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March 2011

Capital Agenda Insights

Investing in China: mapping JV integration to deliver value Boardroom issues

• Do you plan to invest in China, but are concerned about choosing the right Chinese partner?

• How do you deal with differences in

objectives and aspirations between you and your Chinese partner?

• Are you concerned about maintaining the Chinese authenticity of the partnership when you are either a majority or minority owner?

• Do you face the challenge of choosing the right team to work in China and selecting the best candidates for key officer positions?

• How do you maintain alignment

with the local partner on integration priorities?

• How do you ensure that the partnership creates the value that was anticipated?

The dynamism of the Chinese market remains a compelling story for western companies, as many continue to vie for stakes in Chinese companies. Yet, red-hot valuations and new regulatory regimes are contributing to a rapid change in the investment climate, and foreign investors need to be agile enough to consider different approaches and adapt their strategic options in China accordingly. Ten years ago, there were numerous opportunities for multinationals seeking to acquire Chinese companies, although at that time, the strategic intent for most investments was access to low-cost manufacturing. Many Chinese companies in need of western technology and capital were willing to enter into partnerships in which the western buyer would have a controlling stake in the business. However, the investment climate has changed rapidly over the past few years.

At the same time, new government regulations, including anti-monopoly laws and legislation on government procurement, are making deals more challenging. This is in part because the new regulatory climate has increased the bargaining power of local players, forcing potential amendments to the terms and scope of acquisitions of Chinese assets and reducing the benefits for multi-national corporations (MNCs) looking to acquire local companies with government contracts.

Rising valuations have been one of the key factors helping to transform the investment environment in China, as the country has become one of the most desirable destinations for investors in emerging BRIC markets. Chinese businesses are more cash-rich and have evolved rapidly over the past decade. Driven by strong economic growth, many listed Chinese companies have become increasingly successful, making them more expensive for potential foreign buyers.

Overall, Chinese companies and policy makers are becoming more savvy when dealing with western investors than they were 10 years ago. Many, if not all, are asking, “Why do we need you in our own market?”

For all of these reasons, multinationals need to rethink their investment approaches in China, whether they are new entrants or dab hands at the market. Investing in minority stakes or forming joint ventures (JVs) is not uncommon these days, especially in sectors like consumer products, pharmaceuticals and retail. Such new approaches have implications not only for the formation of investors’ inorganic growth strategies in China — namely, how the target companies will fit into their existing business — but also for their subsequent approach to integration and decisions on how best to extract value from these transactions.

Planning for value: getting the initial steps right The average transaction life cycle is 12 to 24 months in China, compared to around three to six months in mature markets. These protracted timetables for concluding deals are clearly taking a toll; in 2007, just 3 out of every 10 Chinese transactions were successfully completed, and those numbers have changed little in the intervening three years. Given this longer transaction life cycle, investors need to remain patient and manage their headquarters’ expectations, while at the same setting the right expectations during initial JV discussions. We believe that foreign companies need to get several crucial steps right during the pre-deal planning stage in order to set the transaction on a reasonable path to success.


The portfolio investment strategy is gaining popularity as many foreign buyers focus on a series of smaller acquisitions, partnerships or JVs instead of one transformative deal. One foreign company that has adapted to conditions on the ground in China while at the same time pursuing a long-term investment strategy is a Belgium-based global brewer, which took equity stakes ranging from 20% to 71% in a series of Chinese companies over a period of 20 years.

Determining the strategic intent of the JV and objectives from both sides Foreign and Chinese companies come to the table with very different aspirations and perspectives on one another. There is an old Chinese saying that aptly describes the challenges of a partnership between a Chinese company and a foreign company: “same bed, different dreams.” This highlights the often large divergence in objectives between foreign and local partners. In order to set the initial discussion on the right path, each side needs to maintain a clear view of its own objectives for the partnership and develop a realistic assessment of the likely underlying objectives of its partner. In a rapidly changing market like China’s, partners’ objectives are likely to change as well. Therefore, it is also important for both partners to think strategically about how to preempt or influence the other when one party changes its objectives for the JV. Thinking creatively about reshaping the JV and (or) developing robust contingency plans will be important even at this early stage.

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In 1996, a leading Chinese fast moving consumer goods (FMCG) brand formed a JV company with a France-headquartered global food and beverage company. The Chinese company owned 49% of the JV with the Western company owning 25.5%. Two years later, the Western JV partner became the majority shareholder after buying out the interest of another investment partner, taking control of the JV and its trademark. However, this change in ownership was not recognized by the Chinese JV partner, which continued to maintain control of the JV’s day-to-day operations. The Chinese JV partner claimed that it had not transferred ownership of the trademark to the JV, just its exclusive license. By 2000, the Chinese JV partner had established other companies to sell the same products as the JV and used the Chinese trademark, setting off a series of arbitration and lawsuits on the part of both parties.

