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Joint venture success in China: how should we select a good partner?

From 1979, when China officially opened its doors to foreign investment with the promulgation of a joint venture law, through the end of 1996, Chinese authorities approved the establishment of over 283,793 foreign-invested enterprises involving $466.80 billion in foreign capital. Of these, over 140,000 ventures representing $175.74 billion investment have commenced operations (MOFTEC Bulletin, 1997). Today, China is the second largest but fastest-growing foreign direct investment (FDI) recipient in the world. The share of total industrial output in China made by foreign ventures reached 13% in 1995. The share of total national export volume climbed to 31.3% in the same year. The tax contribution as a share of the nation's total was 10 percent. FDI already accounted for 18.3 percent of total gross domestic investment in 1994. Seventeen million Chinese people are currently employed in these ventures (Bulletin of MOFTEC, 1997).

Although the ratio of wholly foreign-owned ventures has been growing in recent years (about 7% prior to 1990 versus 29.85% in 1996), the equity and cooperative joint venture (IJV) is still the dominant foreign entry mode, accounting for 70.54% in 1995 and 68.96% in 1996, respectively. In an attempt to accomplish sustained competitive advances in China and other global marketplaces, MNCs have in recent years turned increasingly to the use of joint ventures or alliances. However, the intercultural and interorganizational nature of IJVs results in enormous complexity, dynamics, and challenges in managing this cross-border, hybrid form of organization. One popular argument is that inter-partner comparative or configurational features, variously termed as strategic symmetries (Harrigan, 1985), interfirm diversity (Parkhe, 1991), or complementary resources and skills (Geringer, 1991), create inter-partner 'fit' which is expected to generate a synergistic effect on IJV performance (Luo, 1997).

It is assumed that firms establish IJVs only when the perceived additional benefits of exercising the IJV option outweigh its expected additional costs. One of the key notions in the IJV literature is that these additional benefits will accrue only through the retention of a partner who can provide the four 'Cs': compatible goals, complementary skills, cooperative culture, and commensurate risk (Brouthers, Brouthers, & Wikinson, 1995). Partner selection determines an IJV's mix of skills, knowledge, and resources, its operating policies and procedures, and its vulnerability to indigenous conditions, structures, and institutional changes (Geringer, 1991). In a dynamic, complex, or hostile environment, the importance of local partner selection to IJV success is magnified because the right partner can spur the IJV's adaptability, strategy-environment configuration, and uncertainty reduction (Luo, 1997).

Local partner selection is critical to the success of IJVs investing in newly emerging economies, most notably China. On the one hand, such economies have in recent years become major hosts of direct investment by MNCs because these rapidly expanding economies, characterized by an exploding demand previously stifled by ideologically-based government interventions, provide tremendous business opportunities which MNCs can preempt. On the other hand, transnational investors in such economies face the challenges of structural reform, combined with weak market structure, poorly specified property rights, and institutional uncertainty (Nee, 1992). Although some economic sectors have been decentralized and privatized, governments in these economies still hinder industrial and market structure adjustments. Indeed, the 'invisible hand' in the reform process often causes unexpected social, political or economic turmoil that may go beyond the tolerance level of the government or society. Under these circumstances, the visible hands of administrative, fiscal, and monetary interventions are called to the rescue. The administrative option is often the most expedient, allowing for swift action which will be promptly reflected in the market. In this situation, local partners can be of great value to foreign firms. They can make investing in restricted industries possible and help MNCs gain access to marketing channels, while meeting government requirements for local ownership. In addition, having recourse to an IJV as a means of reducing political risks or achieving political advantages is a logical choice for many MNCs operating in strategic sectors in such economies. Moreover, local partners can assist foreign partners in obtaining insightful information and country-specific knowledge concerning governmental policies, local business practices, operational conditions, and the like. Furthermore, the IJV form helps MNCs gain access to, or secure at a low cost, locally-scarce production factors such as labor force, capital, or land.

During the process of IJV formation, foreign parent firms must identify appropriate criteria for local partner selection as well as the relative importance of each criterion. They are divergent depending on firm, setting, and time. Broadly, the criteria can be classified into three categories related to: (i) tasks or operations; (ii) partnership or cooperation; and (iii) cash flow or capital structure. Operation-related criteria are associated with the strategic attributes of partners including marketing competence, relationship building, market position, industrial experience, strategic orientation, and corporate image. Cooperation-related criteria often mirror organizational attributes such as organizational leadership, organizational rank, ownership type, learning ability, foreign experience, and human resource skills. Cash flow-related criteria are generally represented by financial attributes exemplified by profitability, liquidity, leverage, and asset management. A partner's strategic traits influence the operational skills and resources needed for the joint venture's competitive success, organizational traits affect the efficiency and effectiveness of inter-firm cooperation, and financial traits impact the optimization of capital structure and cash flow.

Conceptually, strategic, organizational, and financial attributes are all crucial to IJV performance. A partner with superior strategic traits, but lacking strong organizational and financial characteristics, results in an unstable joint venture. The possession of desirable organizational attributes without corresponding strategic and financial competence leaves the joint venture unprofitable. A partner with superior financial strengths without strategic and organizational competencies can lead to an unsustainable venture. From a process perspective, the linkage between partner selection and IJV success lies in inter-partner fit (Hamel, 1991; Yan & Gray, 1994). While strategic attributes may affect strategic fit between partners, organizational traits are likely to influence organizational fit, and financial attributes will impact financial fit. Figure 1 schematically summarizes these relationships.

