The High Failure Rate of International Joint Ventures - Coursework Example

From a business perspective, international joint ventures have been used as a method to attract foreign business and there have been a variety of entry mode choices in China available since the implementation of the first “open door” policy of 1979, with the continuous momentum of foreign direct investment (FDI) (Ping, 2001). Interestingly, by the end of May 2000, the contractual FDI in China had totalled $623 billion in 349,500 investment ventures (Ping, 2001). Moreover, the influx of FDI fuelled rapid economic growth, creating jobs and technological change to the country. The figures in 2000 coupled with China’s desire to close the economic gap with other developing nations led to the Government driven “Western Development Strategy” as part of the tenth fie year plan (2001-2005) covering six provinces. Notwithstanding the economic policies favouring commerce and FDI; the OECD in particular have regular reported on challenges facing FDI in China’s regional development. The focus of this paper is to critically evaluate company strategy in international joint ventures to minimise risk of failure. It is submitted at the outset that international ventures in China provide a prime example of the risks associated with international joint ventures, which will be considered contextually with practical examples. Examples of other territories shall also be considered. Whilst foreign investors are ultimately autonomous on the mode of entry into the Chinese Market from equity joint ventures (EJV), wholly foreign owned enterprises (WFOE) and contractual or cooperative joint ventures (including licensing and technology transfer agreements) joint exploration, and co-operative development; it has been submitted that the reality of entry into the market has been challenging in practice, particularly with international joint ventures (Ping, 2001). Since, the late 1980s the predominant mode has been EJVS and WFOES (Ping, 2001). Between 1993 and 1997, the actual use of WFOEs in China grew at an annual rate of more than 25 per cent while EJVs grew by only 6 per cent (Rugman & Hodgetts, 2003). Various problems have been associated with the Chinese EJVs, namely joint ownership, which often involves management by at least two parent firms (Grant, 2007). However, with shared management, partners can disagree on just about every aspect and thereby paralyse decision making (Child et al, 2005). Indeed, it is evident with Sino-foreign decision making and business practices, whereby social and cultural differences contribute to the intrinsic flaw in the contemporary Chinese markets. Indeed Ping refers to Vanhonacker’s reports that Lucent Technologies saw its share of the market for optical fibre transmission equipment in China decline from 70 to 30 per cent in 2000 (Ping, 2001). Ping argues that the key reason is that Lucent’s business relied on EJVs in China and because of shared operational control management, it had to negotiate technological change in a product with a local partner. Therefore if a local partner proves uncooperative, such internal problems cannot be addressed quickly enough to ensure minimum damage to market entry and market position in a foreign territory (Ping, 2001). Therefore it is vital for businesses considering international joint ventures to consider developing strategic alliances (Glaister & Buckley, 1996). Glaister and Buckley argue that forming alliances is vital to international joint venture risk minimisation and define strategic alliances (Glaister & Buckley, 1996). They can be informal, such as a pooling of information or contractual. They further argue that it is vital to ensure synchronisation between corporate strategy and alliance purpose in any given market (Glaister & Buckley, 1996). Essentially, Glaister and Buckley define successful strategic alliances as moves to pursue corporate strategies, selecting alliance purposes to align with specific corporate strategies in order to increase the performance of partnering firms by facilitating successful strategy implementation (Glaister & Buckley, 1996). Additionally, Glaister and Buckley posit that businesses operating in competitive markets and emerging industries faced with instability (Glaister & Buckley, 1996). To this end, they provide the example that firms operating in intense competition, market saturation and new emerging industries tend to use franchising, strategic alliance, external corporate venturing, customer relationship management and subcontracting to enhance their competitive position (Glaister & Buckley, 1996). A prime example of this is Tesco’s customer relationship management strategy via its international joint venture with Accenture in Korea (www.accenture.com/global/services/By_Industry/Retail/Client_Successes). Accenture provided the CRM support technology for the retail joint venture between Samsung and Tesco to break into Korea’s competitive retail market, by creating a Homeplus discount store chain, which has now proliferated to 30 locations across the capital