Trade between UK and China with a Focus on Joint Ventures - Assignment Example

1 Introduction This report identifies the advantages and disadvantages to both parties in a joint venture between Tots bots, a UK based nappy company, and a Chinese babywear company called V-Baby. It examines the profitability for such a joint venture by weighing the potential benefits to either company against the losses they are likely to incur. It studies the similarities and differences in goals between the joint venture partners, the potential of the Chinese market and its incentives, as well as the hurdles the market presents to foreign investment in the form of present laws relating to joint ventures in People's Republic of China(PRC), the cultural barriers, the influence of the bureaucracy, of labour situations and so on. In doing so, it provides an insight into trade between UK and China, with a focus on joint ventures. The importance of trade between UK and China cannot be underestimated as Dr Kegang Wu, (director of Chinalink, an arm of Liverpool Chamber of Commerce which offers expert help to companies across UK looking to trade with China and Chinese companies seeking an entry into UK), points out : There are still only around 300 UK companies doing business with China. In Cologne in Germany there are already more than 1,000. The numbers in France and Spain are also in the thousands. ....Relationships between Europe and China are being forged across many sectors. ....It is also estimated that in a few years China will control a 25% share of the worldwide textiles market. At the moment the focus is very much on British firms doing business over there but that will change rapidly as more and more Chinese companies look to expand into Europe. (MC Donough, 2005) Joint ventures have been used as entry vehicles as well as modes of sustaining operations in China. To understand the benefits and losses of a joint venture between Tots bots and V-Baby, one needs a basic understanding of the definition of a joint venture, at least a brief acquaintance with the background of each company, and an idea of what other modes are available for a foreign investor like Tots bots to gain a foothold in the Chinese market. 1.1 Company backgrounds Established in 1991, V-Baby is a hundred per cent export-oriented enterprise located in Ningbo, very close to Shanghai. It is a brand owned by V-Baby LLC, an American company located in New York, and is a limited company. It deals in babywear from 0-24 months. All its styles are designed by designers in New York, while the sales and production are carried on by the Ningbo V-Baby. It employs between 100 to 500 people for its sales and production and 40 to 50 people for its research and development, and operates from well established production premises. It has an online presence, and its products can be purchased over the internet. It emphasises on quality, protection of children, and is environment-friendly. It seeks to make sales worldwide by adding to its current client base, increase its present revenue, and build a stable brand reputation. On the other hand, Tots bots was born in 2000 in Glasgow, and is the brainchild of a Scottish mother who decided to provide an effective, easy, environment-friendly and cost-saving alternative to disposable nappies. With a staff of merely 20 people and counting, this company has recorded phenomenal growth in sales, and a great brand reputation in UK and other European countries. Its products are also available for sale online, and it caters to the 0-24 months segment of babies, just like V-Baby and it similarly prioritises baby welfare by using chemical-free soft terry fabric for its nappies, perfect for better baby health. It is a nascent company with great growth potential that currently seeks to lower the cost of raw materials and manufacture without compromising on quality and possibly enter different markets as well as further segments of baby products. 1.3. What exactly is a joint venture and why this is the best option for both companies Joint ventures can be defined as legally and economically distinct organizational entities created by two or more parent organizations that collectively invest capital and other resources to pursue certain strategic objectives (Pfeffer, Nowak, 1976). Since there is no set minimum foreign contribution required to set up a joint venture in China, it can have various levels of participation, financial commitments, management responsibilities, investment in terms of technology and so on. Joint ventures are therefore flexible, as opposed to Wholly Owned Foreign Enterprises(WOFE), where the entire investment has to be from the foreign company. Though WOFEs are better in terms of control over management, protection of intellectual property and so on, they require a significant financial investment as well as a thorough knowledge of the Chinese market and its many unspoken rules and hidden pitfalls. Tots bots, being a very young company may not be able to make such a sizeable investment. Moroever, it stands to benefit from a joint venture with a Chinese partner like V-Baby which has experience in the local situation for more than 14 years, and already has access to land, infrastructure, hired labour, and most important in China, possible political connections. A joint venture also allows the company to have its own sales network, separate from that of the partner. This is crucial if Tots bots wants to retail in China, because V-Baby is presently a totally export-oriented unit, and is not concerned with a national sales network. V-Baby, on the other hand, would like to retain a degree of control over its management and production, and is hence better off with a foreign investor in either an equity joint venture where the rights of the partners are proportional with their equity investments, or a cooperative joint venture under which it can negotiate its rights through a contract. 