The above three-fold classification scheme (strategic, organizational, and financial) may be of interest to both theory and practice. Although this study uses China as its analytical setting, such scheme and key components may be applicable to other contexts. The literature on partner selection has paid little attention to the systematic categorization of various partner attributes. Such classification is imperative because each group affects a different kind of fit (strategic, organizational, and financial), thus influencing different dimensions of IJV performance. Moreover, most previous studies in the area have not yet incorporated financial attributes into the framework. Such attributes are important because cash flow positions, financial strategies, and capital structures of partner firms impact the degree of both financial and operational synergies derived from venturing activities. Further, some strategic and organizational attributes such as strategic orientation, relationship building, learning ability, organizational leadership and rank remain under-researched in the study of partner selection. We addressed these variables using an integrative approach with an aim to include all relevant attributes that may influence IJV success in the scheme. In the selection process, international managers may use this scheme to examine the strengths and weaknesses of the potential partners and to determine whether partner attributes fit their own in strategic, organizational, and financial arenas.

STRATEGIC ATTRIBUTES

It is important to note that different strategic, organizational, and financial traits may have a heterogeneous effect on different aspects of IJV performance. MNCs need to discern not only important partner selection criteria in general but also which ones are crucial to their specific strategic goals. We sought to address the performance implications of each attribute as specific as possible throughout the article. The specific performance effects include profitability, market growth, cost minimization, stability, risk reduction, export growth, and the like. The term of 'IJV success' is generally defined as the accomplishment of the parent firm's strategic goals from the venture.

Marketing Competence

As far as the composition of GNP is concerned, China has already become a market economy. Government-instituted distribution, wholesale, and retail systems under the central planning regime have been essentially dismissed. Instead, competitive pressure from both local rivals and other foreign competitors have become increasingly strong in all deregulated industries. In this new environment, a local partner's marketing competencies in distribution channels, promotional skills, knowledge about local business practices, and relationships with major buyers, wholesalers, and relevant governmental authorities are fundamentally important for foreign companies seeking market position and power in China. Because Chinese society is built around a complex social and business web, the costs of establishing distribution channels or business networks in China by foreign businesses are likely to outweigh the potential benefits. Moreover, establishing such a network can be such a long process that foreign companies may be unable to seize market opportunities or align with contextual changes in a timely fashion.

On the other hand, a partnership with a local firm with superior marketing competence enables a foreign company to quickly establish its market position, organizational image, and product reputation in the Chinese market. This also helps the foreign company increase profitability, reduce uncertainty, and boost its competitive edge in the host country. Shenkar (1990) suggests that a foreign company's technological strengths and a local partner's marketing competence creates operational synergies which are mutually beneficial to both parties. Luo (1995) observed an importance of such marketing competence, particularly skills in personnel direct marketing, to the market performance of IJVs in China. As one of the well-established and well-reputed Chinese auto firms, Shanghai Automotive Industry Corp. has utilized its marketing expertise and resources to help its joint venture, Shanghai Volkswagen AG, quickly establish distribution channels, after-sale service centers, and high-quality image recognition nationwide. Today, it is the largest foreign-invested enterprise in China with regard to total sales, and has a market share of more than 50% of domestically manufactured passenger cars in China.

Relationship Building

Foreign companies can gain an edge over their competitors in the Chinese market if they have a guanxi network with the business community (e.g., suppliers, buyers, distributors, and banks) and government authorities (e.g., political governments, industrial administration departments, foreign exchange administration bureaus, foreign trade and economics commissions, commercial administration bureaus, and taxation departments). Guanxi refers to the concept of drawing on connections in order to secure favors in personal or business relations (Luo & Chen, 1996). It binds thousands and thousands of Chinese firms into a social and business web. Rather than depending on an abstract notion of impartial justice, Chinese people and businesses traditionally prefer to rely on their contacts with those in power to get things done. Personal connections and loyalties are often more important than organizational affiliations or legal standards. Whenever scarce resources exist, they are mainly allocated by guanxi rather than bureaucratic rules. Guanxi provides a balance to the cumbersome Chinese bureaucracy by giving individuals a way to circumvent rules through the activation of personal relations.

Although foreign companies can establish and maintain their own guanxi networks by themselves, the more efficient and effective way is certainly to utilize the local partners' existing business or personal connections. This is because guanxi cultivation is a highly complicated social investment process which can be costly, unstable, and unreliable if the relationship is constructed inappropriately or with the wrong people. A local partner's guanxi network constitutes strategic assets for all IJVs regardless of their strategic goals, orientations, or objectives. Such networks help foreign companies obtain scarce production factors, facilitate value chain contributions, promote relationships with various governmental institutions, and increase the effectiveness of market penetration. Recently, various studies have found that the utilization of local firms' guanxi connections significantly facilitates IJVs' financial and market-based performance measures such as ROI, sales growth, and risk reduction (e.g., Luo, 1995; Luo & Chen, 1996; Shenkar, 1990). For example, the well established guanxi networks of China Postal and Telecommunication Corp. (CPTC) have given a tremendous boost to the amazing growth of Shanghai Bell Telephone Equipment Manufacturing Co., currently one of the China's top ten most profitable Sino-foreign joint ventures. Because this industry remains controlled by the central government, CPTC's superior relationship with top Chinese officials, including Jiang Zemin and Zhu Rongji, has substantially contributed to the venture's success in preempting and dominating China's vast telecommunications market. In 1996, it had 40% share of China's telephone digital switching market, with Ericsson at the second place only taking 15%.

