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Courting China

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Forming business partnerships through joint ventures remains an attractive way to do business in China. However, establishing and operating a successful business partnership is not getting easier, and the ability to anticipate, prevent and resolve challenges associated with partnerships is more important than ever. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China www.pwchk.com


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About the report Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China is a report commissioned by PwC and written by the Economist Intelligence Unit (EIU). It explores the motives of Sinoforeign business partnerships in China and the challenges companies face as they partner to conduct business in the world’s second largest economy. It provides key success factors for prosperous Sino-foreign business partnerships, relevant to both Chinese and foreign companies. In February 2015, the EIU surveyed 300 senior executives, 50% of whom are C-level, on a wide range of issues related to the formation and operation of joint ventures (JVs) and strategic alliances (SAs)1 in China, both of which will be referred to in this report as business partnerships. • Raymond Akers, executive chairman, Akers Biosciences • David Ahlstrom, professor, department of management, The Chinese University of Hong Kong • Thibaut Helleputte, general manager, Danone Mengniu • Jean-Michel Vallin, president, Faurecia China • Wu Xiaobing, regional president, Pfizer China • Ari Mervis, managing director, SABMiller Asia Pacific and chairman, China Resources Snow Breweries • John Kajander, general counsel, Shanghai General Motors • Yadong Luo, professor of management, University of Miami 17 17 The study covered nine geographies (the US, UK, France, Germany, Japan, Singapore, Hong Kong, Australia and China) and 19 industries (primarily manufacturing; retail & consumer goods; healthcare, pharmaceuticals & biotechnology; IT & technology). Company sizes varied from small (less than USD500m in annual revenues) to large (more than USD10bn in annual revenues). In addition to the survey, the EIU conducted a series of in-depth interviews with the following senior executives and experts (listed alphabetically by organisation): China US UK 17 Respondents by country % Australia France 17 Germany Japan 4 Hong Kong Singapore 4 8 8 8 Source: Economist Intelligence Unit In joint ventures and strategic alliances, two or more firms partner and commit resources to achieve a common set of objectives. Unlike strategic alliances, (non-equity alliances and equity participations), joint ventures utilise a separate business entity to allow two or more parties to collaborate in conducting specified business activities. 1 2 Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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12 13 Manufacturing Consumer goods & retail Healthcare, pharmaceuticals and biotechnology 10 IT and technology Energy and natural resources 17 Financial services Respondents by industry % 1 1 2 9 Entertainment, media and publishing Construction Telecoms Agriculture and agribusiness 2 9 2 Automotive Chemicals 3 3 3 3 3 3 4 Travel and tourism Logistics and distribution Transportation Real estate Aerospace/defense Other (including Government/public sector and Education) Source: Economist Intelligence Unit 15 5 7 22 More than $10bn $5bn to less than $10bn Respondents by annual revenue % $1bn to less than $5bn $500m to less than $1bn $150m to less than $500m $50m to less than $150m 29 Less than $50m 10 11 Source: Economist Intelligence Unit Please note that not all answers add up to 100%, either because of rounding or because respondents were able to provide multiple answers to some questions. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 3


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Contents About the report.............................................................................................1 Contents.........................................................................................................4 Foreword........................................................................................................5 Executive Summary.......................................................................................6 Introduction...................................................................................................7 1. Choosing the JV/SA business model to address the Chinese market............8 1.1 The attractiveness of China’s ‘world-class consumers’......................8 1.2 The relevance of the JV/SA model in China.....................................8 1.3 Risks related to JVs/SAs................................................................13 2. Complexities and challenges raised by the JV/SA business model.............14 2.1 Selecting a partner........................................................................14 2.2 Negotiating partnership terms.......................................................14 2.3 Operating the JV/SA.....................................................................16 3. Key takeaways..........................................................................................18 Conclusion...................................................................................................20 Contacts.......................................................................................................21 