CHINA - So you want to do a Joint Venture in China, eh? Foreign companies must consider local business structures when planning to enter the Chinese market. Relationship mapping is a vital tool in gaining an insight into the priorities, constraints and advantages which a local joint venture partner can bring.

“When a privatised Chinese corporation gets successful the government adds another failing state owned enterprise to its portfolio hoping to turn it around,” says Madame Liu Lichun, rearranging a display of small ornate blown-glass animals, adding: “We’ve just been given the glassware factory which makes these.”

Although her name card describes her as a packaging economist, Madam Liu is chairperson of the Shengdao Group Company, the largest plastic based product packaging conglomerate in China with 20 subsidiaries, 3,800 staff and total assets of $314 million, located in the port city of Dalian, near the North Korean border in Liaoning Province, one of China’s most picturesque and economically vibrant cities.

As the country’s largest flexible plastic packaging converter, the Dalian Shengdao’s Group operates in base resin, through sheet extrusion, BOPP, CPP and PE, to pack forming and printing either flexo or gravure.

Her company engineers designed and commissioned Japanese press-builder, Fujimori, to construct the only in-line 12-colour gravure printing press in the world, giving it the capability of running combinations of two six-colour jobs, three four-colour jobs or a single 12-colour job.

When she took the company into flexographic print process, Madam Liu did so through a joint venture (JV) with a German company, Nordenia, and ordered two state-of-the-art Eu1.5 + million printing presses from Windmöller & Hölscher and Fischer & Krecke, and announced proudly, “I have a BMW and Mercedes on the factory floor and want to see which one runs fastest,” adding prophetically “I have space for 11 more.”

In addition to her German JV she has 11 other joint ventures with foreign companies which provide the components for the packaging she produces; inks, printing plates, plastics.

In Chinese terms, she’s a ‘player’.

Command economy

The Dalian Shengdao group is a classic example of the restructured Maoist command economy, now dominating the headlines in world business.

As recently as 1995, China’s product packaging sector was a confusing mix of more than 38,000 packaging enterprises, from large state-owned outfits down to small village collectives. Packaging, like every other industry sector in China, evolved during the Great Leap Forward, which simultaneously nationalised all private enterprise and decreed industrial self-sufficiency to be the goal. Every village, town and district was to be entirely self sufficient in manufacturing.

This turned into a Great Leap Backward as farmers literally stuffed their ploughs, shears and cooking utensils into furnaces to meet a quota decreed by Beijing in the all-encompassing Five Year Plan.

Village or collective enterprises threw up factories; when a farm collective needed HDPE sacks for rice it; simply put up a case to the district committee which, reporting along a complex chain to the central planning committee in Beijing, got approval and funds. The next village 20 miles away might also have an identical proposal approved.

The resulting plant belonged to the local collective, which ultimately fell under the purview of the Ministry of Agriculture (see chart A) multiply it across 27 provinces and you are looking at China’s packaging sector, pre-1995.

Similarly, the People’s Liberation Army’s (PLA) need for ammunition or food rations set up PLA factories and packaging plants. There are more than 5,000 PLA-owned packaging enterprises (everything from corrugated carton, PET to steel and glass), staffed by serving military officers – it isn’t forced labour, for a Chinese squadie it beats guard duty on the Russian border

In China, cut off from the world by the Bamboo Curtain – and striving towards a cashless society – workers were paid in coupons, the factory provided housing, canteens and schools (as many still majority still do), and funding for these packaging plants came from central government in the form of credits.

Were it not for the politics, operations would be strangely familiar to the inter-divisional transactions in large MNCs where rarely is a cheque written as payment for goods supplied by another group member; details being handled by central accounting, or in the case of China, the Ministry of Finance.

Importantly, none of these goods were supplied at market value but at an internal transfer price – as is often the case with the multi-national corporation. The sole purpose of these factories was to produce, not to make money or profit, which was illegal.

In the 1960s, the Cultural Revolution, the cult of the individual demonised by youth mobs dressed in the same unisex Mao suits, swept away the last vestiges of capitalism. Product branding was evil: brands aim to differentiate a product from the competition, but the state provided everything and the package became a purely functional container.

Four Steps to China Inc

Step one: Corporatise

Restructuring began after the death of Mao, but only seriously got underway in 1995. Of China’s 38,000 state owned packaging enterprises, not one was a company with any ownership structure, no board of directors or articles of association - only a reporting chain of command.

Step one involved rationalising these operations; small village plants were either closed or taken from the bureaucrats, and handed over to managers to run.

Larger operations were transferred from Beijing’s direct control to provincial or municipal authorities, consolidated into structured packaging groups, under a local holding company, established for the purpose of corporatising the SOEs (not just in packaging, but all sectors).

Since Beijing’s Ministry of Finance would no longer be handling transactions, provincial Investment Corporations were established to fund and invest in newly corporate entities. This included the provincial banks (see Chart B level one).

At the bottom of the tree (level four) sat the enterprises or factories, which were converted into companies or merged to become subsidiaries of a group. For example, the plastics products group might have a flexible packaging company, a PET bottle company and a rigid container company. Paper, glass and metal would all have a parallel organisation structure (chart B level three).