Appointing key officers While minority shareholders’ influence over the board is likely to be limited, the ability to exercise management control of operations is important. If the minority partner is able to name the chief financial officer, they are likely to end up with a candidate who is more attuned to Western styles of running a company and better able to fulfill compliance measures, both during the integration phase and over the longer term. The CFO controls all financial matters, from setting the annual budget (especially important for companies with high capital spend), to finance and management reporting and internal controls.

A successful CFO will hold broader responsibility for the operational side of the business and will also have compliance officers reporting to him or her. Another key position that most foreign investors plan for is in manufacturing operations or quality control. While local employees often have valuable know-how in this area, Western leading practices are frequently needed to bring manufacturing and quality control to the next level, especially when the JV is seeking to export its products to overseas markets. By contrast, sales and distribution, which tend to be more localized, are better left in the hands of the local partner.

Having won the battle to have the right to elect a CFO for the JV, many foreign companies then face the challenge of selecting the right candidate. In a recently completed transaction, a US industrial products company elected an expat CFO for the JV. A highly regarded veteran with several years of operating experience in China, the CFO-elect had the dilemma of deciding whether to relocate to a third-tier city where the JV is headquartered or attempt to run the business from Shanghai. In addition, due to a lack of Chinese-language skills, the CFO-elect cannot effectively communicate with the local finance team without an interpreter, making it harder for him to forge a strong relationship with the local teams.

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Protecting intellectual property (IP) and other rights Foreign investors need to ensure adequate measures are put in place from Day One to protect IP rights, whether for the technology or for the management processes and know-how that Western partners are introducing. Such measures may seem unusual, but Chinese JVs have a defined lifespan; therefore, it is incumbent upon the Western partners to ensure that their IP is not merely “transferred” to the Chinese partner’s hands, but instead reflects some of the value that the Western partner contributes to the venture.

Mapping out a clear path for the future Finally, foreign companies will also need to anticipate the end game for the JV. Do they see an eventual increase in their equity stakes or a buy-out of the Chinese partner that will allow them to become the majority owner of the JV? Do they anticipate listing the JV on the public market? Alternatively, do they expect to form similar JVs in other product categories or geographies?


In a recently completed JV in a metals-processing business, the Western party’s contribution included their “know-how” around efficient processing systems deemed leading in their industry. In forming the JV, the Western partner insisted that a portion of the final processing be completed by one of their wholly owned facilities, thereby allowing them to ensure that not all aspects of their highly valued systems were simply given to the Chinese-controlled JV. Mapping out the potential evolution of the JV they are getting into is as important as, if not more important than, setting the right set of objectives at the onset of partnership discussions. While it will be extremely difficult to anticipate potential end-game scenarios, foreign companies investing in China are encouraged to plan rigorously for such outcomes and for their potential triggers. This has implications during JV negotiations, whether they involve the valuation of the business at a time of sale or non-compete clauses. Developing and rigorously testing a set of key assumptions will help to shape decision-making and trade-offs during JV negotiations.

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Focusing on JV value creation Both parties to a negotiation are likely to agree on value creation as a common business objective for any JV. Chinese companies look for foreign partners for many reasons: to achieve a global profile in a scalable way and gain access to massive export markets; to develop branding expertise and gain access to new technologies or to learn new ways of overcoming quality issues that can restrict their ability to export. Foreign companies, meanwhile, must prove to their Chinese shareholders that they are active minority investors; they need to ensure effective transfer of knowledge and business practices to their local partners. The JV will create value by leveraging the foreign partner’s manufacturing, technology and marketing capabilities and the local partner’s local market and regulatory knowledge, market access and distribution capabilities. Successful value creation requires both sides to agree on a set of integration priorities and rapidly translate these into specific initiatives within each functional area. This process will also allow each functional area to deeply understand the capabilities of the other and work out feasible plans through assignment

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of responsibilities. If done correctly, this will also give the foreign party a greater degree of management control and influence in the specific areas of focus. However, our experience tells us that this is often not a straightforward process.

Watching your language Let’s start with what to call the integration project. In Chinese, an integration plan is “ ” (zheng he ji hua), which colloquially means “a plan to fix things up.” While Chinese senior management will understand the goal of the project, line managers, who are often proud of the history and achievements of the enterprise, frequently react negatively or defensively. China-savvy foreign companies, therefore, will refer to the integration project as “ ” (xiao neng ti gao ji hua), which means “performance improvement plan.” This is likely to go down well throughout the organization as the central government has often called upon all enterprises in China, be they state-owned or privately owned, to continue the drive toward performance improvement in their respective sectors.


