Dr. Stephane J. Grand

Success in China

Or the Absence of Failure

Dr. Stephane J. Grand

Success in China is the absence of failure

The limits of experience

• Your Instructor

• What you will learn and what to do with it– The fundamentals: there is indeed a Chinese culture– Application: working with the Chinese– Application: investing in China– Application: navigating and troubleshooting daily business– Futurology: Strategies for the long term

• Keep in mind: – Political Correctness, or how to refuse to learn– Limits of Experience: reconnecting theory and practice


Success, Failure and China

• I do not need to convince you China is important• 1.35 bn. people (2012 UN est.), 95+% literate• 2nd economic power in the world • 7.8% growth rate (2012, est.)• 2.057 tr. USD exports (2012 est.)• 1.735 tr. USD imports (2012 est.) • 3.3 tr. USD foreign exchange reserves (end 2012)

• What makes the first cut of success or failure of a foreign company in China? Thinking it is a Western country.


What you need to walk away with from today’s lecture

• China is not a country as you understand it

• There is no truth in China

• Friendship, contracts, trust are different concepts there

• There is no authority, there is only power

• The history of the people you do business with in China is different from this of anyone you know in the West


Why this matters

• The above has a tremendous impact on:– The relations with customers, suppliers and

business partners– The sensible and efficient mode of entry on the

market– Contractual and general business risk– Intellectual Property Rights (IPR) and their

protection – Strategy

The Chinese in the Last 60 Years


Recent History

• Timeline of Modern China and the lives of your counterparts

1949 – Liberation from foreign powers, birth of the PRC1953 – Anti-rightist campaigns – end of private property1957 – Launch of the Hundred Flowers Campaign (open criticism, followed by violent crackdown)1958-1962 – Great Leap Forward (widespread famine, 20+ million deaths)1966 – Beginning of the Great Proletarian Cultural Revolution (political violence at an unprecedented scale)1976 – Death of Chairman Mao Zedong, end of GPCR1978 – Downfall of the Gang of Four, rise to power of Deng Xiaoping1981 – One Child Policy (beginning of forced abortions)1989 – Tian An Men events (June 4th)1989 to now: continued economic growth under CCP supervision – Acceleration of reform (Bonsai theory)

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50

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1960s


1970s


1980s


1990s


1965-1985 – Family structure


There is more than one China

Economic geography of China• North (Beijing, Changchun, Harbin, Shenyang,

Tianjin, Dalian): Rust belt: heavy industry, heavy unemployment, destroyed environment. Political and industrial, not commercial. Third FDI destination.

• East (Shanghai, Hangzhou, Suzhou, Wuxi, Nanjing) : High value added manufacturing, heavy FDI, modernized economy, commercial. Environment slightly less damaged. First FDI destination.

• South (Guangzhou, Shenzhen, Xiamen, Zhuhai, Zhongshan): Light manufacturing, labor intensive industries, Oil & Gas, recycling. destroyed environment. Second FDI destination, mostly Asian.

• West (Chengdu, Kunming, Chongqing, Xi’an, Wuhan, Baotou, Hohot): Heavy industries, agriculture, very polluted, VERY corrupt, bad economic situation. Ethnic minorities. Some political violence. Said to be up-and-coming.

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What this gigantism means

• The Sky is High and the Emperor Far: relations with the local authorities are important

• Local Chinese markets are different

• It is difficult to move your teams

• People are connected locally


Social Dynamics

• Truth

• Understanding of power: from the family to society

• The guanxi system

• What makes contracts different in China

It is not about the people you do business with, it is about how they interact with you


Truth


Truth Redux

• What do we learn from Zhuangzi (and Heidegger)

– Truth can be inferred, it is an implicit world– There is no demarcation between subject and

object, not leaving space for absolute truth, – Truth is relative to the context of the enunciation

• How this translates to business– There is no rational business conversation– Your “fact-based” truth does not matter


Guanxi or Social Networks

• Social interconnections, organized

• Origins of Guanxi: Guilds– Short story of a cobbler in Ancient China

• The guild of cobblers• Autarkic village• Making the deal • Breaking the deal• Protection

