Lack Of IP Protection: Overrated. Overrated,” and an article in the Conference Board Review, entitled, “In China, Piracy is no Excuse,” on how foreign companies are sometimes overly hamstrung by piracy and the lack of IP protection in China.

I particularly like the post’s no-nonsense approach to law-skirting:

One of the most serious potential risks to any business in China is the tacit acceptance of the “This is China” approach to business ethics and compliance issues. “We can’t do business without paying the occasional bribe to win contracts” or “it’s OK to allow employees to take a few kickbacks from suppliers – that’s how business is done here”. I’ve heard similar sentiments from managers in China and I worry that they are leaving themselves exposed to more serious issues further down the line. By condoning “low level” corruption within the organization, there is a serious risk of it getting out of control and in the worst case putting the entire operation in jeopardy. A zero tolerance approach is certainly not easy, and requires time, effort and budget, but I would say it is the best way to operate in China, just as in other parts of the world. And it is essential that senior management lay down the law and set out the company culture towards such issues from the very start.

I am often criticized for emphasizing (or over-emphasizing) the risks of not complying with China’s laws. Those who criticize me are usually violating one or more laws and their “evidence” is that “so and so has been doing the same thing for five years without any problems.” All I know is that in my experience (which consists of having represented and/or spoken with thousands of companies doing business in China), nearly all foreign companies with unresolvable legal problems in China have those problems not because the Chinese government or Chinese laws are “crazy,” but because they either ignored or clearly violated Chinese law.

Note how I use the word “clearly.” I do so because so many times when foreign companies assert that their problems are due to a lack of clarity in Chinese laws, that simply is not the case. Way more often than not, when foreign companies find themselves on the wrong side of Chinese laws, it is because they either willfully chose to ignore the laws or because they chose to search out an English language explanation (usually not by a lawyer) to justify what they sought to do. For more on this, check out “China’s Business Laws. Ignore Them At Your Peril.

The All Roads post nicely notes the role of lawyers in helping to understand and mitigate a company’s China risk:

If you are new to China, whether sourcing, selling or manufacturing, the first step needs to be to ask for advice. But who to ask? Lawyers are a necessity, but as I have seen from my own experience, they do not always give you the full picture of the risks your operation may face. So the biggest risk is actually not actively assessing and properly planning for the risks! Many firms still don’t really do this until something goes wrong.

I completely agree. Lawyers cannot give the full picture or the risks your company may face in China because no lawyer can ever know your company as well as you do, no lawyer is ever going to be positioned to see the day to day matters with which your company has to deal, and, most importantly, most of the risks your company is going to face in China are not going to be related to the law.  

So how then can your company operate risk free in China? Well of course it cannot:

I don’t think any company can run “risk free”, no matter what sector or what size of operation. From the largest MNC with multiple manufacturing and distribution facilities around China, to the “one-man-band” sourcing operation, everyone will face risks.

Moreover, you can never reduce risk to zero. No matter how good your risk management program, there will always be someone who does something without considering the possible outcomes and impacts thoroughly, or simply faces a problem that couldn’t be anticipated or couldn’t be prevented. And thus you need to be able to react appropriately and have contingencies in place. But a good awareness of the risks from the very beginning, along with regular (twice a year) reviews of your level of risk exposure, will go a long way to mitigating many of your operational risks.

What are your business risks in China? How do you quantify them? How do you deal with them?

Brilliant post over at Paul Denlinger’s China Vortex blog, entitled, “Risk is in the Eye of the Beholder,” on how and why Chinese companies measure risk differently than do Western companies. I have often wondered about this, but without the business background even to know on what I was wondering.
One of the things I have noticed and am forever complaining about is how American companies are so often late in going into emerging market countries. (I have intentionally shifted from talking about Western companies to talking about American companies because the overwhelming bulk of my own personal experiences in this area come from working with American companies.) The high margins American companies expect and their high labor costs are no doubt factors, but I also wonder if it is not just plain and simple risk aversion based on an unwillingness to risk jeopardizing that which has already been achieved. All I know is that I have worked with an untold number of companies over the years that have come to the brink of going into an emerging market country (including China), but then backed down at the last minute because of some (often very small) risk that would not be present stateside.
So many times when American companies have been unwilling to go in, companies from other countries do go in and succeed. Then, at that point, the American company begins looking anew at going forward. Reminds me of the passing game on my 10 year old daughter’s basketball team where the kids so often see the open girl but fail to pass it to her until she is completely covered. The problem with waiting until a country “stabilizes” or becomes “low-risk” is that so often by the time it has done so, it is already too late for you to make your mark. I see this happening in China’s wine industry, where the French and Australian wineries are already establishing their distribution networks and their reputations while American wineries are, for the most part, still dithering.
Am I, of the inherently risk averse lawyer class, way off base here in criticizing American companies for an unwillingness to assume developing country risk? How do American companies compare with those from other Western nations? How does economics explain all this and is American company behavior rational? Conversely, who am I to complain when it is this very same aversion to risk that causes American companies to hire lawyers and when I am constantly complaining about how Asian companies take so many riskes by not using lawyers here in the United States?