Market Position

Because a major objective of foreign investors in the Chinese market is to preempt market opportunities and business potential (Beamish, 1993), a local partner's market power is a key asset. In China, market power is often represented by a local partner's industrial and business background, market position, and established marketing and distribution networks (Luo, 1997). Market power also enables the firm to influence some industry-wide restrictions on output, increase bargaining power, and offer the advantages of economies of scale (Luo, 1995). Over the last few years, the Chinese government has relinquished control over a growing number of industries. The rapidly expanding Chinese economy, together with high market demand, has made market positioning extremely important for the success of any business in the country. In such circumstances, a Chinese partner's market strength is key to the IJV's financial return and indigenous market growth. Moreover, strong local market power can strengthen the IJV's commitment to local market expansion (Park & Ungson, 1997). This commitment will make the IJV less inclined to increase exports in its business operations. Furthermore, strong market power can lead to greater bargaining power with the local government. This can help the IJV reduce political risks and business uncertainties (Kobrin, 1982).

These benefits have been confirmed in a recent study by Luo (1997) who found that the market power of a local partner is significantly and positively associated with an IJV's profitability, sales growth, and risk reduction. Many case studies also support the above argument. For instance, Avon Products, Inc.'s local partner, Bureau of Light Industry in Guangzhou (BLIG), manages 140 factories and dominates the Southern China market for many light industry products including fashion jewelry, cosmetics, apparel, gifts, collectible and home furnishings, to name a few. Because Avon's primary market focuses on Southern China, the market position of BLIG fits Avon's strategic needs. In 1995, Avon sold $40 million dollars worth of products in China, nearly doubling its sales of 1994. The business in China has gone so well that the company ranks the China market among their leading expansion markets and expects its China sales to reach $250 million by the year 2000.

Industrial Experience

When operating in a transitional economy characterized by weak market structure, poorly specified property rights, and institutional uncertainty, an IJV seeking efficiency and growth needs an adaptive orientation, a solid supply relationship, comprehensive buyer networks, and a good organizational image (Luo, 1997). The local partner's market experience and accumulated industrial knowledge are of great value to the realization of these goals. In China, a local partner's established history and strong background in the industry often result in a good reputation or high credibility in the market. Lengthy industrial/market experience signifies that the local firm has built an extensive marketing and distribution network, a badly needed competence for IJV market growth.

In addition, since China has a stronger relationship-oriented culture compared to industrialized market economies (Luo & Chen, 1996), the business activities of IJVs in China can be greatly facilitated by local partners' connections in the domestic business scene and good relations with influential persons. Local firms with longer market experience are expected to have developed a better business relationship network. Goodwill and superior contacts constitute country-specific knowledge or what the resource-based view calls the 'resource position barrier' (Wernerfelt, 1984)which enhances an IJV's competitive advantage, economic efficiency, and risk reduction capability. According to Luo (1997), a local partner's industrial experience has a favorable influence on the IJV's market growth and operational stability. A good case example is Esquel Group Co.'s investment in China. The company's major local partner, Changzhou No. 1 Garment Manufacturing Co., has operated in the industry for more than fifty years. Although this local partner is not an extremely large firm, its long presence and market experience in the industry has created prestigious company and product reputations, and solid marketing and supply channels. These superior attributes helped Esquel Group become one of the leading foreign investors in China's garments and fabrics industry. Recently, its annual output exceeded 1 million dozen garments and 24 million yards of quality cotton fabrics.

Strategic Orientation

The strategic orientation (i.e., prospector, analyzer, or defender, see Miles & Snow, 1978) of local firms is important to venture success because how well it matches that of its foreign partner influences inter-partner consistency in terms of strategic goals and behaviors, cooperative culture, and investment commitment (Parkhe, 1991). These in turn affect the formulation and implementation of technological, operational, financial, and managerial policies at various levels including corporate, business, functional, and international. As strategic orientation determines organizational adaptability and innovativeness, it may affect not only the local firm's strategic but also organizational behaviors such as managerial philosophy and style and long-term orientation, which may in turn influence mutual trust and collaboration between parties.

In order to reap benefits from market demand, a defensive orientation (i.e., defender strategy) may be too conservative for firms seeking market expansion in China. However, it is not realistic to orient Chinese firms in a highly proactive direction (i.e., prospector strategy) because this could lead to vast operational and contextual risks and innovative and adaptive costs in a complex, dynamic, and hostile environment. An analyzer orientation fits the environmental traits in a transitional context where environmental sectors are fundamentally complex and dynamic, information is not codified, and regulations are not explicit (Nee, 1992). Under this orientation, the partner candidate should be innovative and adaptive but not extremely aggressive and risk-taking when the market changes. They should allocate most of their resources to a set of reasonably stable environments while at the same time conducting somewhat routinized scanning activities in a limited product-market area. They monitor market situations, and carefully apply previously developed product and market innovations. This analyzer strategy reduces the likelihood of outright failure and creates upper limits to success. In general, Chinese firms with the analyzer orientation are ideal candidate partners for foreign companies pursuing both profitability and stability. For example, Shanghai Instrument Industry Co., the local partner of Foxboro Co., is extremely skillful in scanning and analyzing environmental changes and balancing market effectiveness and cost efficiency. Today, Shanghai Foxboro Co. has become one of the leading electronic process control instrument manufactures in China. Tan and Litschert (1994) empirically show that the analyzer orientation best fits China's transitional environment.