– The morals of the story:• More than moral suasion: excommunication • Informal judicial systems and business

promotion agencies


The Traditional Family or the School of Power Thinking

Since families are linked by guanxi, the structure connects into society like a power grid and transmits power virtually throughout the Chinese World

• Traditional family structure centered on males

• From father to elder son, to younger son

• The power of each one is limited by the power of the one above in the line

• The law limits the power of each one


So What Does This Mean for Business in China

• Very high incidence of – Fraud – Corruption– Breach of Contract– IPR Theft


Impact on Contracts

• Impact on Contracts: – Contracts organize horizontal relations between

equivalent actors, based on the possibility to obtain enforcement – Chinese social fabric is woven vertically, as everyone is above all a member of a group

– Extension of the business networks beyond the close family, though closeness prevents contract – Contract allows business where there is no guanxi.

– However, guanxi is always stronger than a contract


Corruption

• In a regimented society with positive freedoms, the control over the licenses is extremely powerful.

• It is traditional for public officers to receive payments for their work, or the absence thereof.

• Intermediation and facilitation fees are not considered as payoffs in society, though they are in theory frowned upon by the legislator.

• The guanxi system allows for non-cash payments. Goodwill creates debts.

• The brightest minds go to low-paying jobs in the public administration. Their lifestyle shows they made the right choice.

• Corruption money is now sought after by foreign countries promising citizenship or permanent residency against investment in job-creating projects.

• There is an estimated USD 3.7 trillion worth of wealth in China, which wealth is not under management.


IPR Theft

• Stealing a book is an elegant offense: tradition against the protection of IPR

• Some figures to fathom the depth of the problem– 90-99% of all software is pirated in China– Over 50% of all shampoo, razor blades, cell phones, cigarettes

sold in China are fake.– 50% of all branded bottled water is fake.– 15 to 20% of the GDP of the country is constituted by the

manufacturing and distribution of forged goods. Some of it is exported, some sold online or in physical stores dedicated to fake goods.

– There even are fake stores, such as McDonald’s, IKEA, Starbucks, Dairy Queen, Apple Store.

– American companies, according to the USITC, have lost USD 48 bn. in licensing fees in 2010 because of Chinese IP infringement.


Culture of Fraud

• Fraud? What fraud? Where there is no truth, there is no lie. Where the others are only worth what you can get of them, there is no fraud:

– According to a survey conducted by the Shanghai Academy of Social Sciences in 2011, 90.2% of the respondents found that people who were “honest and trustworthy” put themselves at a disadvantage.

– In 2010, 1,563 false (fraudulent) lawsuits in the province of Jiangsu have led to an economic loss of USD 64 m. (RMB 390 m).

• Academic fraud, some figures:– Wuhan university estimated in 2009 that the Chinese industry of the

production of fake research papers was worth USD 150 m. Its growth rate was estimated at 250% per year.

– In 2010, Nature noted that 1/3 of the scientist at the 6 top Chinese research institutions confessed to plagiarism, falsification and fabrication.

• Fraud investigation and mitigation has become an industry of its own.

SJ GRAND Financial and Tax Advisory

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PERNOD-RICARD CASE STUDY

The Story of Pernod Ricard in China


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Key figures

1987

1989

1998

2.3mill

ion

Pernod-Ricard started a joint venture in China with the locally made wine called Dragon

Pernod-Ricard exited : as being a foreign company, they were not allowed to own the brand at that time

Cases of cognac were sold in the country in 2011, 22% increase over 2013

The company bought Australia’s best-selling wine : Jacob’s Creek

The Joint Venture with Dragon Seal


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Pernod Ricard (“PR”) chose to enter the Chinese market through a Joint Venture (“JV”) with the Chinese leading wine-maker Dragon Seal (“DS”).PR would bring the French wine-making technology, cash investment and specialists to train the JV’s staff.DS would contribute the ownership of the brand, some of the equipment, the factory and the distribution networks.

The JV was established in the Beijing premises of the Dragon Seal company, in 1987.

One Bed, Two Dreams


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PR trained the personnel of the JV, which started producing an international-standard wine under the old and recognized brand “Dragon Seal”, formerly owned by the DS Company and contributed to the JV.A few years later, in the early nineties, PR executives heard reports that a very low quality wine was sold under the brand “Dragon Seal”.Acquiring a stock, the French team realized that the wine was indeed of very low quality, but bottled in identical bottles, with identical labels and markings.The origin of the bottles was traced to a factory adjacent to theirs, and belonging to DS.

