UN C OMMON WISDOM

Remastering the Art of Doing Business in China

BY ROBERT LAWRENCE KUHN

For foreign companies in China, the game has changed.

ive years ago, I wrote an article called Mastering the Art of Doing Business in China. It was my first for Chief Executive and it dealt with the tactical details of doing deals in China, especially the subtleties of relationships. Since then the world has changed. Chinas rise has been astounding. As 2006 began, Chinas foreign reserves were just over $800 billion. Today they are approaching $3 trillion. At the same time, the financial crisis undermined the economies of developed countries, boosting Chinas relative strength. Chinas senior leaders, especially the new generation, whocoming to power in 2012-2013have a grand vision of China as an emerging superpower, particularly in economics and trade, and this requires industrial transformation. Chinas leaders must also grapple with Chinas biggest, most intractable problemeconomic and social imbalances between rich and poor (urban vs. rural, coastal vs. inland). Chinas leaders recognize that for China to complete its historic modernization, its domestic market must expand dramatically. Two factors drive this. First, the Chinese people, ever more vocal (especially on the

Internet), demand more of the fruits of their countrys success. Second, China must never again be held hostage to economic crises in other countries by being permanently dependent on exports. What this all means is that for foreign companies in China, the game has changed. Simply bringing capital is no longer sufficient. China has capital, including, recently, many private equity firms and diversifying sources of funding. What also no longer works are low-end manufacturers leveraging lowest-cost labor, especially if their processes are energy intensive or in any way polluting. Sure, deals can be done, but not as in the past. Today, many companies want to enter China, but the landscape has a new shape. Some companies should not even tryrunning uphill is not good strategy. For others, the converse is true: the time is propitious because they have what China needsand now China can and will pay for it. (It is not always obvious which companies fit todays China. Surprises are common.) Hence, in advising international clients on doing business in todays China, I use the following guiding principles for optimizing success.

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Alignment with Senior Leaders My watchword can be encapsulated in a single word: Alignment. Foreign companies will succeed in China to the extent that their China strategies are consistent with the principles and policies of Chinas senior leaders, particularly Chinas new leaders. (Note that this can mean modifying ones corporate strategy or simply presenting the unmodified strategy in a congruous, inside mannereither or both.) China claims that a prime benefit of its one-party system is that principles and policies can be set

long-term with minimal risk of reversal (It is hard to lose an election when there are no elections). Thus, when business executives set China strategies, they can be confident that current principles will prevail (even if policies that express these principles continue to evolve). Following are principles of Chinas leaders with which foreign companies should align: increase domestic consumption; increase social services for the masses (particularly healthcare, including pharmaceuticals and medical services); increase high technology capabili-

ties; attract and develop world-class talent (particularly in science, technology and management); favor inland and rural areas; build worldclass Chinese companies in every industry of importance; and develop strong Chinese brands. (Hightech priority fields include IT, biotech and agritech, advanced materials, advanced manufacturing and automation technology, energy, water resources, oil and gas, environment technology, alternative energy, and disaster prevention and mitigation.) Sometimes, problems are slippery. One multinational, a world leader in its industry, had obtained all the approvals and endorsements needed; all the company did not have was business and they could not figure out why. The answer was that China was determined, long term, to build its own world-class companies in this industry and it would not have a foreign company thwart this overarching mission by dominating Chinas domestic market. Alignment here meant discerning how the success of the foreign company could increase, not decrease, the likelihood of building strong Chinese companies. On the surface, this would seem a contradiction, a zero-sum game. The key was to invert conventional wisdom and have the foreign company help its domestic competitorsan anathema in normal markets. But because of Chinas unique growth, and its appreciation in world capital markets, a counterintuitive solution made financial sense. Strategic Principles Following are strategic principles that are now working in todays China:

ROY SCOTT

CEO Magazine March/April 2011

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Assess every strategic move by testing it against