4 Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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Foreword Partnerships are becoming a compelling strategic option for many companies to drive growth in emerging markets and adjacent industry sectors. Our PwC 18th Annual Global CEO Survey recently showed that 51% of global CEOs planned to enter into new joint ventures (JVs) and/or strategic alliances (SAs) in 2015. This trend is particularly strong for China. Indeed, the same survey found that 60% of China based CEOs planned to set up JVs/SAs in 2015. As one of the top financial advisors in Asia, we have seen that China’s radical changes in the past years have resulted in a shift in M&A strategy and execution. Increasingly, both foreign and Chinese companies are going beyond the traditional acquisition model, using Sino foreign partnerships to achieve their business goals. At the same time, partnerships are extremely challenging to execute and operate (a broad range of skillsets is required), and the ability to anticipate, prevent and resolve challenges associated with partnerships is more important than ever. Failure to identify and consider the risks in these arrangements can have a significant impact on their likelihood of success and their value to the respective parent companies. In order to identify key success factors for prosperous Sino-foreign business partnerships, relevant to both Chinese and foreign companies, PwC commissioned the Economist Intelligence Unit (EIU) to learn more about the challenges faced by these companies when they set up a Sino-foreign JV or SA in China. We are excited to share the findings with you and grateful to the over 300 executives whose insights form the basis of this report. Katy Spooner Deals Partner PwC HongKong Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 5


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Executive Summary The key findings of this report are: No signs of a slowdown when it comes to using joint ventures to do business in China. Despite China’s slowing economy, recent scrutiny of foreign companies and rising labour costs, forming business partnerships through joint ventures remains an attractive way to do business in China (less risky, less costly and sometimes the only alternative). 76% of foreign respondents and 70% of Chinese respondents are planning on entering into a business partnership in China. For now, there are enough opportunities to go around. A significant majority of respondents describe the prospects of a partnership in China as good or excellent. Foreign companies are focusing more on their business’s compatibility with potential partners in China than in the past. When considering their Chinese partners, foreign firms are looking beyond local business, political and social networks and focusing more on strategic features of Chinese companies, such as their market responsiveness and openmindedness. This will likely be a growing trend as Chinese companies increase in sophistication and capabilities. Divergent objectives can exist from the very beginning of a JV or SA partnership. The main strategic focus of foreign companies is access to China, while for Chinese partners it is international expansion. This requires leveraging the capabilities and competencies of the partner (notably distribution channels and market knowledge) and therefore requires a high level of trust and openness between partners. Interestingly, more than one third of the Chinese companies are still forming JVs/SAs to strengthen their competencies and capabilities in China, notably as they want to be able to satisfy a more demanding Chinese population. Financial performance is now a top concern for business partners in China. No matter how complementary the relationship between partners, the JV or SA must ultimately deliver on financial objectives once it is off the ground. Poor financial performance is the top factor cited by survey respondents why partnerships in China may have to be terminated early. Strategy misalignment and cultural differences are among the main reasons why partnerships are not formed. Both foreign and Chinese parties agree that the chances of being successful are almost nil without a shared strategy and the ability to deal with cultural differences. For foreign respondents, the primary driver of choosing JV/SA business model versus other entry modes is because of the regulatory requirements in China. Nevertheless respondents say JVs/SAs also offer the benefit of sharing resources and skills at a reasonable cost while limiting risks. Both foreign and Chinese partners are worried most about the costs and complexities of setting up a JV or SA. As with most business ventures, costs remain a key point for all parties and an important area of consideration prior to establishing an operation. Foreign investors are also concerned about the risk of JV/SA failure, whereas this is less of a concern for Chinese respondents. However, they are more focused on the lack of personal connection with their partner and their partner’s lack of willingness to share its technology and R&D capabilities. 