Corporate Image

A superior corporate image usually implies a superior product brand, customer loyalty, or organizational reputation. Corporate image may be unusually critical in China because Chinese consumers are particularly loyal to the products made by the companies maintaining a superior image in the market. For instance, when purchasing household appliances, Chinese people tend to attach more importance to corporate image than to the physical attributes of the products (Luo, 1995). In deciding whether to buy a joint venture's products, they are used to evaluating not only the reputation of the joint venture itself but also the goodwill of Chinese partners in the past. Therefore, it is essential for foreign investors to collaborate with those Chinese businesses that have maintained a good organizational reputation and product image. This selection will significantly benefit the market power and competitive position of the joint venture in the relevant industry. For example, Panda Electronics Group, the local partner of Philips in Nanjing, is one of the most famous Chinese giants in various electronics products in terms of high quality and customer responsiveness. This image helped the joint venture's products quickly become pervasive and popular in the Chinese market. Today, their joint venture, Huafei Colour Display Systems Co. Ltd. is one of the top twenty foreign-invested enterprises in terms of total sales.

A superior company image in China also implies better relationships with the local government, as well as with suppliers and distributors. These relationships are crucial for firms pursuing a market share and competitive position in the industry. Recently, the State Council of the P.R.C. has decided to form business groups as part of the reform focus for the next five years. It is deemed that a firm with a superior corporate image will be more likely to be the leading or core unit in the group. Such business groups, which will soon become new market-driven oligopolists in related industries, will become the ideal local partners for MNCs in the future.

ORGANIZATIONAL ATTRIBUTES

Organizational Leadership

Leadership in Chinese state-owned businesses is a fairly complicated issue because top-level management positions are assigned by upper level government authorities. Moreover, the communist party representatives in the firm, normally remaining out of sight, are politically the real bosses of the firm. On the other hand, leadership is fundamental to venture success in China. The relationships with leaders often outweigh the contractual terms and clauses agreed upon by both parties to an IJV, because law enforcement in China has been weak for many decades as a result of tradition, the public's poor concept of law, and habitual working practices. The leadership of the Chinese partner also critically influences the cooperative culture between the two partners, which in turn affects their mutual trust. In addition, the partner's relationships with the government are largely determined by the interpersonal relationship between its management and government officials. These personal connections, or guanxi, can be the most important factor for a joint venture's competitive edge, especially if the venture has to rely upon the government in acquiring approvals, materials, capital, and other resources or in securing various kinds of support and assistance for dispute resolution, infrastructure access, distribution arrangements, and taxation holidays or allowances (Luo & Chen, 1996). As a result of continuous industrial decentralization and economic reforms, which further increase the autonomy and authority of corporate-level managers, the effect of a Chinese partner's leadership appears to be even more fundamental to the joint venture operation today. The successes in China of Celanese Corp. (with Jiangsu Tobacco Co.), Hewlett-Packard (with Beijing Computer Industry Corp.), McDonnell Douglas (with Shanghai Aviation Industrial Corp.), and Wang Computer (with Shanghai Computer Co.) all suggest that a partner's superior leadership can strongly enhance venture performance. To evaluate the leadership of Chinese businesses, foreign investors should scrutinize such areas as educational background, relationship with government authorities, innovativeness, international experience, managerial skills, length of previous leadership, and foreign language skills.

Organizational Rank

Organizational rank includes both business level and class in China. Chinese organizations, including state-owned and collectively-owned enterprises, are generally ranked by upper level government into the following levels: national, provincial, city, county, and so on. At each level, especially the national and provincial levels, firms may be further classified into different classes. For instance, the Panda Electronics Group in Nanjing, Jiangsu Province, is a national-level first-class company, while the Nanton Bicycle Factory in Nanton, Jiangsu Province is a provincial-level first-class business. In general, different levels of firms imply various kinds of autonomy and authority offered by the government. The higher the organizational level, the greater the power delegated to the firm and the greater the support it attains from the government. However, these are often achieved at the expense of increased government interference. For foreign partners, the solution to this trade-off largely depends upon their strategic goals and organizational capabilities in the strategy-environment alignment in the host country. Unlike organizational level, business rank by class is more closely associated with the efficiency and effectiveness of the company. The higher class firms generally have superior product quality, better internal management, quicker customer responsiveness, and superior organizational performance. Thus, foreign companies seeking high financial and market outcome in China should closely examine the level and class of potential Chinese partners. The successes of Xerox and Johnson & Johnson (both in Shanghai) illustrates this point. Although not extremely large, Shanghai Shenbei Office Machine Co., Xerox's partner, was ranked municipality-level but first class. Shanghai Daily Chemical Industry Development Co., Johnson & Johnson's partner, was approved as a state-level first-class business. Both joint ventures are now among the top fifty foreign businesses in China with respect to total sales.

Ownership Type

Economic transition in China has given birth to a new diversity of organizational forms. The spectrum spans the continuum from state-owned to non-state-owned (private and collective) businesses (Nee, 1992). A Chinese partner's organizational form influences not only its motivations for forming an IJV but also its commitment and contribution to operations, which in turn affects the IJV's local performance. During structural reforms in the Chinese economy characterized by a weak market structure, poorly specified property rights, and strong governmental interference, state-owned firms have the advantage in gaining access to scarce resources, materials, capital, information, and investment infrastructure. In addition, state-owned organizations usually have an advantage over privately or collectively-owned firms in terms of industry experience, market power, and production and innovation facilities. Moreover, it is fairly common for state-owned enterprises to have privileged access to state-instituted distribution channels. These channels play a dominant role in product distribution in the Chinese market. State-owned businesses are also treated preferentially by the government when selecting market segments. This organizational form may hence facilitate the market growth in new domains. Finally, hierarchical state firms tend to have a better relationship with various governmental institutions. This relationship is expected to result in greater problem-solving capacity for these firms. For all these reasons, state-owned organizations may contribute more to an IJV's local market expansion than non-state-owned organizations. This is empirically confirmed by Luo (1997). To name two case examples, Otis Elevator Co. and Smithkline Beckman Corp., both in Tianjin, selected state-owned firms: Tianjin Lift Co. and Tianjin Pharmaceutical Industry Corp., respectively. The aforementioned advantages for state businesses are certainly among key factors making the two ventures dominate their respective markets and become two of the top sixty foreign-invested ventures since 1991.