These groups would then report to a corporation (table two level two). Now with a recognisable corporate structure, the Chinese packaging industry has a series of vehicles which can legally enter into joint ventures with foreign companies.

Step two: foreign investment

Under Chinese law, foreigners are not permitted to invest directly in Chinese businesses, but if foreigners want to do business domestically, a joint venture is the most common option, in which the two parties come together to form a third legal entity: the JV company. Generally, this is done at level four.

So the Chinese flexible packaging company would create a JV with a German flexibles company to form a separate Sino-German flexible company, with the local partner holding 51 per cent equity minimum.

But this is where life for the foreign investor gets tricky - unless you have done due diligence, which includes relationship mapping (identifying the ultimate ownership and its holdings), you may find yourself in direct competition with your JV partner (which will certainly continue to operate its plant, probably in the next building) but you will also be competing with another subsidiary of the same parent company; who will be entirely free to enter into a JV with anyone it chooses.

Similarly, if the foreign investment strategy is to open several plants in other provinces, you will have to find additional partners. Rarely is a provincially-owned company allowed to venture out into another province.

Step three: the listing

From the Chinese perspective, with a few JVs with foreign companies in place, the scene is now set for step three: an Initial Public Offering (IPO) on some stock exchange. Shanghai and Beijing were favourites for a while around 2000. Offshore, Chinese companies are listed in Hong Kong and Singapore, although the NYSE is becoming popular.

No more than 40 per cent of the equity in level three is usually offered. This is parent company level, not JV partner level.

Increasingly, the British Virgin Islands (BVI), Bahamas, and other tax havens are appearing in listing prospectus as existing shareholder domiciles. It does give pause for thought since Chinese nationals are not even permitted overseas bank accounts. However, an IPO may present problems for a foreign investing company if it only owns 49 per cent of the JV and the majority partner’s holdings are assets of the Chinese parent company which is being publicly traded (note that the level two corporation remains unlisted).

This may not be an acceptable development, depending on the foreign investor’s strategies and conflicts outside China.

It should also be remembered that foreign investors are not permitted to sell their equity in JV companies, other than to their local partner. Nor is the export of used equipment permitted.

For this reason a Special Purpose Offshore Vehicle (SPOV) is often the solution: a wholly-owned private limited company registered offshore (in Singapore or Hong Kong). If there is a need to divest, it is the SPOV which is sold, yet ownership of the Chinese equity remains legally unchanged – the Singapore company still owns the equity.

Given that this restructuring process has been occurring across the board in China’s industries (not just the packaging sector), chart D may be a realistic, if simplified, map of the relationships involved.

The provincial holding company and investment corporation may actually control the entire supply chain in its province: the packaging group, paper supply group (paper mills), food group, beverage group, transport and distribution group, each of which have their own JV networks with foreign companies.

Understanding the relationships could prove that the motivation behind Chinese interest in approving your foreign-invested bottle JV was actually driven by the needs of the holding company’s beverage group, which in turn has a JV with a US soft drinks MNC (Coke has 27 JV bottling plants, while Pepsi has 14).

The product will be sold through the holding company’s retail outlets, themselves a JV with a French company (Carrefour has 47 hypermarkets and reported income of €1.138 billion ($1.37bn) from China in 2004 – not a single imported product, or package, on the shelves).

In the final analysis, the industrial strength of a province, or city like Dalian, rests in the hands of a group of chief executives, comprising, at the most, 50 people who run the holding company, investment corporation, bank and their linked industrial conglomerates.

These are actually the industrial elite, in a province the size of France, and they sit on each others’ boards and are just a phone call away when there is some new technology being developed, or when new investment loans are needed.

Does that sound like capitalism, or is it market socialism?

Step four: globalisation

It comes as no surprise that foreign converters brave enough to enter China as a WOFE (wholly owned foreign enterprise) often find closed doors and little profit in the domestic market.

Nor is it a surprise that after similar restructuring, and access to cheap (almost free) investment capital, brands little-known outside China are buying their way to global pre-eminence.

Recent overseas investments:
Domestic computer company, Legend, changed its name to Lenovo and last year acquired IBM for $1.2 billion – it is 60% owned by Legend Holdings.

Not surprisingly, Chinese investment money is in demand. Let’s face it, the British government turned to Shanghai Automotive in an attempt to rescue MG Rover.

Nor is it a surprise that Madam Liu’s former boss, Bo Xilai, the former Mayor of Dalian and architect of the Dalian City holding company, is now Beijing’s Minister of Commerce who has been in the forefront of the textile trade spat with the EU using the tactic:

But the ‘crouching tiger’ is waiting - while you may be hunting in China for investment opportunities, China is certainly hunting you in your own markets.

Make no mistake, China has plenty of spare change, as China’s Central bank owns more than $191 billion of US debt, enough to finance several more takeover bids (which does lend some support to the US demand to revalue the RMB).

But what of Madam Lieu’s acquisition of the cutesy-pie glass animal figurine producing factory? A few days after our meeting, she flew to Atlanta to discuss technical specifications and standards with Coke’s bottling people. She returned with a deal and now supplies Coke China with glass and plastic bottles.