of Seoul (www.accenture.com/global/services/By_Industry/Retail/Client_Successes) Accenture highlight that there were significant existing players and barriers in the Korean market place with intense competition across all sectors. Other barriers facing the partners were a limited number of potential store locations and a high cost of site acquisition(www.accenture.com/global/services/By_Industry/Retail/Client_Successes). Korean retailers also face the difficulties of high cost supply chains and high store maintenance costs, and therefore Tesco had to implement a retail concept which would fill a niche marketplace and deliver to the Samsung joint venture the growth it needed to achieve goals geared towards the Korean market place. To this end, it engaged Accenture for its CRM best practice and capability in Korean and global retail markets, which has proven successful in the growth of the Homeplus stores in Korea (www.accenture.com/global/services/By_Industry/Retail/Client_Successes) . Accenture highlight key factors in the success of the Korean venture being linked to effective CRM. Firstly, the CRM strategy operated in four distinct phases, firstly by undertaking extensive research to gain customer insight (www.accenture.com/global/services/By_Industry/Retail/Client_Successes). Secondly, after confirming Samsung and Tesco’s strategy and objectives in the marketplace, Accenture profiled potential customer segments to define the right market. In Phase 2, Accenture undertook a customer segmentation exercise by assessing the value of various segments based on their size, spending patterns and growth potential. (www.accenture.com/global/services/By_Industry/Retail/Client_Successes) Accenture then identified the most attractive of these target segments and developed the value proposition based on this profile, delivering to their preferred products, pricing, brands and service levels (www.accenture.com/global/services/By_Industry/Retail/Client_Successes) Additionally, Glaister and Buckley point to the fact that strategic alliance in the form of equity and non-equity partnerships are popular means of product or service innovation for firms of combining technology in new emerging industries (Glaister & Buckley, 1996). Under these conditions, defensive strategies in the form of joint ventures actually form part of a successful strategic alliance in terms of equity sharing (Glaister & Buckley, 1996). There have been numerous studies on mission strategy connected to joint ventures as undertaken by Glaister & Buckley, who argue that sharing costs with partners is a prime motivator for strategic alliances in the form of joint ventures (Glaister & Buckley, 1996). For example, Glaister and Buckley’s study demonstrated that strategic alliance is an attractive mechanism for hedging risk because neither partner bears full risk and cost of the alliance (Glaister & Buckley, 1996). They further argue that strategic alliance decreases time to market and access to international market at a greater pace of time. Directly linked to this is effective management at board level and Child and Yan (1999) argue that studies concerning IJV board composition indicate that the percentage of equity ownership of the partners of the IJV is reflected in the appointment of directors and therefore the parent’s equity share directly affects representation on the IJV board in terms of the number of IJV directors (Child & Yan, 1999). On this basis, they further argue that one method to reduce risk is the power of the boards to select senior managers (Child & Yan, 1999). Understanding local infrastructure is vital and the involvement of local partners often exacerbates the effect of China’s narrow business licences and prohibits JVs from consolidating distribution of their various products (Ping, 2001). Moreover, an EJV in China cannot sell anything other than its own products; a company with several EJVs therefore often has to set up multiple marketing and distribution systems to serve the same customers, making economies of scale, overheads and scope difficult to achieve and effectively operates as a disincentive to operate in China. Indeed, Ping argues that Sino-foreign EJVs are essentially characterised by differences in a partner’s strategy objectives (Ping, 2001), which is evidenced by the lack of success in Chinese EJVs. This further undermines part of the five year plan as the primary motives for the Chinese entering into an EJV are to obtain technology, capital, management expertise, and short-term success (Ping, 2001). The aim of foreign investors is to gain market access to China with long term goals and growth, therefore the competing interests of both parties is creates a tension from the outset. On this basis, Li and Gao (2008) follow Das and Teng’s approach of focusing on the factors underpinning stability in strategic alliances (Li & Gao, 2008). To this end Li and Gao argue that selecting a partner is critical and consideration should be given to resources, reputation and prior success in the market. Secondly, Li and Gao argue that governance