Private or collective enterprises are typically operated and managed by entrepreneurs. They have fewer principle-agent conflicts and greater strategic flexibility. The existence of many unfulfilled product and market niches in the Chinese economy increases their chance for survival and growth. Their simple structure and small size have positioned them for speed and surprise, giving them greater ability to react quickly to opportunities in the environment and proactively outmaneuver more established firms. In addition, private and collective businesses are pressed by hard budgetary constraints, forcing them to be more efficient and profit-oriented. In contrast, state firms lack self-motivation and operational autonomy, while being highly vulnerable to bureaucratic red tape. It is reported that over 60% of state-owned enterprises in China have shown a loss whereas private or collective businesses have been showing continuous profit (Jefferson, Rawski, & Zheng, 1992). IJVs with efficiency-oriented private or collective partners are thus likely to enjoy superior returns on investment. This proposition has been supported by a recent analysis of China's top 100,000 companies which finds that firms with defined property rights (collective or private firms) are more productive and profitable than state-owned enterprises (Li, Gao, & Ma, 1995). Two joint ventures in Shanghai, Chia Tai (Thailand)'s Da Jiang Co. and Schowel (U.S.)'s Great Wall Zipper Co., both have collectively-owned local parent firms (Songjiang Feeding Co. and Zhoupu Village Industrial Co., respectively). But, today, they both are market leaders in their respective industries and maintain high product reputations. Shanghai Da Jiang has been one of the biggest twenty foreign ventures in terms of sales since 1991.

Learning Ability

It has been noted in the IJV literature that complementary needs create inter-partner 'fit' which is expected to generate a synergistic effect on IJV performance (Buckley & Casson, 1988). However, complementarity is not likely to materialize unless a certain threshold of skills are already in place. Chinese businesses in joint ventures generally seek technological, innovational, and managerial skills from foreign partners (Beamish, 1987). The success of an IJV's local operations and expansion in this market will largely depend upon its local partner's learning capability, or its ability to acquire, assimilate, integrate, and exploit knowledge and skills. The firm's ability to process, integrate, and deploy an inflow of new knowledge and skills closely depends on how these relate to the skills already established (Luo, 1997). This skill base is expected to influence strategic fit and organizational fit between IJV partners, which in turn influence the IJV's accomplishment in terms of both financial and operational synergies. As a result, a Chinese partner's learning ability will contribute to the IJV's profitability and sales growth. For instance, Motorola's partner in Southern China, Nanjing Radio Factory, has the highest R&D intensity and the largest number of engineers in China's radio industry. It has also received government awards several times for advanced innovative or organizational skills. These skills have fundamentally contributed to its superior learning capabilities. In 1995, Motorola (China) Electronics Co. was the second best seller among all foreign ventures in the country, with about US$100 million sales in the local market and an 154% asset turnover.

Foreign Experience

A local partner's previous foreign experience is critical to the success of intercultural and cross-border ventures. Foreign experience affects the organizational fit between partners in the early stages of the joint venture and how well they remain matched as the venture evolves over time. Because the business atmosphere and commercial practices in China are quite different from those in developed countries, mistrust and opportunism have often taken place in the course of IJV operations (Shenkar, 1990). A Chinese firm's foreign experience, through import and export business or cooperative projects with other foreign investors, proves to be a very desirable attribute since this represents superior knowledge, skills, and values regarding modern management methods (Luo, 1997). Contact with foreign companies and business people can sharpen sensitivity toward competitiveness in the international market. A long history of business dealings with foreign markets can increase receptivity toward maintaining quality standards, customer responsiveness, and product innovation. As foreign experience is accompanied by exposure to foreign (Western) values, it also increases a Chinese business's ability to effectively communicate with its foreign partner. This acquired knowledge stimulates the trust and collaboration between partners. As a consequence, a Chinese partner having international experience will contribute more to the IJV's financial return, risk reduction, and sales growth in the domestic as well as export markets. This effect is empirically supported by Beamish (1987), Luo (1997), and Shenkar (1990). Many success stories about Western joint ventures in China such as Brown & Root International (China), Beijing Jeep, Shenzhen Konka Electronics, Guangzhou Procter & Gamble, China Schindler Elevator, Shanghai Squibb, Shanghai Ruby & Johnson Cosmetics, and Xi'an Janssen Pharmaceutical, to name a few, all indicate the importance of local partners' international experience in facilitating interfirm trust, forbearance, commitment, and collaboration, which in turn promote joint venture success.

Human Resource Skills

In an IJV, people with different cultural backgrounds, career goals, compensation systems, and other human resource baggage often have to begin working together with little advance preparation. Unless the ground has been smoothed, this "people factor" can halt the joint venture's progress, sometimes permanently (Cascio & Serapio, 1991). Because of the existence of cultural barriers, the use of a large workforce, and the reliance of Chinese people in the ventures' most managerial functions, human resource management skills of local partners are key to the goal accomplishment of foreign companies. These skills are reflected not only in blending of cultures and management styles with their foreign counterparts, but also in job design, recruitment and staffing, orientation and training, performance appraisal, compensation and benefits, career development, and labor-management relations. Among these attributes, the abilities to surpass cultural barriers, recruit qualified employees, and establish incentive structures are particularly imperative.

