China Joint Ventures Rehabilitated? Big Business Thinks So

October 29, 2008 Posted by China Briefing Reading Time: 4 minutes

Oct. 29 – Joint ventures in China have had more than their fair share of criticism over the years. Tales of deliberately cynical Chinese partners, investors being ripped off, and disasters all around have often done the media and blog rounds. Rhetoric of this sort can be found in abundance at blogs such as Seattle-based, American lawyer Dan Harris’ China Law Blog, with articles such as “China – Damn the Joint Venture,” “China Joint Venture Jeopardy,” and “Beware the China Joint Venture,” all of which make valid salient points, but tend strongly towards rejection of them as a legal vehicle.

The debate, which is a long running (and probably never ending) legal and business topic, essentially depends on the type of business category the investor falls into. Small businesses are probably best left steering clear of JVs, unless they either have to utilize them due to regulatory issues, or have the resources to conduct proper due diligence, a point Harris stresses. Larger businesses however can actually find JVs extremely useful. Commentary from this position appears here: “China JV’s offer easier access to China Markets,” “The JV versus WFOE debate – Choosing Between the Options,” and indeed the May issue of China Briefing Magazine in its entirety, “Managing Your Joint Venture Partner,” which is downloadable by clicking on the cover.

Clearly, there are two camps in the debate; neither is wrong, but the circumstances of the investment do tend to dictate the sensible pragmatic position as regards joint venture utilization. Essentially, JVs are a sensitive legal instrument and require delicate handling. Due diligence is a must, as is experienced and practical operational, hands on management. However, in many larger industries in China, a JV may not only be the only regulatory route available to enter the China market, it may also be the most preferable one. Using a Chinese partner’s existing facilities, domestic purchasing capabilities, distribution channels, and local market knowledge can be highly attractive to foreign investors.

Indeed, we see many JVs in China now being bought out by the foreign investor—the Chinese partner had taken them as far as they could go locally and it was time to bid adieu. The development of a truly national business in China also, is typically taken by establishing a number of different JVs in different cities, exploiting the local partner’s knowledge, and then buying them out to create a national business comprised purely of foreign investment with no local partner in sight. It’s long been a smart move, and in fact the preferred modus operandi when it comes to developing a national strategy for selling to the China market in its entirety. The “China Dream” of foreign investors selling to 1.3 billion people is actually being achieved via the use of a Chinese partner’s local knowledge for initial market access, possibly later buying him out, and then tying all the resulting WFOEs into a national structure. However, increasingly, foreign investors are sticking with their Chinese partners, and even more aggressively involving them in domestic senior management issues.

Consequently, it’s been useful to note the recent Financial Times article, “China Needs Delicate Handling,” in which three different JV managers give their analysis of the role their JV has had to play when it comes to the China market. Interviewed are Bernd Blumenberg, of BASF, who has a US$3 billion JV with Sinopec in Nanjing, Chen Qihua, Caterpillar’s managing executive in China, and Li Xiaowei, who is masterminding ArcelorMittals expansion into China. It’s significant that of these three substantial JV investments, two are now managed by Chinese nationals. The article is well worth a read, but a few points hit home. Blumenberg, on the quality of the Chinese party’s 26-strong management board, overseen by a Communist Party official, states: “They send to the board some excellent people, some of whom will be future leaders.” Chen Qihua meanwhile, says that because he is Chinese, he can “get down onto the shop floor, talk to the workers and get to the heart of what’s going on.” Lakshmi Mittal takes the view that by demonstrating to the Chinese establishment that he can advance the cause of the (foreign investment restricted) Chinese steel industry, he can gain a future greater role for ArcelorMittal in China. That is a specific strategic decision deliberately taken that only a JV relationship can provide.

Key to the success of JVs is the insistence upon management “to put the requirements of the joint venture first.” It has certainly worked for BASF, who sold US$2.1billion worth of product in China last year, with production starting just three years ago. Caterpillar’s sales are now at US$2billion in China, with Cat now owning 85 percent of its primary JV in Xuzhou. ArcelorMittal have a 33 percent minority stake in their JV with Hunan Valin, one of China’s largest steel manufacturers, and clearly view it as a strategic investment with an eye to increasing that when the regulatory position in China permits.

The final words in the piece are telling: “For foreign companies that can overcome the complexities (of a joint venture) the arrangement is evidently a key that unlocks a vast market opportunity.”

For China then, the key to a truly national position appears to be JV driven. Smaller businesses, unless a JV partner is required due to the regulatory climate, would be advised to follow Harris’ advice and steer clear, plumping for a WFOE instead. But clearly, MNC strategy should not discount the JV as regards market access and knowledge acquisition for long term development of the national China marketplace. Joint ventures retain their status as the most delicate, but potentially rewarding legal investment structure that is available to the foreign investor in China.

Chris Devonshire-Ellis is the senior partner of Dezan Shira & Associates and publisher of China Briefing. The firm has handled joint venture structuring in China for MNC’s for over 16 years, with some 250 successful incorporations in place amongst their client base, including ArcelorMittal, Chrysler, Devon Energy, and Zeppelin amongst many others.

For advice on joint ventures in China, please contact Richard Hoffmann, senior associate, Legal Services Division, Dezan Shira & Associates: richard.hoffmann@dezshira.com

China Briefing’s technical guide to establishing joint ventures in China (second edition) is available, priced at US$25 plus p&p from our online bookstore.