Understanding environmental risk for IJVs in China.
| Verfasser | Burgers, Willem |
| Posten | RESEARCH ARTICLE - International joint ventures |
Abstract:
* Finns still have great difficulty joint venturing successfully in China. We contend that the current understanding of environmental risk in China is incomplete. Specifically, the current conceptualization has three problems: l) lack of integration of unique Chinese environmental characteristics, 2) incomplete distinction between different types of environmental risk, and 3) lack of a conceptualization of how the risk pattern changes as the economy transitions.
* We extend the current risk framework to include the unique features of the Chinese context. We offer guidelines for managing risk tradeoffs over time using two key structural decisions: Channel partner relationship and equity ownership.
Keywords: International joint ventures (IJVs) * Risk management. Transitional economies * China
Introduction
International joint ventures (IJVs) continue to be one of the dominant entry modes for firms investing in China's growing market. China approved more than 41,000 new foreign-invested firms in 2003, a 20 percent increase over 2002, with an estimated investment of U.S. $53 billion (Maloy 2004). According to the U.S.-China Business Council, by 2007 foreign direct investment in China totaled $82.7 billion, with a total of 37,888 new foreign invested enterprises (U.S.-China Business Council 2008). However, many of these ventures are considered unsuccessful by their parent firms and significant problems are commonplace. China is a complex and difficult environment for IJVs.
What is it about the environment that makes IJVs so problematic in China? How does the environment in China impact the risk firms face when operating IJVs? More specifically, can we characterize the risks posed by the environment that all IJVs face to gain insights into risk reduction strategies for IJVs? Given that the environment changes rapidly, especially in transitional markets like China, when should IJVs be appropriate as a general investment strategy? Finally, how can firms mitigate the risk they face in IJV arrangements given that the risks often change over time in an environment like China? This article integrates insights from strategic management, economics, and international business to present a framework for managing risk that captures the complexities of the China IJV environment, and offers a beginning point for answering these important and difficult questions.
The China IJV Environment
IJVs have been studied in a variety of contexts (Reus/Ritchie 2004), most notably, in transitional economies such as China since partnering in these situations offers unique challenges and opportunities (Shenkar 1990). IJVs can be advantageous for both foreign firms and the domestic government that hosts the venture. For the foreign firm, IJVs are a way of gaining localized knowledge and navigating the domestic legal and political environment (Beamish/Banks 1987). Host governments often mandate IJVs too as a way of acquiring technology transfer and business expertise that will help develop the economy internally (Shan 1991). In both cases, the critical issue is shortening the time that would be required to accomplish these goals without the IJV format, and thereby gaining a competitive advantage.
While potentially beneficial to both sides, IJVs have a history of performing below initial expectations in transitional economies (Beamish 1985). This is especially true for China, which Si and Bruton (1999) claimed "is a far more complex environment than encountered elsewhere in the world, with a potentially confusing montage of business classes within any given industry, each regulated by different laws." Even veteran firms with successful ventures in multiple international venues can have a difficult time establishing joint ventures in China. For example, General Motors discovered this complexity in its initial IJV in China, a small vehicle venture in Shenyang in 1992 with Jinbei Automotive. The IJV produced only six hundred and sixty S-10 trucks before shutting down, costing GM its U.S. $16.3 million investment (Economist Intelligence Unit 1997). More recently, Danone, which has successful operations worldwide, encountered a significant problem with its closest partner in China--Wahaha--that threatens Danone's U.S. $1.5 billion per year business in China (Barboza/Kanter 2007). Unfortunately for companies interested in IJV investments in China and indeed other transitional markets, the problems encountered by GM and Danone are by no means exceptional, which raises a key question: "What makes China's environment so problematic for IJVs?"
To begin, China is a transitional economy in the process of moving from a Marxist, planned economy toward a mostly capitalist, market based economy (Steensma/Lyles 2000). Similar to other transitional markets (e.g., Russia, Vietnam), China has many of the telltale signs of an economy in transition--underdeveloped infrastructure, mingling of state owned and private enterprise, increased consumption, etc. (Davies/Waters 2004). However, China has three unique characteristics that increase the environmental complexity for IJVs: 1) a Maoist heritage of extremism, 2) a central government that is only gradually changing market mechanisms, and 3) a system of social interaction dominated by networks.
Though China is rapidly modernizing and mirrors more industrialized nations in many respects, China's historic roots still have significant influence on current business practice. From 1949 until 1976, Communist China was led by Mao Zedong, who espoused the philosophy that absolute poverty was virtuous. During this period, the central government expropriated property and resources from both individuals and companies. While this was indeed quite some time ago, the owners/managers of today's Chinese companies were attending universities and gaining experience during this period. Indeed, the impact of the Mao Zedong philosophy has endured, though tempered, and continues to influence current business practice. Specifically, private property rights still lack significant protection under the constitution, and more importantly, the interpretation and enforcement of private property rules lags behind the written legal code (Li 2004). This situation can be catastrophic for IJVs as protecting intellectual property from domestic partners becomes problematic and firms cannot predict the likely response from the authorities in disputes. Consider Danone discovered the chairman of its closest partner and IJV in China (Wahaha Group) to be operating secret companies outside the joint venture that were mimicking the joint venture's products and siphoning off millions of dollars (Barboza/Kanter 2007). Though Mao Zedong and the strict communist policies have been absent in China for many years, the influence still remains an important consideration for companies trying to establish IJVs in China. One would expect the influence of the past to have diminishing influence on the business environment as younger managers take larger roles in China's business environment.
A second consideration that influences the complexity of the macro-environment in China is the high level of control exercised by the government in opening markets to the capitalistic system. To control market mechanisms, China's government has preserved parts of the socialist system, gradually evolving market institutions rather than using the so called "Washington Consensus" approach used by many Eastern European countries in which a market is opened via rapid and comprehensive reform in market mechanisms (e.g., legal code, banking system, infrastructure, etc.). From an IJV perspective, the emphasis on control should be a warning that government might interfere in business dealings. For example, though McDonald's signed a 20 year lease in 1992 with the Beijing municipal government, two years into the lease the government evicted McDonald's to use the building for a development. McDonald's sued, but though the lease was legally binding, the court ruled against McDonald's, who was forced to find an alternate site (see Li 2004 for a discussion). While all markets have the potential for government interference, in China government interference often comes from multiple levels as different government entities have different, and sometimes conflicting, interests in an IJV (Peng 2000).
China is also unique in the prevalence and importance of formal and informal networks. China is a country of relationships, and partners are frequently selected for their "guanxi. " Guanxi refers to the non-institutional structure of Chinese society that holds Chinese society together. Guanxi includes (1) obligations among people who belong to the same group (family, classmates, etc.), (2) obligations among people who are in frequent contact (such as co-workers), and (3) obligations between two persons by way of a third person who has guanxi with both (e.g., a friend of a friend). In China guanxi provides trust when legal infrastructure and/or specialized investments fail to do so (e.g., Peng 2004). While developing network ties is critical to success, foreign firms begin outside the critical networks, and typically have difficulty determining who to connect with and how to establish a useful connection. Recall the aforementioned McDonald's case. Given the long-standing ties between Li Ka-Shing--the developer who wanted the McDonald's location in central Beijing--and the Chinese leadership at the time, it is not surprising that McDonald's, as an outsider, had little ability to retain its location even with legal grounds (Li 2004). Jiang (2006) reports that relationship with the Chinese government is still an important determinant of joint venture effectiveness in China.
Taken together, these three distinguishing characteristics make China an especially risky environment for IJVs. We next discuss how this unique environment manifests itself in different risk components for IJVs. Our...
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