1.4. Similarities and differences between Tots bots and V-Baby It is very important to examine the similarities and differences between the features of the two companies, their expectations from the each other and the venture itself. This will help bring out the possibilities of gains and loss to both and also help predict whether the joint venture will result in success or failure, because a success will benefit both as surely as a failure will result in loss. Both companies cater to babies of the same age segment of 0-24 months. This benefits both, because they both have knowledge of babies and their needs in this age-group. Communication would be easier, as will be transfer of knowledge and technology. Each company may also end up learning about the other's segment and proceed into it. For Tots bots, making apparel in the same age-group as that of the babies for which it has been making nappies may prove an easy crossover. Both companies are environment friendly and concerned about baby welfare, so they would each appreciate the measures taken by the other in this direction. They will each be able to prioritise long term gains from the policy decisions based on this, and be willing to overlook any possible short term losses. Both companies insist on high quality, which is an advantage for both, because none need fear that their involvement with the other may result in a compromise on quality. This is especially helpful for Tots bots, because quality of the product is always a main concern for foreign investors in China, especially those interested in shifting their manufacture into China. Quality control of items manufactured by local suppliers has provided an additional cause for concern. .......In fact, quality in both services and goods remains the foreign investor's primary concern in China because much of its technology is obsolete, and the training of its workers is mostly theoretical. ( Wong, Maher , Jenne , Appell, Hebert, 1999) Further, Tots bots will have access to the existing premises and infrastructure, and will only have to expand the facilities if required. Being already conversant with production of baby clothes the workers may be easily trainable in the production of nappies to the required Tots bots standards. Tots bots may also be able to acquire its raw material locally at lower prices. Both companies have an online presence, which means their transaction capabilities are comparable, and both would benefit from it. V-Baby especially stand to gain from this, as Tots bots commands respect among most UK mothers, and any V-Baby products sold alongside Tots bots nappies will be well received. It is also well-worth considering that joint ventures are not very long term in nature, and may end in about eight to ten years. It is usual for one company to sell off its entire rights to the other for a handsome compensation. If V-Baby is willing to sell at the end of that period, it will be a good exit strategy for them to sell their company to Tots bots, which at that time would be looking to become a WOFE, having gained experience in China, and wishing to take full control. This could end up being a disadvantage for V-Baby in the long run because in China they believe in long-term relationships, and V-Baby may be more interested in continuing the joint venture than Tots bots. Both companies are owned by entities owned outside China, and this is a major advantage for Tots bots, because it does not have to go through the problems usually faced by those with PRC state-owned partners, in terms of local government restrictions on how many people are to be employed and so on. This is a very important factor because the fundamental goals of the PRC government in allowing foreign investment lie in providing jobs for its people, importing technology at low cost, and earning foreign exchange, which are far removed from the Western business goals of profitability. V-Baby being owned by an American company, is not burdened with the PRC goals and is likely to be more aligned to Tots bots' profit-making objectives. The difference between the objectives of the two companies may lie in one fundamental aspect: V-Baby is a totally export-oriented unit and does not have distribution networks inside China. But Tots bots should be looking not only to manufacture in China starting at the premises of its venture partner but also to explore the burgeoning Chinese market. Thus in joining with V-Baby, Tots bots will have to forgo the usual benefit a foreign investor receives on forming a joint venture with a Chinese partner, which is a well-established sales and distribution network. Though V-Baby handles its sales out of Ningbo, it sells abroad, and not in PRC. Thus V-Baby may gain the advantage of an increased client base through its partnership with Tots bots which sells nappies all over Europe, and even as far as Australia, but Tots bots will have to start its own sales and distribution in China from scratch. Unless V-Baby decides to sell in China as well, buttressed by the reputation of being in a foreign joint venture, because in China everything with a foreign label has an added fascination for the consumer: Products from the west are considered "fashionable" and implies that the wearer or user is a worldly person. For young children, it often creates the perception that their parents have either studied abroad or have relatives who live overseas. This provides a certain social status within communities although it does contradict the socialist doctrine. (Herbig,Shao, 1994) 1.5. The Chinese market and its equations for Tots bots and V-Baby The Chinese market has certain inherent features which a small foreign company like Tots bots can benefit from and others which may cause concern. It is to be hoped that V-Baby, being a company based in America, will not be associated with the negative factors associated with the Chinese market. 