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Taiwanese Enterprises in China

Failure – and How to Avoid It

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Failure – and How to Avoid It

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In China two companies go bankrupt every minute. How can Taiwanese companies avoid stepping on the landmines lurking in the Chinese market?

Failure – and How to Avoid It

By Jimmy Hsiung, Elaine Huang
From CommonWealth Magazine (vol. 442 )

In early March Chinese Premier Wen Jiabao declared before the annual meeting of the National People's Congress that China would focus on signing an Economic Cooperation Framework Agreement with Taiwan this year. As year one of closer cross-strait economic ties, 2010 will probably be a boon for Taiwanese investors in China. But on the other hand, they will also have to face ever fiercer competition and a greater risk of failure.

Wu Xiaobo, a prominent Chinese business writer, estimates that every minute two companies go under in China. In his bestselling book Great Failures, a history of Chinese entrepreneurship in the reform era, Wu analyzes the failures of more than a dozen well-known Chinese enterprises. He attributes the majority of these "Chinese-style failures" to political complications, problems with internal management or strategic deployment, and imbalances in the external environment.

But what characterizes a "Taiwanese-style" failure? After interviewing 20 Taiwanese entrepreneurs with investments in China, CommonWealth Magazine came to the conclusion that they all face five major risks of catastrophic failure, whether they be distributors, manufacturers, or well-known brands.

Landmine No. 1: Blind Expansion and Investment

Many successful companies have stepped on this landmine, and Taiwanese enterprises are no exception.

A case in point is Taiwan's home appliance maker Tsann Kuen Enterprise, which runs the 3C electronics retail chain.

In 2003 ambitious company founder and president Wu Tsann-kuen hired some 1,000 new employees for his planned expansion into China, where he intended to replicate his Taiwanese chain store success. Within half a year Tsann Kuen established 50 outlets, opening an average of two new stores per week. The pace of Tsann Kuen's expansion broke all records in Chinese business history, and the company soon became China's fourth largest electronics retailer.

But two years later the eye-catching bright yellow 3C shop signs had disappeared from China's streets, as the retail giant collapsed amid fierce competition. Tsann Kuen Enterprise general manager Yan Junjie, a driving force behind the 3C chain store expansion, acknowledged in an interview with CommonWealth Magazine in Zhangzhou, Jiangsu Province, that back then Tsann Kuen was "lost in space" – lost in its own massive nationwide expansion drive.

"We defeated ourselves. We weren't defeated by our competitors," says Yan, explaining that Tsann Kuen's most lethal mistake was that it expanded too quickly and that its outlets were too dispersed over a vast area, so that it proved impossible to create regional economies of scale. The chain store withdrew from six of its original eight business regions. Only the outlets in the eastern and southern regions remained open. Yet the retail chain kept racking up losses, threatening to bleed the Taiwanese mother company to death. So eventually Tsann Kuen had no choice but sell the chain to the biggest electronics retailer in the Shanghai area, in order to cut its losses to survive.

"The biggest market is probably also the biggest graveyard," says Yan gravely, now that the venture is dead and buried.

Landmine No. 2: Delayed Upgrading and Transformation

Business writer Wu observes that last year China became the world's largest car market, and its production and marketing patterns are already established. This indicates that the country's industrial revolution is complete. The traditional business model, solely tailored to manufacturing, is set to be thrown out, Wu believes. Instead, domestic demand, which has begun to thrive regionally, will play a prominent role in driving economic growth.

This means that Taiwanese companies which want to stay in the Chinese market for the long run need to upgrade and transform now to adjust to the changing business environment.

Micky M.C. Chen, chairman of the Management Institute in Taipei and an expert on China-invested Taiwanese companies, diagnoses an urgent need for transformation. Last fall Chen led a business delegation to the Pearl River Delta for a fact-finding mission. He found that the Taiwanese companies based there that have not yet transformed face pressure to do so within the coming three years or else "the market will eliminate some 60 percent of them."

Landmine No. 3: Wrong Attitude and Cooperation Style

Joint venture disputes are a problem that Taiwanese companies often stumble upon.

Seventeen years ago, Taiwanese confectionery maker Ganso invested in China for the first time. Using a Virgin Islands registered holding, Ganso teamed up with a state-owned enterprise and a local government-owned enterprise in Shanghai. However, this so-called cooperative relationship was actually a full joint venture, with shared investment, shared management and shared profits and losses.

Very quickly differences surfaced between the joint venture partners as to how the company should be run. A Taiwanese industry peer recalls that Ganso's Taiwanese management judged employees based on actual performance, while the Chinese side put a greater emphasis on interpersonal relations. The Taiwanese side wanted to expand the business, whereas the Chinese side wanted to see bonus payments. The differences escalated to the point where the Chinese side tried to seize full management control.

Seizing the opportunity when the Taiwanese executives went on home leave, the Chinese management froze their bank accounts, took away their seals and put the company under custodial management. Subsequently, Ganso sued for international arbitration. The company was able to win the lawsuit, because power sharing and control within the joint venture's board of directors had been defined very clearly. When Ganso entered the Chinese market for a second time later on, it opted for setting up a 100-percent company-owned subsidiary, rather than going for another joint venture.

Taiwanese companies that hope to take advantage of domestic demand often choose to found joint ventures with local companies or to buy them out in order to expand their businesses quickly. "This means you need to learn how to cooperate with others. You can't have everything your way," warns Jack Huang, partner-in-charge at the Taipei Office of international law firm Jones Day. Huang feels that Taiwanese businesspeople are not well suited for teamwork and collaborative projects, because of their strong entrepreneurial personalities.