and division of responsibilities should be determined to create stability within the alliance (Li & Gao, 2008). Additionally, Li and Gao argue that a lack of mutual commitment in an alliance can be destabilising as commitment is key to alliance development and sustaining position in the marketplace (Li and Gao, 2008). Equity joint ventures are equity sharing arrangements between two partners or a consortium of three or more partners, whereby the risk of joint venture entity, profits and losses are shared in direct correlation to their equity ownership (Charles, 2005). Equity joint ventures are further considered to be a relatively risky entry mode to the Chinese market as they are inherently dependent on the success of the relationship with the managers from another company in a local territory (Luo, 2000). As such, Li and Gao highlight the need for collaboration and relationship management (Li and Gao, 2008). Conversely, EJVs may reduce the risk because local Chinese partners may help foreign companies understand how to be more successful in the Chinese Business environment and understand the nuances and differences in local markets (Boilon & Michelon, 2000). Alternatively, wholly owned entry modes include the development of subsidiaries either from scratch using a Greenfield approach, or through the acquisition of existing Chinese companies (Charles, 2005). Moreover, it has been argued that since the wholly owned strategy mode of entry has been legally acknowledged by the government in China, there is been a sharp proliferation of FDI (Charles, 2005). Export strategies are generally perceived as being a less risky method of doing business in China, which is considered to be unstable and difficult. There are two forms of export strategies as part of entry mode strategy. Firstly, home based sales persons to acquire export contracts from China who work as representatives of the foreign companies and build up relations with the Chinese (Grant, 2007). The primary advantage is the low risk as no capital investment is required at this point, therefore it enables the market to be tested and early pullout with minimum financial consequence. However, the downside of this export strategy is that foreign exporters are often unwilling to stay behind the contract and there is no room for building up a relationship with the Chinese and as the Chinese company has a permanent presence in China, it is arguably better to utilise a Chinese distributor (Rugman & Hodgetts, 2003) With regard to contractual joint ventures, in China, in addition to the problems of EJVs mentioned above, whilst termed as “joint ventures” these are more akin to licensing agreements as foreign companies will not take up ownership in ventures with the Chinese (Grant, 2007). Licensing agreements and technology transfers are common examples and often with the payment of a one off license fee and royalty payment structures. Alternatively, the advantage of the contractual joint venture is the low risk to foreign companies (Grant, 2007). Most foreign companies involved in these ventures are likely to recover the cost from the up front fee. There is however opposition from the Chinese and foreign companies to this approach as the Chinese prefer to work with foreign companies who have taken some ownership in the venture to ensure national benefit, therefore this clearly impacts co-operation and royalty payments under a contractual joint venture (Grant, 2007). Additionally, many foreign companies believe that taking minority interest in a joint venture with Chinese is disadvantageous due to the clout of major shareholders, which again sets up this medium as potentially obstructive to effective FDI from the outset (Charles, 2005). This is further compounded by concerns regarding intellectual property protection as there is little protection for foreign technology in the Chinese market (Luo, 2000). The concern regarding technology control and the imposition of controls over is a valid concern for foreign companies because this practice could eventually result in new international competition for the foreign companies who were putting up technologies in this pool (Rugman & Hodgetts, 2003). As mentioned above, EJVs are encouraged by the Chinese government as these provide great benefits to the Chinese economy and standard of living for Chinese (Luo, 2000). Therefore notwithstanding the inherent power struggle issues raised by this mode of entry, the Chinese government offers the most incentives for this particular mode of entry such as land, factories and tax concessions (Luo, 2000). This benefited the Chinese with higher incomes, long term technologies and strategies that have learned western management skills that can benefit China in the long term (Charles, 2005). However, the main concern from a foreign company’s perspective is finding suitable partners in China and most available partner organisations in China are state owned companies, which imports the inherent problems of the political and legal framework directly into an FDI initiative (Pei, 2008). These Chinese