In recent years, foreign companies have encountered increasing pressure from local government agencies to hire redundant or unqualified people, from trade unions to set minimum or maximum wage rates, and from labor departments to obey bureaucratic stipulations over human resource management. Under these circumstances, a foreign company needs a local partner which is skillful in managing the workforce and dealing with unions while externally handling labor departments and other governmental authorities. It is important to create a corporate culture that contains some aspects of Western management style and is, at the same time, acceptable to the Chinese staff. Therefore, a local partner should also be knowledgeable about Western human resource management wisdom. Several lessons for foreign companies include: (1) avoid taking too many employees from a single source, as this can heighten the risk of hiring a lot of people who will reinforce similar bad habits; (2) practice patience and flexibility when looking for high-quality personnel; (3) resist pressures to overhire by Chinese authorities; (4) find a local confidante among the local managers who has experience in dealing with the bureaucracy and is trustworthy; (5) mold the right individuals according to the needs of the company. The success of Shanghai Mitsubishi Elevator, Guangzhou Procter & Gamble, Beijing Toshiba Color Kinescope, Tianjin 3M, Shengzheng Epson Electronics, Fujian Hitachi TV, and Shekou Sanyo Electric Machines has to be attributed largely to the local partners' superior skills in human resource management.

FINANCIAL ATTRIBUTES

Profitability

A local partner's profitability will directly influence its ability to make a capital contribution, fulfill financial commitments, and disperse financial resources to the joint venture. These in turn affect the joint venture's profit margin, net cash inflow, and wealth accumulation. The profitability attribute will also indirectly influence the joint venture's capital structure, financing costs, and leverage. As in developed countries, less profitable firms usually have to pay higher interest rates or accept shorter terms in order to attain bank loans in China. In recent years, a sustained tight monetary policy, reflected in increased interest rates and reduced bank lending and money supply (the 'credit crunch') has resulted in liquidity problems for many Chinese businesses, particularly those heavily relying on bank loans. Moreover, in a recent step, the Chinese government began separating bank functions from policy directing. This measure led banks to more strictly control those loans made to less efficient, less profitable firms. As a large proportion of capital contribution by Chinese partners to joint ventures comes from bank loans, this new measure substantially constrains the capacity of Chinese partners to meet their financial commitments.

Viewed from the operational perspective, a less profitable business often implies organizational weaknesses in the technological, operational, and managerial spheres. To Chinese consumers, an unprofitable business normally means poor product quality, poor management, and/or slow customer responsiveness. If this poorly performing business is a state-owned enterprise, reasons may include a 'class struggle' within management, organizational rigidity, and/or conservative leadership. If the poorly performing business is a collectively-owned or privately-owned enterprise, the underlying factors may also include weak competitive advantage, little market power, underdeveloped distribution channels, and/or lack of guanxi with the business community or governmental authorities. In sum, lack of profitability of local partners can be symbolic of internal weaknesses in financial, technological, operational, organizational, and managerial arenas. Foreign investors should be wary when scrutinizing a possible local partner's ability to make profits. Indicators of profitability include the gross profit margin, net profit margin, return on assets, and return on equity, among others.

Liquidity

A local partner's liquidity is critical to IJV operations because it directly affects the venture's ability to pay off short term financial obligations. In the international business literature, it is commonly understood that foreign investors attain financial synergies from the optimization of operational cash flows. A foreign venture can reduce the default risk and uncertainty of operational cash flow, but this depends on the correlation of the pre-cooperation cash flow of the two firms. A larger joint venture will have better access to capital markets and lower financing costs, other things being equal. Given the partial segmentation of national economies and markets, this benefit is even greater for IJVs than for domestic joint ventures. Ideally, in an attempt to achieve the maximum financial and operational synergies, two partners should be complementary not only in capital structure but also between their financial and competitive strengths.

Liquidity is extremely low in most Chinese firms, particularly state-owned enterprises. Many firms have a current ratio even lower than 1. In harsh contrast to the equity status of Western businesses, the initially contributed capital and accumulated retained earnings, called 'retained funds' in China, account only for a very small percentage of the capital resources needed for operations. Consequently, most Chinese firms have to depend heavily on short and long term loans. This is the major reason why Chinese firms are so vulnerable to changes in governmental monetary policy and the 'credit crunch'. International investors should realize that the poor liquidity of Chinese firms and the tight monetary policy will continue for a long time during the economic transition. This is inevitable because the pressure of high inflation and necessity to maintain social stability during a time of economic boom and transformation leave no option but a more tightly controlled monetary supply and vigorously confined capital reinvestment for state-owned businesses. Foreign partners seeking cost and risk sharing or pursuing the reduction of operational cash flow uncertainties should be particularly cautious to ensure that they have a thorough grasp of their Chinese partners' liquidity.

Leverage

As a consequence of the fundamental lack of equity necessary for many business activities, the leverage level of most Chinese firms is markedly low. This is reflected in the high level of various leverage ratios such as debt-to-assets ratio, debt-to-equity-ratio, or long term debt-to-equity ratio. It is well known today that many Chinese firms are encountering a 'triangular debt' problem, whereby the firms owe large sums of money to each other but have no cash with which to settle their accounts. Accounts receivables open more than 180 days are very common, often representing a substantial part of a Chinese company's liquid resources. Apart from the aforementioned 'credit crunch,' this situation can be attributed to cultural factors. Preferential terms of payment, particularly temporal extension of payment deadlines, are widely used in China as a primary marketing tool. In a country where guanxi is painstakingly nurtured and the maintenance of harmony is of paramount importance, sellers will do their utmost to avoid embarrassing customers who may be temporarily unable to pay.

