Dr. Stephane J. Grand

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Success in China Or the Absence of Failure

• Dr. Stephane J. Grand

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The limits of experience

• Your Instructor
• What you will learn and what to do with it
• The fundamentals there is indeed a Chinese
  culture
• Application working with the Chinese
• Application investing in China
• Application navigating and troubleshooting daily
  business
• Futurology Strategies for the long term
• Keep in mind
• Political Correctness, or how to refuse to learn
• Limits of Experience reconnecting theory and
  practice

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Success, Failure and China

• I do not need to convince you China is important
• 1.35 bn. people (2012 UN est.), 95 literate
• 2nd economic power in the world
• 7.8 growth rate (2012, est.)
• 2.057 tr. USD exports (2012 est.)
• 1.735 tr. USD imports (2012 est.)
• 3.3 tr. USD foreign exchange reserves (end 2012)
• What makes the first cut of success or failure of
  a foreign company in China? Thinking it is a
  Western country.

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What you need to walk away with from todays
lecture

• China is not a country as you understand it
• There is no truth in China
• Friendship, contracts, trust are different
  concepts there
• There is no authority, there is only power
• The history of the people you do business with in
  China is different from this of anyone you know
  in the West

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Why this matters

• The above has a tremendous impact on
• The relations with customers, suppliers and
  business partners
• The sensible and efficient mode of entry on the
  market
• Contractual and general business risk
• Intellectual Property Rights (IPR) and their
  protection
• Strategy

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The Chinese in the Last 60 Years
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Recent History

• Timeline of Modern China and the lives of your
  counterparts

1949 Liberation from foreign powers, birth of
the PRC 1953 Anti-rightist campaigns end of
private property 1957 Launch of the Hundred
Flowers Campaign (open criticism, followed by
violent crackdown) 1958-1962 Great Leap Forward
(widespread famine, 20 million deaths) 1966
Beginning of the Great Proletarian Cultural
Revolution (political violence at an
unprecedented scale) 1976 Death of Chairman Mao
Zedong, end of GPCR 1978 Downfall of the Gang
of Four, rise to power of Deng Xiaoping 1981
One Child Policy (beginning of forced
abortions) 1989 Tian An Men events (June
4th) 1989 to now continued economic growth under
CCP supervision Acceleration of reform (Bonsai
theory)
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1960s
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1970s
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1980s
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1990s
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1965-1985 Family structure
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There is more than one China

• Economic geography of China
• North (Beijing, Changchun, Harbin, Shenyang,
  Tianjin, Dalian) Rust belt heavy industry,
  heavy unemployment, destroyed environment.
  Political and industrial, not commercial. Third
  FDI destination.
• East (Shanghai, Hangzhou, Suzhou, Wuxi, Nanjing)
  High value added manufacturing, heavy FDI,
  modernized economy, commercial. Environment
  slightly less damaged. First FDI destination.
• South (Guangzhou, Shenzhen, Xiamen, Zhuhai,
  Zhongshan) Light manufacturing, labor intensive
  industries, Oil Gas, recycling. destroyed
  environment. Second FDI destination, mostly
  Asian.
• West (Chengdu, Kunming, Chongqing, Xian, Wuhan,
  Baotou, Hohot) Heavy industries, agriculture,
  very polluted, VERY corrupt, bad economic
  situation. Ethnic minorities. Some political
  violence. Said to be up-and-coming.

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What this gigantism means

• The Sky is High and the Emperor Far relations
  with the local authorities are important
• Local Chinese markets are different
• It is difficult to move your teams
• People are connected locally

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Social Dynamics

• Truth
• Understanding of power from the family to
  society
• The guanxi system
• What makes contracts different in China
• It is not about the people you do business with,
  it is about how they interact with you

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Truth
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Truth Redux

• What do we learn from Zhuangzi (and Heidegger)
• Truth can be inferred, it is an implicit world
• There is no demarcation between subject and
  object, not leaving space for absolute truth,
• Truth is relative to the context of the
  enunciation
• How this translates to business
• There is no rational business conversation
• Your fact-based truth does not matter

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Guanxi or Social Networks

• Social interconnections, organized
• Origins of Guanxi Guilds
• Short story of a cobbler in Ancient China
• The guild of cobblers
• Autarkic village
• Making the deal
• Breaking the deal
• Protection
• The morals of the story
• More than moral suasion excommunication
• Informal judicial systems and business promotion
  agencies

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The Traditional Family or the School of Power
Thinking