parent companies, mainly state owned companies and government departments can exercise controls on the joint venture and bring management philosophy into the business, which is creates a breeding ground for conflict (Pei, 2008). Accordingly, trust is vital in international joint ventures and Das and Teng argue that “trust and control are inextricably interlinked with risk in strategic alliances. Hence to understand how partner firms can effectively reduce and manage this risk, need to examine interrelationships between trust, control and risk” (Das & Teng, 2001). They further argue that effective risk minimisation is comprised of certain key dimensions such as commercial risk and trust and that trust and control are linked with the risk in alliances (Das & Teng, 2001). Therefore, they argue that ultimately, risk management is vital and in China for example relational risk is a problem due to the “probability and consequence of not having satisfactory cooperation” (Das and Teng, 2001). Additionally, foreign company concern is the lack of control on investment in China and Chinese have in certain cases ceded control to foreign companies even when they had majority ownership of a venture (Pei, 2008). However, such moves are subjective and inconsistent in practice and are motivated by economic goals and not by any establishment of a consistent framework within which to enter the market (Pei, 2008). On the other hand, whilst foreign companies prefer to use wholly owned subsidiaries, the common problems underlying all of the possible entry modes into the Chinese market are cultural differences, foreign exchange, quality of local employees, training needs of the Chinese, the high cost of doing business in China and intellectual property (Luo, 2000). Therefore, combining effective corporate strategy and understanding the local infrastructure is vital and a prime example is the success of KFC in China. KFC firstly opened in 1987 and now has 2,000 outlets in China. Cho argues that “the improbable success of KFC China can be attributed to a few key ingredients: context, people, strategy and execution” (Cho, 2009 at www.knowledge.insead.edu accessed 6/6/09). Additionally, in Liu’s “KFC in China: Secret Recipe for Success” (2008), he argues that in terms of international joint ventures, “strategy is context-dependent; a strategy that works well in a stable and mature market economy would most likely not work well in China, given the diversity of its people, geography, the heritage of a rich and complex culture, and a rapidly and continuously changing business, environment since China’s economic reforms commenced in 1978” (Liu, 2008). For example, Liu refers to the fact that KFC was first introduced to Hong Kong in 1973 and expanded to 11 restaurants by 1974, however by misunderstanding the local market, KFC failed to develop a suitable business model and by 1975 all restaurants were forced to close (Liu, 2008). This is in stark contrast to KFC’s success in China since 1986, where they re-entered the market by franchising to a company called Birdland. Additionally, KFC selected local partners with government connections and “leveraged tangible local resources” as part of corporate strategy (Liu, 2008). Indeed, Liu states that “in order to be successful, especially for foreign companies or non-local companies, a deep understanding and a broad understanding of that market context is critical to success. To the extent that understanding is intuitive… meaning that you don’t have to do the market research, you don’t have to have multiple meetings to come to the best solution to a problem or to point to a future strategic direction” (Liu, 2008). In conclusion, the above analysis highlights that from China’s perspective in particular, notwithstanding the economic drive towards globalisation and proliferation of FDI, many barriers operate to effective FDI in China, which is inherently rooted in the entrenched political framework wanting to retain tight controls, which is intrinsically paradoxical with a capitalist market (Pei, 2008). As such, this effectively narrows the wide range of entry modes into the Chinese market with the selection of an adequate and worthwhile entry strategy proving a difficult task. Indeed, aside from the Chinese business and political environment, some foreign companies have expressly referred to the local Chinese business environment as “hostile” to foreign enterprises (Grant, 2007). This is further compounded by the instability of the Chinese infrastructure evidenced by recurrent policy alterations and lack of effective enforcement provisions for the protection of technology transfer. To this end, it is submitted that ultimately any entry strategy for business in China requires a subjective risk assessment from the business perspective going forward. Additionally, the synchronisation of a corporate strategy that understands the local market as well as local strategic alliances is vital to the success of international joint ventures. BIBLIOGRAPHY Aziz, (2001). 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