6 Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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Introduction China’s rapid growth trajectory has shifted in recent years. GDP expansion, while still relatively robust for a country of China’s size, has slowed considerably. The pace of infrastructure investment and industrial output has cooled. None of this is to say that opportunities for foreign companies are on the wane. China is currently trying to climb up the value chain and focus its economy on domestic consumption and more knowledge-based innovation. This structural change has brought with it a need for international experience, knowledge and talent and has resulted in a shift in M&A strategy and execution. While wholly foreign-owned enterprises (WFOEs) are still the dominant method of entry and operation in the Chinese market, forming JVs and SAs with local partners has remained a viable option for foreign multinational companies (MNCs) in recent years. According to data from China’s Ministry of Commerce, business partnerships remain the second-largest mode of utilising foreign direct investment after wholly foreign-owned enterprises. At the same time, establishing and operating a successful business partnership is not getting easier. A 2015 study from management consultancy Vantage Partners found that 59% of business alliances completely or partially fail to meet their objectives, mainly due to execution challenges2. Given these hard realities, why pursue a Sino-foreign business partnership in China? What are the challenges and success factors foreign and Chinese companies should take into account? This report explores these questions from both foreign and Chinese perspectives. The first chapter covers the key drivers of JV/SA formation. The second chapter covers the challenges and the third chapter discusses the important lessons learned from the research. 2 Kliman, Stuart and Price, Stuart. “New Alliance Management Study - Success rates increase but challenges remain”, Vantage Partners (2015) p1. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 7


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1. Choosing the JV/SA business model to address the Chinese market 1.1 The attractiveness of China’s ‘worldclass consumers’ Figure 1: Top reasons for choosing JV/SA model China is in the midst of a massive economic transformation, shifting focus from exports and heavy investment to a greater reliance on domestic consumption. In the past, foreign companies sought to establish factories in China to export goods and components. Today, they are increasingly formulating strategies to serve the fast-growing consumer market. The resulting impact on companies looking to do business in China is to push them further up the value chain. Chinese consumers have become more demanding as they look for more innovative and high quality products. “Customers [in China] have become very well-educated about the products,” said John Kajander, general counsel at Shanghai General Motors. “They’re world-class consumers.” Scale: 5=very important and 1=unimportant 3.8 3.9 3.8 Cost reduction 3.8 Access to the Chinese/Foreign party’s resources and competency 3.9 3.6 3.6 Direct management and control of business activities 3.6 Mitigation of business risk Foreign Chinese Source: Economist Intelligence Unit Interest in forming JVs and SAs will grow, with 75% of respondents say they are planning on entering a new business partnership in China. The survey highlights that the top reasons why foreign companies choose a JV/SA business model over others are regulatory requirements (4.0), cost reduction (3.9) and access to their partners’ resources (3.8). 3Similarly, Chinese companies choose the JV/SA business model over others to access their partners’ resources (3.9), to reduce costs (3.8) and to adhere to regulatory requirements (3.8). 3 8 3.7 Note: Results are based on average scores. 1.2 The relevance of the JV/SA model in China From the 1980s to the 1990s, regulatory restrictions in China required foreign investors to partner with Chinese companies in many industries. However, easing of restrictions on foreign investment, especially after China’s World Trade Organization (WTO) entry in 2001, helped the number of newly contracted WFOEs to rise and exceed that of equity JVs. 4.0 Mandatory partnership in China The rankings are based on averages of a scale in which 5=very important and 1=unimportant. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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It is clear that regulatory requirements are still driving the need for establishing JVs/SAs in restricted industries. However, the fast pace of consolidation in some Chinese industries has driven deal values higher and also contributed to foreign companies turning to JVs as a less costly and less risky way of accessing the Chinese market (notably as the quality of potential partners has also improved4). JVs/SAs also provide an appropriate structure to access a partner’s market or to be more competitive in China. Figure 2: Percentage of respondents planning to enter a JV/SA in China by country In line with these observations, the survey indicates that interest in forming JVs and SAs will grow, with 75% of respondents (foreign and Chinese) saying they are planning on entering a new business partnership in the country. 76% of foreign respondents and 70% of Chinese respondents surveyed are planning to enter into a business partnership in China. 84% UK 84% Germany 80% France 72% US 68% Japan 70% China 58% Hong Kong 85% Singapore >80% 70%-80% 70% Australia <70% Source: Economist Intelligence Unit Figure 3: Business partnership plans in China Foreign respondents Chinese respondents Enter a new SA 51% Enter a new JV Set up a new WFOE (cross-border M&A) Set up and new WFOE (greenfield investment) Enter a new JV in China 51% 48% 15% 12% Renegotiate/amend agreement for a JV formed after 2008 None of the above 48% 12% Source: Economist Intelligence Unit 4 Davies, Ken. “China Investment Policy: An Update”, OECD Working Papers on International Investment (2013) p14. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 9