Pernod Ricard in China


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Confronted, DS executives recognized that they were producing fake Dragon Seal wine, but refused to stop the production, arguing that they owned the trademark.By 1996, the brand having taken a beating, and to save their business, the PR executives proposed DS technical help

The idea would be to help DS produce a decent wine thanks to French supervision, as long as it was under a different brand. DS executives refused to relinquish the illegal usage of the brand, which they considered owning in spite of having transferred it to the JV.After some legal struggling, PR exited its JV with DS in 1998, having created its own direct competitor. DS hired French winemakers to oversee production.

Pernod Ricard in China


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PR learned from the Dragon Seal debacle and, the Chinese market being impossible to pass, chose another strategy allowing it to control most of the chain: importation of brands of its portfolio.Demand for spirits such as wine, draft Beer and especially for premium Cognac continues to surge in China, despite growing consumption of Scotch and Vodka.

Indeed, in recent decades the China’s economic boom created new Cognac consumers and the mainland China market become indispensable for Pernod-Ricard which responded to the demand with its Martell cognac.

Pernod Ricard’s return to the China market


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Pernod Ricard now imports, markets and distributes in the PRC brands it owns, without a Joint Venture partner.The strategy has shifted from leaving the marketing and distribution to a Chinese partner to taking control, from selling locally-made products to importing, and from middle range to higher middle market.

Today: A wide range of products


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CADDIE CASE STUDY

Caddie comes to China


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To serve the fast-growing food retail industry of China, Caddie, the world leader in the shopping trolley industry established a factory in the Shanghai municipality, to be headed by their former importer, Frank Jiang. The factory would produce the shopping trolleys locally and sell them to the Chinese as well as Asian marketsCaddie Shanghai generated 25% of the world turnover of Caddie Group in 2010

Caddie ran into financial trouble around 2010 and was purchased and restructured by Altia Group, a French PE fund in early 2012. The Chinese operation went largely unmonitored for over a year.

Caddie, meet Frank Jiang


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• SJ Grand was hired to conduct the pre-acquisition audit in late 2012 and pointed out severe accounting irregularities, as well as a potential fraud.

• After more investigation, the General Manager had established 17 companies to supply all the raw materials and machines as well as to purchase the finished products, diverting the profits of the company into his pockets.

• The new owner of Caddie tried to negotiate with the GM in spite of our recommendation to strike hard and fast.

• We also found HK bank accounts used to divert revenues of foreign sales.• Confronted, the GM went to the next level and started moving the machines

out of the premises, into a new factory established across the river in Jiangsu.• This new factory is using the brand name Caddie.• The account manager with the bank (HSBC), coming from the same village as

the GM refused to cooperate. A collusion is suspected but not proven.• The local police refused to intervene against the Chinese GM, in spite of assault

against an auditor, and instead helped the local bodyguards remove evidence from the hands of the audit team.

The End of the Affair with China


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• When informed the officer of the local bureau of the Administration of Industry and Commerce with the MoC threatened the lawyer of Caddie France before our team for helping a foreign company against a Chinese entrepreneur. The new banker taking over the accounts, was also threatened by the police.

• The GM, effectively fired from Shanghai Caddie, refused to return the official documents allowing to effect changes to the company’s registration, officially remaining the head of the company in spite of the shareholders’ decision.

• Caddie France sued the GM as well in March 2013 for embezzling millions of Euros as well as theft and his new company, Jiangsu Caddie, for IP infringement.

• The Shanghai government, seized by the French Embassy, launched an investigation and an action, putting in charge of the file the officer of the AIC who had threatened the lawyer two weeks before.

• The damage has been estimated at several million Euros, but the exact sum is undisclosed. It is public, however, that the turnover of the company in 2012 was EUR 15M, and most of it had been diverted into other companies’ accounts.


The Absence of Immediate Failure

• Family links

• Power relations

• Weak judiciary

• Low trust

• Contract

• Authority relations

• Strong judiciary

• High-trust

The western world The Chinese world

Success in China

Or the Absence of Failure

Dr. Stephane J. Grand

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Dr. Stephane J. Grand