In selecting local partners in China, foreign investors should choose those who are less vulnerable to the 'triangular debt' and have a strong leverage position. This superior position often implies that the firms (i) are more conscientious about credit screening and investigations, and thus have maintained a network of customers/buyers with a superior leverage position, and (ii) have better asset management or superior organizational skills. It is essential for the firms in China to establish clear-cut working policies, both internal and external, that will promote the best cash turnover possible and maximize benefits from the economics of accounts receivable. Because these issues significantly influence growth and survival in the Chinese market, foreign investors should attach utmost importance to the leverage level of local firms during the selection process.

Asset Efficiency

The asset efficiency of a local partner is critical to the effectiveness of the joint venture because it is a mid-range construct for maximizing return on investment. The net gains from resource contributions depend in large part on the management of assets, especially inventory, accounts receivable, and fixed assets. A partnership with a local firm which manages its total assets skillfully and efficiently is surely beneficial to the foreign investor pursuing either short term profitability or a long term competitive position in the market.

Asset efficiency has become particularly important for the evaluation of Chinese business performance in recent years. Prior to economic reform, a firm's incentives to enhance asset efficiency were rather low because of blurred intellectual property rights and a rigid central planning system. Today, however, firms have much higher autonomy in allocating and utilizing various assets. Thus, the level of asset management mirrors the degree of advancement of managerial skills and the extent of effectiveness of corporate administration. Although a large local firm helps the joint venture increase the economy of scale and gain better access to capital markets or commercial loans, the net size effect on the firm's financial and market performance virtually relies on asset turnover. Foreign investors should research and analyze a local partner's asset efficiency indicators such as turnovers in inventory, fixed assets, accounts receivable, and total assets. Additional insights may be obtained by comparing these indicators longitudinally to see how much improvement the local partner has made over time, and by comparing the indicators with those of other local firms in the industry to see to what extent the partner outperforms its major competitors.

IMPLICATIONS AND SUGGESTIONS

To conclude, it is essential to venture success in China that the potential partner possess complementary skills and resources, and share compatible goals and a cooperative culture. Using reliable sources of information (see below), foreign companies should examine the following attributes of a local partner candidate: (i) Strategic traits, including marketing competence, relationship building, market position, industrial experience, strategic orientation, and corporate image; (ii) Organizational traits, including organizational leadership, organizational rank, ownership type, learning ability, foreign experience, and human resource skills; and (iii) Financial traits, including profitability, liquidity, leverage, and asset efficiency.

Although this paper focuses only on what attributes of local partners are important to overall success of IJVs in China, and was not designed to shed light on how best to go about finding partners with such attributes, we would like to address this issue for international managers active in the Chinese market. First, partner selection should be integrated with the strategic goals of the foreign company. A foreign investor cannot, nor will it need to, find a local partner possessing superior attributes in all of the above. Indeed, the superiority of every attribute in all three categories (strategic, organizational, and financial) is favorable to the IJV's overall success and should be thoroughly evaluated in the selection process. Nevertheless, the importance of specific attributes within a category is dependent on what the foreign company wants to pursue from the venture. If a foreign company seeks long term market growth, the importance of a local firm's marketing competence, market position, industrial experience, organizational rank, and asset efficiency may outweigh other attributes. If a foreign company seeks cost minimization via export, such attributes as learning ability, foreign experience, and ownership type may be more critical than others. If a foreign company seeks short term profitability, it should attach higher value to a local partner's relationship building skills, strategic orientation, profitability, and liquidity. Finally, if a foreign company seeks reductions of financial risks and operational uncertainties, more weight may be placed on attributes such as corporate image, organizational leadership, human resource skills, and financial leverage. The real magnitude of each attribute's influence on an IJV's various aspects of performance is, of course, an empirical question, and should be taken up by future studies.

Second, obtaining as much information as possible about the potential partner is well advised. Get a copy of its business license, which will tell you about its legal capacity to contract with a foreign investor, its registered capital, its business scope, and the name of the legal representative who is legally authorized to sign any joint venture contract. It is also necessary to obtain a copy of the company's brochure and find out about the industry and the candidate's competitors (this can be another good source for potential partners). It the candidate received any award from upper level government authorities, the foreign investor should get a copy. Such an award may include the Chinese party's ranking in terms of size, production, quality, reputation, or economic efficiency as recognized by the industry in a particular province or in the nation.

Third, a site visit is imperative. Social activities, which almost invariably will be pressed on investors during the visit, should be left until the deal is signed, sealed, and delivered. Politely rejecting such offers will not, as many Westerners mistakenly believe, hurt the relationship or cause your potential partner to lose face. It might even earn you respect for taking your business seriously. Diligent work is more, not less, important for IJVs in China than for those in other countries. Reliable information can often be obtained only from such a visit. During the site visit, investors should try to observe employee attitudes and talk to managers, from the lowest to the highest ranks. Don't shy away from asking questions about the operation, employees, finance, technologies, cash flow, and other relevant matters.