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1.2.1 The weight of regulated industries There are still some restricted industries for foreign companies in China that require the formation of a JV/SA. The most commonly cited example is the automotive industry. Since 1983, any foreign automaker that has wanted access to the local market has had to set up a JV with a domestic firm, in which the Chinese ownership must be at least 50%. A more recent example occurred in 2013 and 2014 after the removal of a game console ban in China that lasted from 2000 to 2014. The two giant console makers Microsoft Corporation and Sony Corporation had no choice but to partner with Chinese companies to enter the Chinese market, and announced their JVs with BesTV New Media and Shanghai Oriental Pearl Group, respectively. Looking at other sectors, market access is a key driver for foreign respondents from the healthcare (72%) and energy/natural resources sectors (71%). Both segments are benefitting from China’s growing middle class: more Chinese are demanding and paying for better quality healthcare, while more natural resources are being consumed by the country’s new infrastructure and growth in automobile sales. 10 However, companies from these sectors have faced market access barriers, making it important to find a local partner. In healthcare, onerous clinical trials and regulatory hurdles that affect data protection and competitiveness have been challenges for foreign firms seeking to enter China. In the energy/natural resources sectors, inconsistent access at the provincial and local levels can make market entry difficult. China’s central government is opening up domestic industries to foreign investment, but progress across the country will be gradual. The 2015 Catalogue for the Guidance of Foreign Investment Industries significantly cut the number of industrial sectors that are currently restricted to JVs and partnerships from 43 to 15, and decreased the number of sectors that require a Chinese minority shareholder from 44 to 22. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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1.2.2 Market access and competitiveness in China 1.2.3 An alternative to increasing M&A values The survey shows that foreign companies keen on partnering with a Chinese firm primarily aim to play a role in the Chinese market. Indeed, access to the Chinese market (54%), improved market position in China (47%) and access to Chinese consumers (40%) are the key strategic drivers sought by MNCs. Foreign companies pursuing consumer opportunities in China often require the experience and resources of a local partner to negotiate the local market. The slowdown in the Chinese economy has translated into overcapacity in certain industries (e.g. shipping, construction, auto parts). This situation contributed to a wave of consolidation. Companies became larger and their market value increased, making it more challenging for foreign MNCs to consider acquisitions. As a result, companies targeting China may consider the JV/SA model as a cheaper alternative to reduce the upfront investment. Access to customers is an especially important strategic motive for respondents from Asia Pacific countries excluding China and from industries where delivering a personal service offering is important, such as the retail/ consumer goods (47%) and financial services sectors (46%), according to the survey. The beer market in China is a good example of how industry consolidation can transform the playing field. Consider China Resources Snow Breweries, the JV between SABMiller and China Resources formed in 1994, which produces China’s top beer brand Snow. “Over the last 2-3 years, there have been a few developments,” said Ari Mervis, managing director. “The consolidation game has almost played out – four brewers have close to 70% market share.” Conversely, Chinese partners are looking beyond China. The survey shows that nearly three quarters of Chinese companies (72%) enter business partnerships with foreign businesses to improve their market position in international markets and/or to access international markets. This is the China outbound trend. The implication of these survey results is that many Chinese companies are still not fully equipped to succeed in the international marketplace on their own. Since China’s entry into the WTO, Chinese firms have increasingly pursued business partnerships with foreign partners to access international markets without having to compete directly, and to gain necessary capabilities and knowledge that later will enable them to enter these markets without a foreign partner. Interestingly, one third of Chinese firms (34%) also intend to set up a JV with a foreign partner to improve their market position in China. By establishing partnerships with foreign companies, Chinese companies often benefit from their partners’ resources and capabilities such as technology, R&D capability and capital (34%), to differentiate from local competition. For example, in 2012, Chery Automotive, an automobile manufacturer in China, set up a JV with JaguarLand Rover to acquire production, project-execution and innovation capabilities. Foreign companies pursuing consumer opportunities in China often require the experience and resources of a local partner to negotiate the local market... conversely, Chinese partners are looking beyond China. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 11