Getting behind a common plan Next comes the challenge of agreeing what integration priorities should be. Both parties often have different views as to what is a value-creation priority and what is not. Even when both sides agree on priorities at the onset, these may change very quickly as each side absorbs the realities of the partnership and the changes that are necessary to make it successful. Focus is critical, given the fast-changing competitive and regulatory environment in China. MNCs often focus on the control elements in their integration plans. For example: checking and ensuring existing suppliers and customers have properly documented contracts, there is compliance with the relevant regulatory and health and safety executive (HSE) requirements, checking and ensuring employees and compensation are managed through a structured appraisal system, cash management has the proper internal controls, among others.

— even if gaps still exist between quality requirements and implementation of the Customer Relationship Management (CRM) system. Agreement on integration priorities for both sides will require them to work out their short-term and longer-term value creation priorities, which unfortunately may mean another round of negotiations. Setting realistic expectations about what can be achieved in the initial period is important and will require a fine balancing act between securing control and addressing longer-term value creation needs. Another problem is that foreign partners often make the first assessment of what skills to transfer to the Chinese JV on the basis of a Western view of what is needed in China. This usually is driven by a multinational’s experience in its home market and does not necessarily take account of the Chinese context. Left unchallenged, these sorts of assumptions can potentially lead to a poor use of resources and wasted market opportunities.

Chinese managers, by contrast, sometimes do not see these control priorities as so important; after all, they have achieved success without “fixing” these areas. They are most eager to see their products exported overseas and their plants upgraded so they can start producing the foreign partner’s products, increase utilization and allow their sales force to scale up quickly and sell more products in the domestic market


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In a recently completed JV in Southern China, the European headquarters of the foreign partner quickly assembled a “first strike” multifunctional team armed with a comprehensive integration plan. The essence of the plan was risk mitigation, from ensuring the licensing and HSE compliance of the Chinese factory, to putting in place a set of rigorous controls and budgeting in the partner’s finance department. The integration kickoff in China did not go well. There was strong resistance from local management, who were expecting the roll-out of plans to upgrade their facilities, prepare products for export and shift some production capacity to China, hence increasing the Chinese partner’s factory’s utilization. Both sides ultimately learned the importance of involving both sides in decisionmaking about integration priorities. Reaching a common understanding of what are priorities and what are not during integration is the first step of a successful partnership.

Choosing the right team to back you up Finally, both sides will face the challenge of implementing value-creation initiatives. Foreign companies face the bigger challenge of selecting a group that can parachute into the newly formed JV with the appropriate mix of technical, business and China-savvy managers to accelerate knowledge transfer and operational improvements. Without proper preparation and incentives, members of this team often see their current assignment as their “day job� and can lack sufficient focus to work with the JV partner. On the Chinese side, there may be a limited number of managers with the requisite international experience to work effectively with the incoming partner. Such a mismatch of expectations and capabilities often cause the first challenges in the JV relationship.

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Conclusion The deal environment in China continues to be a dynamic one with strong appeal to foreign investors, but international companies need to recognize the extent to which terms have shifted and adapt their strategies to take account of these new realities. Starting and managing JVs will increasingly become part of any multinational’s winning China strategy going forward. However, this continues to be a complex, uncertain and at times, emotional process. Preparation is more critical than ever to the success of a JV or similar alliance, and investors need to understand the steps that are key to this process, including having a clear vision of the overall strategy behind the deal and what both sides view as the objectives of the partnership, choosing the executives who will have responsibility over major financial operations and envisioning the ultimate endgame for the alliance. Success requires continued engagement, pragmatism, and focus. Due to the differences in culture, experience and management practices, each side needs to pay systematic and explicit attention to clarity of communication and trust-building between the partners. Be patient!


Partnerships that excel in the Chinese marketplace are those that relentlessly focus on market opportunities, remain alert to the evolving objectives of the partnership and focus post-JV-formation efforts on the opportunities that will create the highest value. Those whose initial partnerships fail to develop according to plan also have the potential to become winners, so long as they apply the experience they have gained to new opportunities in China, either on their own or with new and (or) existing partners. Whatever the route, the Chinese market continues to offer significant opportunities and rewards to those that take a long-term view, make the effort and persevere to the end.

Yew-Poh Mak Operational Transaction Services — Asia-Pacific T: +86 21 2228 3002 E:

About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 141,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit About Ernst & Young’s Transaction Advisory Services How organizations manage their capital agenda today will define their competitive position tomorrow. We work with our clients to help them make better and more informed decisions about how they strategically manage capital and transactions in a changing world. Whether you’re preserving, optimizing, raising or investing capital, Ernst & Young’s Transaction Advisory Services bring together a unique combination of skills, insight and experience to deliver tailored advice attuned to your needs — helping you drive competitive advantage and increased shareholder returns through improved decision making across all aspects of your capital agenda. © 2011 EYGM Limited. All Rights Reserved. EYG no. DE0228 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.


Capital Agenda Insights

Capital Agenda Insights - Investing in China  

Red-hot valuations and new regulatory regimes are contributing to rapid changes in the investment climate in China. How are foreign investor...