the policies, and expected policies, of Chinas leaders.
1. Alignment. This heads the list. Assess every strategic move by testing it against the policies, and expected policies, of Chinas leaders. Emphasize competitive strengths that support alignment. I stress alignment and I enjoy figuring out how to achieve it in diverse industrial settings (sometimes with out-of-the-box thinking). 2. Complementary Interests: Seek Chinese partners or business allies that can use your company, its resources and products, to bolster their own competitive positions in the market. Many Chinese companies, having grown large and confident, worry about domestic competitors, not foreign competitors. This means that if your company can help a Chinese company in its bruising domestic battles, you can cut a good deal. (Be warned: it will not be the deals of old, as valuations and sophistication of Chinese enterprises have skyrocketed.) At some point, however, Chinese partners or allies will likely have interests that diverge from your own. This presents strategic challenges, but recognizing them upfront enables subtle structural adjustments. 3. Target Provinces and Municipalities. Local governments in China, in fierce competition with one another, compete to attract foreign investment and can offer very attractive support (in one form or another). When Im representing multinational companies, I like to arrange a kind of informal auction among local governments, exploring with three or four. (Foreign business executives may be dumbfounded to find that the local boss, usually the Communist Party secretary, is more like a deal-doing investment banker than a Mao-suited ideological watchdog.) 4. Be Important. When working with local entities, whether governments or companies, target managers at the proper level so that what you bring to the table is meaningful to them. Balance their capabilities in your market with their perception of your relevance. A powerful partner to whom you are not important might look good in board presentations but will not work in the real world. 5. Recognize Relationships. Individuals remain key to doing business in China. I generally start with governmental officials who, in one way or another, are central to a client companys success. This is highmaintenance work. Usually only the foreign CEO can meet the number one person on the China side China respecting hierarchies and protocoland thus to do serious business in China, the CEO must visit China on a regular basis. When Hank Paulson was running Goldman Sachs, he came to China more than 70 times. 6. Be Vigilant. China is dynamic; uncertainties and high variances are the rule, not the exception, so that ongoing monitoring is essential. Scan regularly for early warnings of potential disruptions. Just because your business is running well today does not mean that it will do so tomorrow. All foreign companies have a China strategywhether they know it or notand many should be active there. But doing business in China is only for the committed, not for the casual. If thats you, remember my watchword: Alignment. s
Robert Lawrence Kuhn, with a doctorate in brain research, is an international investment banker and corporate strategist who advises multinational corporations on doing business in China. A longtime counselor to the Chinese government, he is the author of How Chinas Leaders Think, featuring exclusive conversations with Chinas senior leaders, current and future. Dr. Kuhn is senior international commentator on China Central Television (CCTV) and senior China commentator on Euronews.

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> su b je ct

Uncommon Wisdom Designing a China Business Framework

Looking to succeed in China? Align your strategy with the agenda of Chinas leaders.
by Robert Lawrence Kuhn

Xxxxxx

My work involves frequent and extensive interaction with senior executives of diverse companies doing or seeking to do business in China. During those candid and confidential discussions, I am struck by the common assumption that Chinas transformation into a market economy should translate into Chinas adoption

A better way to think about the Chinese government is as another corporation China Inc.
of a Westernized style of doing business. Consequently, executives become viscerally annoyed, some even apoplectic, when they find doing business in China is troublesome, irksome and risky. When executives are slow to sense how business and government are intertwined in China with multiple layers of nuance, simplistic thinking can become a self-fulfilling prescription for frustration and failure. In some cases, these executives are from companies entrenched in China. Others are deciding how (not whether) to enter this vast, burgeoning market. All believe that an increasing percentage

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Designing a China Business Framework > Uncommon Wisdom

of their global revenues will come from China. While all are committed, none are satisfied. This article offers an explanation of Chinas unique structure, culture and characteristics, both political and economic, which can be used to build a framework for generating meaningful revenues and profits in China.

A Politico-Strategic Framework
I call my framework for doing business in China politico-strategic because I seek the intersection between the corporate strategy of the firm and the political agenda of Chinas leaders, which in China has singular significance. Many large companies have government relations offices, but in China the term is misconceived and counterproductive because a government-relations mindset underrates the pervasive power of Chinese officials who are far more than regulators. A better way to think about the Chinese government is as a large corporation China Inc. The Office of the Chairman of China Inc. is the Politburo Standing Committee (PSC), comprised of nine senior leaders. Everything in China reports to one of these nine leaders. But the PSC is not like the U.S. Cabinet, whose members the U.S. president can replace for any reason at any time. The president of Chinawho is more meaningfully the general secretary of the ruling Communist Partycannot replace PSC members, who are more or less equal, each with his own portfolio. This means that the philosophies and policies of these leaders exert great influence in China. This is why the watchword for doing business in China is alignment and why politico-strategic defines this framework. Foreign companies prosper in China to the extent that their strategies and operations facilitate or enhance the agenda of Chinas senior leaders. Chinas 12th Five-Year Plan (2011-2015) favors businesses that enhance standards of living (i.e. healthcare and education), encourage domestic consumption (i.e. consumer product companies), boost science and technology, serve rural markets, facilitate sustainable development and strengthen environmental protection. It may seem odd that aligning with the objectives of Chinas senior leaders can make much difference to companies

fighting in the myriad trenches of market competition. After all, when doing business in the U.S. it usually makes no matter if a firms strategy is aligned with President Obamas agenda. China is different. Because the Chinese government operates like China Inc., it oversees the activities of state-owned enterprises and even modulates private companies (which must always conform with policy) as well as maintains regulatory functions. All high-level officials, at central and local levels, and all senior