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1.2.4 Leveraging the best of both partners The clear advantage of the JV/SA business model is that it combines the strengths of both partners. The strategic motives cited by foreign firms establishing partnerships with Chinese firms included capitalising on their partners’ resources and capabilities such as distribution channels (33%) and market knowledge (33%). For example, Pfizer formed a JV with Zhejiang Hisun Pharmaceuticals in 2012 that allowed Pfizer, which was globally affected by patent expirations, to enter the fastgrowing Chinese generics market. Akers Biosciences, a US-based manufacturer of medical diagnostic equipment, found the benefits of local expertise and market knowledge were attractive enough to set up a JV in China in 2014. “We did evaluate other business models,” said Raymond Akers, executive chairman, Akers Biosciences, which currently runs a medical testing JV with Hainan Savy Investment Management. “But at the end of the day, all sales and marketing are local, everywhere around the world, so if you’re going to do a good job you need people on the ground there that are local and know the market.” Figure 4: Most important strategic motives for forming a JV/SA in China raised by foreign and Chinese respondents Access to the Chinese market/International markets 54% 36% 47% 48% Improve market position in the Chinese market/International markets Access to customers 34% Improve market position in the domestic market 33% 34% Access to distribution channels 40% 33% 30% Access to market knowledge 22% 31% Access to low cost sourcing 26% Access to capital 22% Access to technology, R&D capability Foreign 33% 36% 34% 34% Chinese Source: Economist Intelligence Unit 12 Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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Foreign and Chinese companies ranked the cost and complexity of establishing a JV/SA in China as a significant risk. 1.3 Risks related to JVs/SAs Firms seeking partnerships in China are optimistic about the opportunities, as more than two-thirds of foreign and Chinese respondents (69%) describe the prospects of a JV/ SA in China as either good or excellent. However, for the JV/ SA establishment process to succeed, it is important to have an understanding of the risks associated with the business model. Respondents from both foreign and Chinese companies ranked the cost and complexity of establishing a JV/SA in China as a significant risk. However, they have different views on other risks related to forming a business partnership in China. 5 Foreign respondents tend to see growing competition in China (3.9) and JV/SA failure (3.8) as important risks, whereas Chinese respondents highlight changes in domestic demand (3.9) and rising labour costs (3.8) as key risks.5 In addition, Chinese respondents perceive a lack of willingness of their partner to share resources and capabilities, such as technology and R&D (3.7), as an important risk. Foreign respondents did not place such a high importance on the same factor (3.4). This suggests knowledge transfer could fester as an underlying issue for business partnerships unless explicit terms are created within charters. The rankings are based on averages of a scale in which 5=very important and 1=unimportant. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 13


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2. Complexities and challenges raised by the JV/SA business model From defining a strategy and selecting a partner to developing a contract and finally operating the partnership, the survey results highlight the main challenges of the process. 2.1 Selecting a partner Partner selection is an important variable influencing the performance and viability of the alliance, especially in restricted industries. “In the automotive sector at the OEM manufacturing level, a foreign entity has to partner with a state-owned entity, which has to have at least 50%, so everybody gets married in the automobile sector,” says GM’s Mr Kajander. “The strategic question is who do you get married to?” The survey reveals that good reputation, good legal standing and alignment on commitments are critical to both foreign and Chinese companies when it comes to some desired characteristics of a business partner. However, there are also some differences. The factor cited by the most foreign firms (41%) is being aligned strategically, though this is not a top factor for Chinese companies (22%). Conversely, Chinese companies are more concerned about control and profit distribution (38% vs 24%) and ensuring compatibility between corporate cultures. Being unaware of these expectations can lead to misunderstanding and raise complexity when selecting a partner. The survey reveals that good reputation, good legal standing and alignment on commitments are critical to both foreign and Chinese companies when it comes to some desired characteristics of a business partner. 