China Joint Ventures as Strategic Investment

October 27, 2009 Posted by China Briefing Reading Time: 4 minutes

Part One: Why the Need for a Chinese Partner?

By Chris Devonshire-Ellis and Richard Hoffmann

Oct. 27 – As the United States shows signs of emerging from recession, there has been some discussion on the best way to enter the China market but perhaps under reduced financial constraints. A joint venture partner is often considered because it is less expensive than building from scratch.

In fact, this debate has been doing the rounds ever since China became a major beneficiary of foreign direct investment. Another school of thought dictates that under no circumstances should a joint venture in China be considered: Chinese laws are said to favor the Chinese partner; there are issues of corruption and the Chinese side is difficult to manage in terms of adherence to international standards of accounting and transparency.

While there is a measure of truth in all arguments both pro and con as regards JVs, a sensible application of due diligence and an understanding of what a Chinese partner can bring to a JV are paramount. In this series of articles we examine these issues, developed from over seventeen years experience of our firm establishing joint ventures in China.

Why the need for a Chinese partner?

In our experience, the occasionally perceived adage that is it less expensive to set up in China with a partner than going it alone isn’t really true. It certainly should not be used as the primary reason to have a Chinese partner. In fact, so much so, that we would advice setting that in stone. If you intend to go into a JV purely as a cost-cutting measure, you shouldn’t be considering one.

Restricted industry access

Certain industry sectors demand a Chinese partner. In this case, the regulatory position gives the foreign investor no choice. Certain sectors vary in terms of how this manifests itself, however if the law says a partner is required, then there is no maneuverability on the subject. In which case, the immediate concerns move on to management and equity structures, and due diligence. We shall address these points later.

Existing facilities and workforce

If the potential partner’s premises, workforce and production capabilities are a match for your product, then you have potential for examining the situation further. However, added to these should be an examination of the supply chain, both in terms of suppliers, and in terms of delivering to the point of sale. Are these intact and part of the agreement? Also important is the marketing aspect. A product that is new to China may take an additional length of time to sell to the market.

This needs to be properly factored into the business negotiations and agreed. We recall one JV which failed because the initial product volume was too low and the marketing resources required too high for the Chinese partner, which made other, related products, to maintain interest and devote time to brand development and marketing.

Although the Chinese partner could have delivered and was certainly capable of doing so, the product failed because they were not prepared to invest in its marketing development. The foreign investor lost a lot of time, effort and money. So a JV is not just about the Chinese partners capabilities. He also has to be similarly motivated and sufficiently financed to want to push the product.

Regional market capabilities

Tastes, consumer behavior, brands and even language vary considerably across China. Reaching out to consumers in Central China may well require a different set of market evaluations than consumers in Shanghai. A JV partner can be a useful asset in a new regional market to allow you to develop your brand, sales and market penetration. In fact, if your business is looking long term at developing a national structure throughout China, then a strategy of starting each location as a JV makes sense.

Use the local partner’s knowledge to build up each regional location, then gradually buy out each local partner. The result is a fully owned, national business. If you’re in this league, then examining the potential of a JV as a stepping stone to your ultimate goal is a sound and well proven concept in China.

Existing brand awareness

There are new opportunities in China for selling to the domestic market. In which case, if you have a product that can piggy-back on an existing, respected Chinese brand, you save the trouble of having to build a market on your own. The Chinese have for years been selling auto components to international auto brands. There’s no reason why you can’t do the same in reverse in your industry.

Supply chain

This is a major component and highly valuable to gain access to the Chinese market. Without it, selling to the China market requires an extra layer of business relationships and expense. If your potential China partner possesses a proven supply chain then this may well prove to be a primary driver. It is a major asset. However, when evaluating a partner, access to the supply chain, and the conducting of due diligence on it is a prerequisite. From our perspective we identify the China supply chain as the key element as to why you would want to have a JV partner.

Chris Devonshire-Ellis is the founding partner of Dezan Shira & Associates and lived in China for 21 years. He has over 17 years of experience in establishing JVs in China. He is now based in Mumbai.

Richard Hoffmann is a senior associate of Dezan Shira & Associates and has seven years experience of foreign direct investment in China. Richard also writes for the Legal Ease column on the Beijing Review, China’s only English national news magazine. He is based in Beijing.

To contact Dezan Shira & Associates’ business advisory services division for JV advice and other corporate establishment issues email info@dezshira.com.

Tomorrow: Part Two: Legal due diligence

China Briefing Books:
Setting Up Joint Ventures in China (available in hard copy and PDF)