• Traditional family structure centered on males
• From father to elder son, to younger son
• The power of each one is limited by the power of
  the one above in the line
• The law limits the power of each one

Since families are linked by guanxi, the
structure connects into society like a power grid
and transmits power virtually throughout the
Chinese World
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So What Does This Mean for Business in China

• Very high incidence of
• Fraud
• Corruption
• Breach of Contract
• IPR Theft

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Impact on Contracts

• Impact on Contracts
• Contracts organize horizontal relations between
  equivalent actors, based on the possibility to
  obtain enforcement Chinese social fabric is
  woven vertically, as everyone is above all a
  member of a group
• Extension of the business networks beyond the
  close family, though closeness prevents contract
  Contract allows business where there is no
  guanxi.
• However, guanxi is always stronger than a
  contract

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Corruption

• In a regimented society with positive freedoms,
  the control over the licenses is extremely
  powerful.
• It is traditional for public officers to receive
  payments for their work, or the absence thereof.
  
• Intermediation and facilitation fees are not
  considered as payoffs in society, though they are
  in theory frowned upon by the legislator.
• The guanxi system allows for non-cash payments.
  Goodwill creates debts.
• The brightest minds go to low-paying jobs in the
  public administration. Their lifestyle shows
  they made the right choice.
• Corruption money is now sought after by foreign
  countries promising citizenship or permanent
  residency against investment in job-creating
  projects.
• There is an estimated USD 3.7 trillion worth of
  wealth in China, which wealth is not under
  management.

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IPR Theft

• Stealing a book is an elegant offense tradition
  against the protection of IPR
• Some figures to fathom the depth of the problem
• 90-99 of all software is pirated in China
• Over 50 of all shampoo, razor blades, cell
  phones, cigarettes sold in China are fake.
• 50 of all branded bottled water is fake.
• 15 to 20 of the GDP of the country is
  constituted by the manufacturing and distribution
  of forged goods. Some of it is exported, some
  sold online or in physical stores dedicated to
  fake goods.
• There even are fake stores, such as McDonalds,
  IKEA, Starbucks, Dairy Queen, Apple Store.
• American companies, according to the USITC, have
  lost USD 48 bn. in licensing fees in 2010 because
  of Chinese IP infringement.

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Culture of Fraud

• Fraud? What fraud? Where there is no truth, there
  is no lie. Where the others are only worth what
  you can get of them, there is no fraud
• According to a survey conducted by the Shanghai
  Academy of Social Sciences in 2011, 90.2 of the
  respondents found that people who were honest
  and trustworthy put themselves at a
  disadvantage.
• In 2010, 1,563 false (fraudulent) lawsuits in the
  province of Jiangsu have led to an economic loss
  of USD 64 m. (RMB 390 m).
• Academic fraud, some figures
• Wuhan university estimated in 2009 that the
  Chinese industry of the production of fake
  research papers was worth USD 150 m. Its growth
  rate was estimated at 250 per year.
• In 2010, Nature noted that 1/3 of the scientist
  at the 6 top Chinese research institutions
  confessed to plagiarism, falsification and
  fabrication.
• Fraud investigation and mitigation has become an
  industry of its own.