14 When it comes to partner selection, alignment of strategies is particularly important for foreign healthcare companies (62%). China’s healthcare sector has seen sharp growth from a low base in recent years, thanks in part to income growth and urbanisation as well as the government’s focus on healthcare as a strategic priority. Healthcare expenditures in the country grew from 4.8% of GDP in 2003 to 5.6% in 2013, according to the World Bank. Still, distribution channels, facilities and government policies in the sector remain at a relatively early stage of development, making it important from the outset for business strategies to be in sync. Wu Xiaobing, regional president for Pfizer in China, explained that after screening “hundreds” of companies, they decided to work with Zhejiang Hisun based on its strategic position in the industry. “They share a similar vision to increase the quality of local Chinese generics, and to demonstrate that China can manufacture high quality drugs. This view is aligned with our vision,” he said. 2.2 Negotiating partnership terms Once the strategy is clear and a partner has been selected, the next step is to discuss and agree on the key terms of the partnership. All parties have to reach an agreement on objectives, activities and respective contributions but also control, governance, profits distribution (for JVs only) and length of the partnership. The contract negotiation process can ultimately be a matter of give and take. “Some industries are especially looking for financial capital, so companies have to be a little strategic about what they can give the local partner and what they have to hold back – it’s kind of a delicate negotiation,” said David Ahlstrom, professor at the department of management, The Chinese University of Hong Kong. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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Figure 5: Most important criteria for selecting a JV/SA partner in China raised by foreign and Chinese respondents 41% Strategic fit 22% 37% 40% Same level of commitment and trustworthiness Both foreign and Chinese firms cited the lack of alignment on the strategic purposes of the JV/SA as a top reason why partnerships fail before being formed. 37% 32% Good legal standing 36% 40% Good reputation among customers and suppliers 28% Complementary resources and competency 34% 24% Agreement on control and profit distribution 22% Compatibility between corporate cultures Foreign 38% 32% Chinese Source: Economist Intelligence Unit Strategic alignment Control and governance Both foreign (45%) and Chinese firms (44%) cited the lack of alignment on the strategic purposes of the JV/SA as a top reason why partnerships fail before being formed. If not handled properly at early stages, this lack of alignment might lead to misunderstanding between the partners, frustration and loss of confidence. Ultimately, 26% of respondents (28% for foreign and 18% for Chinese) consider strategy issues a reason to terminate an existing JV or SA. Consideration must also be given to the day-to-day management of the JV and the procedures and instances that will allow it to make major decisions (governance) regarding the business and future strategy of the partnership. The survey results do not reflect sensitivities regarding control of the partnership, with 80% of respondents saying they feel either somewhat comfortable or very comfortable being a minority shareholder. Figure 6: Comfort as minority shareholder in a JV/SA with a Chinese partner raised by foreign respondents Figure 7: Comfort as minority shareholder in a JV/SA with a foreign partner raised by Chinese respondents 68 50 Very comfortable 14 % Somewhat comfortable Very comfortable 22 % Somewhat uncomfortable Very uncomfortable 2 Somewhat uncomfortable Very uncomfortable 2 16 Somewhat comfortable 24 Source: Economist Intelligence Unit Source: Economist Intelligence Unit Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 15


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Duration and termination Though many of the companies interviewed for this report did not set a desired lifespan for their partnerships from the outset, foreign and Chinese respondents had somewhat similar views on JV/SA lifespan. About two-thirds of them expect their JV/SA to last 10 years or less. It is nevertheless essential to agree upfront on the duration of the partnership and how a premature termination would be handled. Figure 8: Expected lifespan of JV/SAs in China 37% 34% 28% 27% 21% 18% 17%18% Pre-formation planning More generally, poor pre-formation planning is also cited as a key reason for JV/SA early termination (29% of Chinese and 20% of foreign companies). The results suggest that rushing too quickly from strategy to execution without investing enough time and resources on performing analysis supporting the strategy and elaborating a clear implementation plan can result in negative outcomes for partnerships. 2.3 Operating the JV/SA Once an agreement is reached, the focus shifts quickly to smooth operation and spotting signs of trouble that can directly impact the JV/SA’s performance. Financial results are usually considered as the best way to monitor the performance of a JV/SA. 39% of the survey respondents cited poor financial performance as the top reason why partnerships in China have to be terminated earlier than expected. This could be due to one or a combination of factors that had not been properly addressed at preformation stage. A majority of respondents say their JVs/SAs are meeting their expectations (76%). Only 21% say their JVs/SAs are either exceeding or significantly exceeding their expectations. The key issue for foreign and Chinese companies is to identify factors conducive to superior JV/SA performance. The performance of a JV/SA is strongly reliant on the management team and its ability to make the partnership successful. Here are a couple of success factors mentioned by the interviewees. 