Fourth, it is always important to check whether or not your Chinese partner shares your investment objectives, or at least is able to reconcile his objectives to yours. If your partner puts his own interests, benefits, and political advancement above those of the joint venture's, or if his management style differs substantially or completely from yours, or if he wishes to base the venture's potential success on his political clout, you have cause for concern. In general, foreign partners are interested in market access, cheap labor, and lax rules on pollution control; the Chinese side is interested in capital and technology as well as promoting their exports. When these priorities are at odds, coordination between the joint venture partners becomes very poor. As the Chinese phrase goes, they are "sleeping in the same bed but having different dreams." Beijing Jeep typified one of these clashes over priorities between foreign and Chinese partners. With a strong interest in absorbing technology, the Chinese felt that AMC had reneged on the terms of their contract, which called for joint design and production of a new Jeep, when exhaust system, noise controls, and speed failed to meet international standards.

Finally, while recognizing the importance of a local partner's ability to build relationships, we should note that guanxi alone cannot ensure venture success at all. Guanxi is not a substitute for basic organizational fundamentals such as the various strategic, organizational, and financial attributes examined above. Guanxi cannot make customers buy the IJV's products, cannot make the quality of those products acceptable to overseas buyers, and cannot increase the productivity of workers. If guanxi is improperly used to obtain approvals or resources, and if the impropriety is discovered, there may be negative repercussions resulting in revocation of the approvals and a taint on the foreign investor's reputation which will affect his future investment opportunities. All in all, do not place undue reliance on guanxi and particularly beware of someone who claims nothing but guanxi in China. Another pitfall emerging recently in locating a suitable Chinese partner is that some potential candidates are in serious financial trouble. They perceive joining forces with a foreign partner as a way to rejuvenate their dying organization. William Mallet of Tianjin Otis Elevator, China, advises that, "foreign investors should not try to resurrect worthless organizations. They should link with ones that were strong financially, because that will provide a solid investment foundation" (Goldenberg, 1988).

Nevertheless, many MNCs have had success stories in finding suitable Chinese partners. A good Chinese partner can be very helpful in a number of ways. They can significantly cut the cost of production, help break entry barriers to the targeted market, and even enhance the technology of the parent company. The operations of the McDonnell Douglas cooperative venture and the Johnson & Johnson venture in Shanghai are two examples of success among many illustrated above. In both cases, the Chinese partners played a key role in promoting their products in the Chinese market.

For both academics and managers alike, the following key areas concerning partner selection await further examination necessary to deepen our understanding of the requirements for joint venture success in China. First, interpartner cooperation antecedents and dynamics should be diagnosed. While partner selection determines the possibility of IJV success or failure, partner collaboration determines the realization of such possibility. China's dynamic, complex environment characterized by structural transition, industrial property reform, and central authority transformation makes this cooperation both of paramount importance and enormously difficult. Those foreign companies pursuing a long term market position should attach utmost value to the ways their Chinese partners develop, maintain, and improve their evolving collaboration.

Second, the integration of partner selection with other investment strategies such as location selection, entry timing, and sharing arrangement needs to be investigated. Given the economic, cultural, and historical diversity of China, foreign companies cannot use homogenous criteria in evaluating and selecting local firms for projects in different regions. The importance of each criterion to a foreign company may also differ according to timing of investment, given the changes in the environment and strategic intent and needs of the investor over time (Luo, 1998). Because the degree and scope of control needed for a planned venture are an important factor underlying partner selection, a local firm's attributes may have different effects on a foreign company's goal accomplishment within different equity arrangements.

Third, more evidence about the evolution of IJVs in China is needed. Partner cooperation in the operational and managerial process has largely been unexplored. Undoubtedly, many IJVs there do not have inter-parent fit in strategic, organizational, and financial areas in the formation stage, but they survive, sustain, and evolve in the country. In other words, we need to longitudinally and dynamically examine how partners maintain fit or adjust mis-fit over time for the attainment of mutual benefits. We have seen a variety of studies focusing on investment strategies such as equity control, timing of entry, and industry selection for Chinese IJVs, but very little examination of business and operational aspects of interfirm cooperation. As a large number of IJVs have moved to the second stage in China, with about ten years of operations, their evolution remains a key issue for us to investigate.

Fourth, the implications of recent economic policies enacted by the Chinese central government for foreign businesses should be assessed. For example, the 'holding big, relaxing small' policy in reforming state-owned enterprises may create more choices and freedom for foreign companies selecting small or medium state-instituted businesses. However, a few large state firms in oligopolistic sectors are likely to be better protected and supported by the central government, implying that joint ventures with such firms may more readily succeed in preempting scarce resources and maintaining market power in the industry. In addition, the permission to establish 'umbrella' investment companies for foreign investors may necessitate such attributes of a local partner that not only fit strategic needs of the IJV but also operational requirements of other integrated subunits with a foreign investor's network. Moreover, the deepening transformation of Chinese industry structure may imply that firms in different industries will encounter idiosyncratic pressure from market demand and industrial competition, and face varying governmental policies and institutional support. Joint ventures operating in different industries may demand different criteria in selecting local partners. In other words, it is vital to have a match not only between a foreign company's goals and a local partner's attributes but also between an industry's characteristics and a local firm's characteristics. Furthermore, China may postpone the convertibility of RMB and tighten monetary control for several more years due to the impact of the recent Asian financial crisis. This implies that foreign investors should attach utmost importance to the local firms' ability to earn foreign exchange, cultivate relationships with financial institutions, and maintain strong leverage and liquidity positions.

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Yadong Luo, Department of Management, College of Business Administration, University of Hawaii at Manoa, 2404 Maile Way, Honolulu, Hawaii 96822 <yadong@busadm.cba.hawaii.edu>.
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Author:Luo, Yadong
Publication:Journal of World Business
Date:Jun 22, 1998
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