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PERNOD-RICARD CASE STUDY
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The Story of Pernod Ricard in China
Key figures 1987 1989 1998 2.3million
Pernod-Ricard started a joint venture in China
with the locally made wine called Dragon
The company bought Australias best-selling wine
Jacobs Creek
Pernod-Ricard exited as being a foreign
company, they were not allowed to own the brand
at that time
Cases of cognac were sold in the country in 2011,
22 increase over 2013
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The Joint Venture with Dragon Seal
Pernod Ricard (PR) chose to enter the Chinese
market through a Joint Venture (JV) with the
Chinese leading wine-maker Dragon Seal (DS). PR
would bring the French wine-making technology,
cash investment and specialists to train the
JVs staff. DS would contribute the ownership of
the brand, some of the equipment, the factory and
the distribution networks.
The JV was established in the Beijing premises
of the Dragon Seal company, in 1987.
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One Bed, Two Dreams
PR trained the personnel of the JV, which started
producing an international-standard wine under
the old and recognized brand Dragon Seal,
formerly owned by the DS Company and contributed
to the JV. A few years later, in the early
nineties, PR executives heard reports that a very
low quality wine was sold under the brand Dragon
Seal. Acquiring a stock, the French team
realized that the wine was indeed of very low
quality, but bottled in identical bottles, with
identical labels and markings. The origin of the
bottles was traced to a factory adjacent to
theirs, and belonging to DS.
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Pernod Ricard in China
Confronted, DS executives recognized that they
were producing fake Dragon Seal wine, but refused
to stop the production, arguing that they owned
the trademark. By 1996, the brand having taken a
beating, and to save their business, the PR
executives proposed DS technical help
The idea would be to help DS produce a decent
wine thanks to French supervision, as long as it
was under a different brand. DS executives
refused to relinquish the illegal usage of the
brand, which they considered owning in spite of
having transferred it to the JV. After some legal
struggling, PR exited its JV with DS in 1998,
having created its own direct competitor. DS
hired French winemakers to oversee production.
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Pernod Ricard in China
PR learned from the Dragon Seal debacle and, the
Chinese market being impossible to pass, chose
another strategy allowing it to control most of
the chain importation of brands of its
portfolio. Demand for spirits such as wine, draft
Beer and especially for premium Cognac continues
to surge in China, despite growing consumption of
Scotch and Vodka.
Indeed, in recent decades the Chinas economic
boom created new Cognac consumers and the
mainland China market become indispensable for
Pernod-Ricard which responded to the demand with
its Martell cognac.
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Pernod Ricards return to the China market
Pernod Ricard now imports, markets and
distributes in the PRC brands it owns, without a
Joint Venture partner. The strategy has shifted
from leaving the marketing and distribution to a
Chinese partner to taking control, from selling
locally-made products to importing, and from
middle range to higher middle market.
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Today A wide range of products
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CADDIE CASE STUDY
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Caddie comes to China
To serve the fast-growing food retail industry of
China, Caddie, the world leader in the shopping
trolley industry established a factory in the
Shanghai municipality, to be headed by their
former importer, Frank Jiang. The factory would
produce the shopping trolleys locally and sell
them to the Chinese as well as Asian
markets Caddie Shanghai generated 25 of the
world turnover of Caddie Group in 2010
Caddie ran into financial trouble around 2010 and
was purchased and restructured by Altia Group, a
French PE fund in early 2012. The Chinese
operation went largely unmonitored for over a
year.
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Caddie, meet Frank Jiang

• SJ Grand was hired to conduct the pre-acquisition
  audit in late 2012 and pointed out severe
  accounting irregularities, as well as a potential
  fraud.
• After more investigation, the General Manager had
  established 17 companies to supply all the raw
  materials and machines as well as to purchase the
  finished products, diverting the profits of the
  company into his pockets.
• The new owner of Caddie tried to negotiate with
  the GM in spite of our recommendation to strike
  hard and fast.
• We also found HK bank accounts used to divert
  revenues of foreign sales.
• Confronted, the GM went to the next level and
  started moving the machines out of the premises,
  into a new factory established across the river
  in Jiangsu.
• This new factory is using the brand name Caddie.
• The account manager with the bank (HSBC), coming
  from the same village as the GM refused to
  cooperate. A collusion is suspected but not
  proven.
• The local police refused to intervene against the
  Chinese GM, in spite of assault against an
  auditor, and instead helped the local bodyguards
  remove evidence from the hands of the audit
  team.

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The End of the Affair with China

• When informed the officer of the local bureau of
  the Administration of Industry and Commerce with
  the MoC threatened the lawyer of Caddie France
  before our team for helping a foreign company
  against a Chinese entrepreneur. The new banker
  taking over the accounts, was also threatened by
  the police.
• The GM, effectively fired from Shanghai Caddie,
  refused to return the official documents allowing
  to effect changes to the companys registration,
  officially remaining the head of the company in
  spite of the shareholders decision.
• Caddie France sued the GM as well in March 2013
  for embezzling millions of Euros as well as theft
  and his new company, Jiangsu Caddie, for IP
  infringement.
• The Shanghai government, seized by the French
  Embassy, launched an investigation and an action,
  putting in charge of the file the officer of the
  AIC who had threatened the lawyer two weeks
  before.
• The damage has been estimated at several million
  Euros, but the exact sum is undisclosed. It is
  public, however, that the turnover of the company
  in 2012 was EUR 15M, and most of it had been
  diverted into other companies accounts.

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The Absence of Immediate Failure
The western world
The Chinese world

• Family links
• Power relations
• Weak judiciary
• Low trust

• Contract
• Authority relations
• Strong judiciary
• High-trust

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QA
Success in China Or the Absence of Failure

• Dr. Stephane J. Grand