16 1-5 years 6-10 years 11-20 years More than 20 years Foreign Chinese Source: Economist Intelligence Unit Figure 9: JV/SA performance vs expectations Significantly exceeding expectations 2% 0% 16% Exceeding expectations 32% 78% 66% Meeting expectations Underperforming expectations 3% 2% Significantly underperforming expectations 0% 0% Foreign Chinese Source: Economist Intelligence Unit 39% of the survey respondents cited poor financial performance as the top reason why partnerships in China have to be terminated earlier than expected. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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Incentivising partners Be involved in operations to ensure quality Some companies try to ensure at the very beginning of a partnership that the JV structure incentivises both partners to outperform. “Akers Biosciences and my co-chairman Thomas Knox own 44% of the JV between us and the JV partners own the rest. By doing it that way we give them incredible incentive to not only generate revenues but also then to have a real equity piece that can be a differencemaker for them,” says Dr Akers. “That’s really a key reason for doing this, because otherwise you would penetrate one of the largest-growing diagnostic markets in the world at a snail’s pace.” Other companies take a different approach and make sure they have operational control at the onset, in order to guarantee that the quality of the JV’s products and services matches the quality the company offers in other, more developed markets. “We wanted to ensure that our partners would give us operational management,” said Jean-Michel Vallin, president of the China operation of French automotive parts maker Faurecia. “Our partners understand and welcome the fact that the JV Management, for which the GM role is given to Faurecia, would follow Faurecia procedures and processes to ensure the quality of our products, and that we would go on delivering the level of quality we have been delivering for years.” Figure 10: Main reasons to terminate a JV/SA Figure 11: Main reasons to abort a JV/SA 39% 40% Poor financial performance Business objectives of one party that conflict with the ongoing operation of the partnership 29% 28% 28% 32% Inappropriate management structure Strategy problems Financial difficulties of one party 42% Divergent values 36% Regulators or third parties did not allow the partnership to go through 28% 18% 28% Poor pre-formation planning 45% 44% Lack of agreement on goals for the partnership 30% 18% 28% 26% Material misstatement, error or omission in the representations and warranties 31% 36% 27% Resources for the partnership did not materialize for one party 42% 22% Poor planning and coordination 20% Setting up the partnership proved too costly Foreign Chinese Source: Economist Intelligence Unit Foreign 40% 32% 32% Chinese Source: Economist Intelligence Unit Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 17


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3. Key takeaways The insights below are based on interviews and an analysis comparing survey results from executives who said their JVs/SAs outperformed with respondents who said their JVs/SAs either only delivered on expectations or performed below expectations. The gaps between the cohorts informed some recommendations on how to produce positive outcomes with regard to business partnerships in China. Consider various criteria to assess your partner, such as reputation, alignment of goals and values The need for guanxi—professional and political connections—notably figured low on the list for successful foreign respondents. This may be evidence of an important shift in the way foreign companies are approaching potential partners and perhaps an acknowledgement that companies in China have become much more sophisticated in their capabilities. “Previously, foreign companies tended to focus more on relationship-building capabilities, from business networks to guanxi, from business-government ties to social capital,” says Yadong Luo, professor of management at the University of Miami. “But today, I would suggest that foreign companies need to look at both transactional and relational competence possessed by Chinese partners. Transactional competence would include innovation skills, market response, brand and organisational image, entrepreneurial orientation, learning effectiveness, strategic leadership and an open-minded culture.” 18 Manage divergence in values and culture Obviously corporate values and culture will vary between foreign and Chinese companies and the survey indicates that Chinese firms should consider pairing with foreign companies that share the same corporate culture and values. If identified and properly addressed, cultural differences will be less of an obstacle to success. “We have different teams and different cultures,” Mr Helleputte of Danone Mengniu said. “It is difficult but also an opportunity. It is understandable that you can look at the same reality, but the way that a European, or a Chinese with an international background would describe it, or a Chinese with a local background, would be different. It doesn’t mean one group isn’t telling the truth. It means they are seeing the same reality with different eyes.” Be open about discussing conflicts or concerns arising from the partnership early in the process Frank discussion about objectives and areas of concern, such as IP protection for foreign companies and control for Chinese companies, early during the negotiation process is optimal. In addition, this would allow all parties to become aligned on the main features of the partnership and potentially identify regulatory issues upfront. “Some companies get this idea that they’ve got to do a deal in China because it looks like such a huge opportunity, and they push things that will become issues later on to the side. But there has to be clarity as to the roles of the different parties,” says Mr Mervis of SAB Miller Asia Pacific and China Resources Snow Breweries. Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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Figure 13: Main reasons to terminate a JV/SA (based on JV/SA performance) 42% 39% Poor financial performance 26% 21% 24% 29% Poor pre-formation planning To facilitate communication, partners may want to agree on dispute resolution mechanisms to ensure that misunderstandings do not take root between them and damage the business’s growth momentum. Faurecia’s Mr Vallin says, “Every other month, we have shareholder meetings. We meet with our partners and with the JV’s general management in order to put everything on the table. For us, this has been a big success factor, in order to avoid things being misunderstood for a period of time, leading to issues.” 24% 18% Financial difficulties of one party Business objectives of one party that conflict with the ongoing operation of the partnership 23% 31% 19% Strategy problems 29% JVs/SAs performing above expectations JVs/SAs performing as expected or below expectations Figure 12: Main reasons to abort JV/SA discussions (based on prior experience) Source: Economist Intelligence Unit 47% Lack of agreement on goals for the partnership 40% 42% Divergent values 39% 40% Regulators or third parties did not allow the partnership to go through 29% Material misstatement, error or omission in the representations and warranties 32% 30% 30% 29% Resources for the partnership did not materialize for one party Experienced JVs/SAs abortion 26% 30% Disappointment with a partner’s contributions to the partnership Agree on dispute management Setting up the partnership proved too costly 19% Inappropriate management structure Objectives for business partnerships can change over time in response to changing conditions in the marketplace. “We have a long history in China and not all of our partnerships were a success so the challenge is how we ensure that we don’t go down that road again,” said Mr Helleputte. Poor planning and coordination 39% Local business and regulatory conditions Be flexible and regularly review the objectives of the partnership 23% 29% 20% 29% Did not experience JVs/SAs abortion Source: Economist Intelligence Unit Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 19


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Conclusion China will undoubtedly gain further importance in the global economy as it shifts its focus from infrastructure- and export-led growth to domestic consumption. Foreign businesses interested in the opportunities that this evolution affords will have to anticipate the expectations of China Inc, understand and exploit complementary strengths with Chinese businesses and focus intensely on profitability. Like any marriage, forming and running a JV or SA in China requires trust, commitment and communication. The complexities that this study reveals could translate into future challenges for both international business leaders looking to capitalise on opportunities in the Chinese market and for firms in China seeking to internationalise. The survey shows how different viewpoints of foreign and Chinese firms are focused on three main areas: choosing a business partner, deciding to make investments and forming business strategies – with further differences highlighted across specific industries and views of what makes a JV partnership successful, as well as factors that could derail a JV’s launch at the starting gates. At the same time, the survey shows multiple areas of common ground between foreign companies and Chinese firms, including identification of risks relating to business partnerships in China and factors that are important when choosing a partner. The evidence suggests that JVs and SAs are not only here to stay for the foreseeable future, but may be an increasingly popular China market entry strategy for years to come. 20 Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China


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Contacts For further help, please contact: South North Central Katy Spooner Deals Partner Hong Kong +852 2289 2315 katy.spooner@hk.pwc.com Ken Su Deals Partner Beijing +86 (10) 6533 7290 ken.x.su@cn.pwc.com Herve Roesch Deals Partner Shanghai +86 (21) 2323 2585 herve.h.roesch@cn.pwc.com Pui Y Chui Deals Partner Hong Kong / Guangzhou +852 2289 2312 pui.y.chui@hk.pwc.com Wei Guo Deals Partner Beijing +86 (10) 6533 2970 wei.guo@cn.pwc.com Xun Tang Deals Partner Shanghai +86 (10) 2323 3396 xun.tang@cn.pwc.com Courting China Inc: Expectations, pitfalls and success factors of Sino-foreign business partnerships in China 21


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This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. © 2015 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. HK-20150616-10-C1


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