Expect curves in the road: leaders change; agendas change.

executives of major state-owned enterprises are selected by the Partys Organization Departmentand they are judged by their track record in achieving the objectives of the countrys leaders. (For example, since leaders want a sustainable economy, governors are judged by how well they increase their provinces ratio of GDP per unit of energy.) As such, to the degree that your company can advance the careers of senior officials or executives, your company can be favored. Change of leadership almost always triggers a reset, major or modest, in overarching principles and policies. This means that assessing, finding and maintaining alignment is a subtle, continuous

and dynamic process, and it must always skew to the number one person. This is particularly true for Chinas senior leaders, who in 2012 will undergo a complete change (likely led by Chinas current vice president, Xi Jinping). But leadership change also impacts ministries and stateowned enterprises. To the extent that your business is tied to a specific ministry or agency (or company), when the person at the top changes, one must reassess strategy to align with that new person. Personally, I enjoy the creative challenge of figuring out how to align a multinational companys China strategy with the agenda of Chinas leaders. This can be done in two phases. First, seek new profitseeking strategies, stressing core competencies and achieving long-term corporate goals. Second, seek novel ways to reposition current strategies so that they are more aligned with policies. Expect curves in the road: leaders change; agendas change. Even companies who have been in country for 20 years or more are still only partially equipped to compete and win in China, says Sam Fouad, Ernst & Young Americas emerging markets leader. The China market requires long-term commitment and continuous adaptation to the priorities of the Chinese government. Doing business in China is ever dynamic.

Demystifying China
An understanding of the complexity, dynamism and subtleties of China is critical to building robust businesses there. At a minimum, companies that truly hope

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to thrive in China should seek to gain a grounding in the following seven areas: Chinas Future: Economic Prospects and Political Landscape. (China in 10 to 20 years. Can China sustain its remarkable growth? How fragile is Chinas system?) How Chinas Leaders Think. (Why senior leaders affect business, and how they do it.) Chinas New Generation of Leaders. (Who will take power in 2012-2013? How will new leaders deal with foreign companies? Which industries, geographies, structures will be favored?) Working with the Central Government. (Principles for aligning corporate strategies with Chinas leaders objectives.) Working with Local Government. (Appreciating provincial politics and leadership. Seeking beneficial competition among local governments.) Chinese Media. (Medias surprising importance. Opportunities and pitfalls.) Special Issues for High-Visibility Companies. These are not magic bullets. The goal is to shift the probability curve of likely success somewhat in your favor.

Perceived Risks
A survey of major companies doing business in China, conducted by Ernst & Young, generated the following risks (listed in order of concern): theft of intellectual property; difficulties in integra-

There are always trade-offs and reliable generalizations do not work.

tion (acquisitions) or in collaboration (joint ventures); violations of Foreign Corrupt Practices Act; industrial espionage; government regulation after the deal is done; enforceability of contracts; reliability of information about counterparties;

difficulties in performing valuations; government involvement in negotiations; lack of internal consensus within the counterpartys organization; renegotiation of the deal after it closed; repatriation of cash; export controls; scarcity of quality talent. Perhaps my favorite executive comment came from the head of business development at a medium-tech company. He complained vociferously about how tortuous it was to do business in China, but then cheerily reported that of his firms last three acquisitions, all were in China. A common question among companies entering China is whether to establish joint ventures with Chinese partners or to

develop wholly owned subsidiaries. There are always trade-offs and reliable generalizations do not work. Each situation needs to be assessed on its own merits, using commercial due diligence and a politicostrategic framework. Robert Lawrence Kuhn is an international corporate strategist and investment banker who advises multinational corporations on doing business in China. He is senior advisor, office of the chairman, Ernst & Young. A longtime counselor to Chinas leaders, he is the author of How Chinas Leaders Think: The Inside Story of Chinas Past, Current and Future Leaders and The Man Who Changed China.

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