More than two years ago a dispute between Taiwan's Shin Kong Group and the Beijing Hualian Group over management control of the upscale department store Shin Kong Place in Beijing made the headlines. During the incident Shin Kong Group minority shareholder Steven Wu, then manager of Shin Kong Place, was once even barred from leaving China. The Shin Kong Group and the Beijing Hualian Group, which is strongly backed by the municipal government, both had their own agendas when they decided to jointly run the department store. The relationship turned sour and open confrontation erupted over the distribution of profits. Eventually, the Chinese partner took full control of Shin Kong Group's assets in the joint venture.

Landmine No. 4: Unpredictable Policies and Land Expropriation

"Right now, the hottest topic among Taiwanese investors is land expropriation," reveals Steve Fan, CEO of business consultancy Greatman Knowledge Management Group. Fan frequently travels to China to advise Taiwanese businesses there. He notes that across China local governments are pressed to find land for urban and infrastructure development. In many cases this means rolling back older investor-friendly schemes. Often areas previously assigned to foreign investors are rezoned for building roads and bridges. In Kunshan, Zhejiang Province, which boasts a massive Taiwanese presence, a number of Taiwanese factories have already been forced to move to new locations.

Professor Yang Sheng-yung has tutored many Taiwanese entrepreneurs as director of the EMBA Program at National Chung Hsing University. Yang believes that in the coming years companies with investments in China need to earnestly consider how to deal with the risk of land expropriation.

The Straits Exchange Foundation (SEF), Taiwan's semiofficial agency for contacts with China, once published a case of land expropriation involving several Taiwanese companies. In 1999 seven companies had built factories in "Hongyu Economic City," an industrial district just a six-minute drive away from Shanghai's Hongqiao Airport. A company run by the local township government had helped them apply for the necessary documents such as property permits and business licenses.

Seven years later the government decided to expand Hongqiao Airport, ordering that the industrial district be vacated within three months.

The seven companies jointly asked SEF for help, but the Chinese government did not respond. Helplessly, the Taiwanese companies prepared to relocate and accept compensation, even though the amount was not enough to cover their losses resulting from the forced withdrawal. But right then the local government issued another document which claimed that the property permits of the seven companies were all forged and that as a result their factories were illegal structures. In the end, the compensation shrank from an original sum of nearly 1 million yuan to just 400,000 yuan.

Hector Yeh, chairman of Shanghai-based Longfeng Foods, notes that Taiwanese investors frequently encounter land problems in China. And he predicts that the problem will get worse as China's growing urbanization boosts demand for land and the government pushes the conventional manufacturing industries out of the big cities as part of its drive for industrial upgrading in the Pearl River Delta and other coastal areas.

Taiwanese entrepreneurs, used to the rule of law at home, find it difficult to accept the idea that even government-approved measures and policies can be rolled back at any time in China. Therefore, Yeh advises his peers to enlist the help of professional legal experts before delving into a China venture. "Spend the money that needs to be spent on lawyer's fees," Yeh advises.

Landmine No. 5: Poor Judgment about Policy Implications

Feng-jyh Lin, executive director of the EMBA Program of the School of Management Development at Feng Chia University, thinks that Taiwanese companies in China are under pressure to transform. With the rise of homegrown Chinese enterprises and government measures for boosting domestic demand, Taiwanese companies will have to focus on coping with a changing external environment rather than concentrating on internal management and control.

Aside from land expropriation, Taiwanese investors need to pay attention to other external factors such as government policies at various different levels says Lin, urging caution.

Wu's research shows that the rise and fall of Chinese companies is highly related to the government policies being promoted at the time. Similarly, Taiwanese businesses must not underestimate the impact of every single new policy, Wu warns.

Tainan native Chen Shen-Tien, chairman of Shanghai-based real estate developer Metropolitan Group, urges other Taiwanese businesses to do their homework. "When doing business in China, you should hone your ability to ponder the meaning and impact of each new policy whenever one comes out," says Chen, who has been active in China for more than a decade.

For instance, China's Labor Contract Law, enacted two years ago, has left a deep mark on Taiwanese businesspeople. It was the biggest policy change in recent years and dealt a major blow to many companies. In the Taiwanese business community, it is widely believed that this new policy, which increased average labor costs by 30 percent, has triggered the biggest wave of bankruptcies among Taiwanese businesses in China to date.

When asked about the topic, a Taiwanese entrepreneur in Shenzhen reacts with righteous indignation, saying, "If one day things don't go smoothly at work, the employee can immediately join hands with a whole bunch of lawyers offering free advice in the streets on how to 'blackmail' the boss and get money from him." He rants on that in the whole world there is no other law of such lethal force, in particular because it may be retroactively applied to cases that happened up to ten years earlier.

In China, every new policy is an opportunity, but also a crisis. "If you want to make money in China, you need to face every policy with extreme caution," notes Otto Tu, partner in the Taiwan Office of accounting firm Deloitte. "Everyone disregards this interfering hand in the market, and that's why people are often overly optimistic about the Chinese economy," Tu explains.

More than two decades of experience, a million Taiwanese businessmen, and the loss of hundreds of billions of Taiwan dollars in business failures – these are the price that Taiwan has paid for its hard-won lessons in China, and they have revealed five major landmines no businessman can afford to ignore. Before even thinking about reaping the fruits of China's economic rise, it is vital to study these valuable examples of business failure, to lay the foundations for future success.

Translated from the Chinese by Susanne Ganz

Keywords:

好友人數