1.5.1: Tremendous market opportunity: At a real growth rate of GDP touching 9%, China today is one of the fastest growing economies in the world. The buying power of the middle class is on a meteoric rise, and to add to the baby products market, there is the Chinese Government policy of allowing only one child per couple, and penalising those with more than one child. This has today resulted in a lot of "only" children, whose indulging parents are ready to invest as much as possible in their children, especially foreign branded products, products that they themselves were deprived of in their own childhood. This could be a huge advantage to Tots bots and also to V-Baby, if it chooses to enter the local market under the new UK brand name umbrella. The one-child family is bound to create considerable change in the Chinese marketplace. While there will still be multiple-child families, the number of families with an only child will continue to increase rapidly...... From a marketing perspective, many foreign-made products may become more highly demanded by these families as parents indulge their children with those items they were unable to attain with siblings or during the Cultural Revolution. (Herbig,Shao,1994) 1.5.2. Low cost of labour: It is widely accepted that the cost of labour in China is much lower than that in UK, so there will definitely be a cost advantage for Tots bots in carrying out its production in Ningbo than in Glasgow. But the socialist tradition of the Chinese labour which has had state protection for very long can sometimes have its disadvantages as well. Chinese employees expect a foreign company to look after them in a total sense. A common saying about the state-owned enterprises was: 'The factory is my home; therefore, what belongs to the factory belongs to me' To counteract this belief, Western managers have had to exercise strict control over assets and address an avalanche of petty theft. Chinese staff also place high expectations on the foreign company for personal and family benefits:..... They turn the relationship with the company into a moral issue with concomitant disillusionment if the company fails their expectations". (Blackman, 2000) 1.5.3 Cultural Barriers: This turns out to be one of the major problems facing both partners, because the Chinese primarily speak Mandarin and Cantonese and speak very little English. Though more and more Chinese are learning English and foreigners are learning Mandarin, the situation is still difficult. Moreover, the Chinese believe in relationships, which are difficult to form across a barrier of language, customs, race and color, not to mention different concepts of time, life, and business. Chinese society consists of very large numbers of people living closely, working closely and who have a strong sense of 'Chineseness' Any stranger who cannot speak the language of the local community is largely excluded from it, and the Chinese language, unrelated as it is to any Western language, presents a special barrier. Most Chinese have had little contact with Westerners. Western business people are easily identified as outsiders. They are under scrutiny from Chinese managers and employees. The locals will soon note their strengths and weaknesses and use them to advantage. (Blackman, 2000) 1.5.4. Intellectual Property: The first and foremost concern for any foreign investor in China is the safety of its intellectual capital. Despite not being in a sensitive area like Information Technology, having intellectual property stolen or copied is still a considerable loss. Another well-publicised problem within JV agreements has been the difficulty that foreign entrant firms have in protecting their own intellectual property. For example, direct copies of companies' products, logos and production processes have all come to light after foreign firms have entered into partnership with a local business. (Ducker, 2004) Despite international pressure, China continues to be the home of fakes, because in the highly competitive environment local businesses do not want to spend the time and resources required to develop know-how and brand reputation and resort to patent infringements. This could be because of the lack of a proper ethical code: China's leaders spent much of the 20th Century deliberately destroying traditional Confucian values. Communism's own, originally puritanical morality has also been widely discredited, especially in the wake of the excesses of the Cultural Revolution. As a result, it is difficult to identify a common ethos that is accepted in China today. The Chinese have been told that "to get rich is glorious," without a widely accepted value system that puts constraints on the acceptable means to that end.( Norton & Huang, 2001) Unfortunately China has still to enforce intellectual property laws with any degree of efficacy, and the government has so far done little to ensure its implementation. For a small company like Tots bots it is a big risk because copies are encouraged by a legal framework full of loop holes, and a bureaucracy that actually supports it. Lawyers who represent Western companies embroiled in intellectual property disputes in China, however, point to major loopholes in Chinese law and in the country's trademark and patent system as part of the problem. Many Chinese patents, for example, are granted without any examination of their originality, making it easy for local companies to claim others' innovations as their own. ..... foreign experts ... say that local and provincial governments, eager to bolster their economies, sometimes subsidize patent filings for local companies and provide pointers to them on how to beat foreign claims of infringement. (French, 2005) If V-Baby were to engage in such activities, it could gain an unfair advantage, especially if it has strong bureaucratic connections in its local government. 1.5.5. Law and legal system: In China, the law is flexible, and leaves room for maneuvering by the administrators in favour of the local partner. This could be because of a feeling of victimisation in the Chinese locals as well as officials. Many Chinese feel that China has been exploited for generations by foreigners. The discrepancies between their own living standards and those of foreign investors - reflected, for example, in the broad gaps between local and expatriate salaries and benefits - also rankle. Some therefore feel little compunction about enriching themselves at the expense of foreigners. This sense of historic or cultural victimization may also be shared by Chinese officials, making them less inclined to pursue Chinese perpetrators of crimes against foreigners.( Norton & Huang, 2001) Dispute resolution may also become a difficult proposition in Chinese courts, because judgments handed out by one court are not acknowledged by another. But China, especially after its entry into the WTO, is trying to change this situation despite inherent difficulties. "It's a very big country and it doesn't behave as one entity so it'll be more difficult for them to enforce the regulations nationwide," said Madeleine Sturrock, deputy chief executive of the Great Britain-China Business Council, which represents UK investors. 1.5.6. Value inflation: The other problem that a small foreign company like Tots bots might face in China is with relation to the local partner, where V-Baby could be able to inflate the cost of its investment, by not depreciating the value of its building erected years ago, or posing to own the land while only having leased it. While it gives an unfair advantage to V-Baby, this is common practice in China on the part of a local partner and is considered part of the business. This is compounded by the fact that it is very difficult for a foreign company to ascertain the truth about its local partner. - the Chinese tend to quote the original purchase price with no depreciation - buildings - often are valued at the price it would cost today to build and don't actually reflect the fact that it may well be a 15 year old shack that cost USD10,000 to put up in 1988, and importantly, land.... Check the Land Use Rights certificate - if he can show these are granted rights, he owns the land. If they are just allocated, he doesn't and the right to use it should just be the rental value. (Dezan Shira and Associates, 2005) 1.5.7. The influence of the bureaucracy: Another disadvantage for Tots bots and advantage for V-Baby may lie in the bureaucracy, which always supports those with which it has a relationship. Working through the bureaucratic system remains a major challenge even though more than 25 years have passed since the announcement of the Open Door Policy. If there is a dispute with Chinese contractors, local bureaucrats often change the rules and make arbitrary decisions - just as they always have. There is a resulting labyrinth of confusion, and the foreign partner must constantly resort to trial and error with little or no consistent pattern to follow. Further, success in dealing with bureaucrats often depends on the quality of the relationship between the foreign and Chinese partners at any given time.( Wong, Maher , Jenne , Appell, Hebert, 1999) But even the Chinese partner may not be exempt from legal problems in an arena where laws related to joint ventures are still open to interpretation. China is taking steps to formalise, strengthen and standardise its legal system, but risks remain. For the Chinese partner, the task is finding sufficient legal protections for its equity interest in the joint venture in a legal environment where such protections have not yet been firmly established. For the MNE, the risk is that the PRC government may find these developments to be in violation of the PRC's investment laws and policies. (Chow, 1998) 1.1 Conclusion The joint venture is a good option between Tots bots and V-Baby which can be beneficial to both partners. Tots bots can gain in terms of lower cost of labor and raw material, and gain access to the flourishing Chinese baby wear sector. V-Baby can benefit by adding to its client's base through Tots bots and associate itself with a reputed brand name. Projected losses can be avoided if the terms of the venture are agreed upon beforehand, where Tots bots is able to gather information on V-Baby and avoid the potential disadvantages of investing in China like cultural barriers, labour problems, intellectual property concerns, legal and bureaucratic problems and so on. V-Baby can take up this opportunity to expand its client base, associate itself with a UK-based brand name to explore the opportunities in the Chinese market. 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