SABICs International Joint Venture Project with a Chinese Enterprise - Essay Example

International Business - SABIC’s International Joint Venture Project with a Chinese Enterprise - Date Total Number of Words: 4,007 Executive Summary In order to increase the speed of technological change, improve economies of scale, and increase competitiveness in the global markets; Gulf Cooperation Council (GCC) based chemical companies like SABIC has been aggressively entering into joint venture agreement with companies based in another country. In general, expanding the business of SABIC in China is a promising business opportunity because of the ready market and cheap labour. However, the strong control of the Chinese government may serve as a hindrance in terms of maximizing the potential profit and business growth of SABIC in China. Pushing the implementation of SABIC’s international joint venture plan in China opens a lot of business opportunities by enabling SABIC penetrate the market of China within the shortest possible time. Likewise, this strategy could benefit SABIC through economies of scale, cheaply expand the business internationally, increase profit by diversifying its risk management portfolio, improve SABIC’s market power and competitive advantage against its global competitors. Despite the business opportunities behind the international joint venture project, the strong government control in China on top of the market saturation and the differences in the way Chinese people do business could lead to a long-term business failure. To improve SABIC’s internationalization strategies, the company should carefully analyze the current social, political and economic situation in China aside from selecting the right business partner, implementing a proper cross-cultural management, and selecting the best options for international joint ventures. Table of Contents Executive Summary ……………………………………………………………… 2 Table of Contents ………………………….……………………………………… 3 I. Introduction ……………………………………………………………….. 4 II. Business Environment in China ………………………………………... 5 a. Strong Political Influences ………………………………………. 7 a.1 REACH Style Regulation for New Chemical Substances …………………………….. 7 a.2 The China State Secret Law ……………………… 7 a.3 Other Significant Political Factors ……………….. 8 b. Economic Factors ………………………………………………. 8 c. Social Factors ……………………………….…………………… 9 d. Technological Factors ………………………………………….. 10 III. Potential Business Opportunities and Threats behind the Joint Venture Plan with a Chinese Enterprise ……………………….. 10 a. Business Opportunities …………………………………………. 10 b. Business Threats ………………………………………………… 11 IV. Recommended Internationalization Strategies ………………………. 13 a. Analyzing the Current Social, Political and Economic Situation in China …………………………………… 13 b. Selecting the Right Business Partner …………………………. 14 c. Proper Cross-Cultural Management ………………………….. 15 d. Selecting the Best Options in International Joint Ventures …. 16 V. Importance of Entering into Joint Venture rather than an Acquiring an Existing Chemical Company in China ………………… 17 VI. Conclusion ……………………………………………………………….. 18 Appendix I – Foreign Direct Investment in China .......................................... 19 Appendix II – Inflation Rate in China between January 2006 to May 2010 .. 20 References …………………………………………………………………… 21 – 24 Introduction In relation to the tight competition in the global markets, some of the Gulf Cooperation Council (GCC) based chemical companies entered into mergers and acquisitions (M&A) or joint venture as a way of expanding its businesses around the world. For the reason of easy access to domestic and international market, easy access to technology transfer, and product diversification; Saudi Basic Industries Corporation (SABIC) has been continuously entering into joint venture projects with other local and international companies (Arab News 2007). Established back in 1976, SABIC managed to expand its business by going through a series of joint venture. Today, the company is known as one of the biggest and most profitable petrochemicals manufacturing company based in Riyadh (SABIC, 2010a). Other than manufacturing chemicals, SABIC also manufacture polymers and innovative plastics, fertilizers, and metals as part of its product diversification strategy. Earning a total of US$40,203 million in revenue, SABIC managed to be the No. 1 chemical company in Asia and no. 186 in the Fortune Global 500 as of 2009 (CNN Money 2009). Although SABIC has been aggressively entering into joint venture programs, it remains a fact that the top management of SABIC has little knowledge concerning the differences between Chinese and Arab’s business culture. In line with this, the absence of concrete knowledge with regards to the business environment and business culture of another country could lead to a lot of long-term business problems. In worst cases, lack of technical expertise on how to effectively deal with the Chinese business people could result to a serious business failure on the part of SABIC. Aiming to expand SABIC’s business in China by entering into a joint venture with one of the local Chinese chemical manufacturers, this report aims to provide some recommend internationalization strategies that will be useful in making SABIC’s business expansion a successful one. Upon analyzing the business environment in China, this report will enumerate the business advantages of going through the joint venture plan followed by discussing the most appropriate form of investment and possible cultural or institutional obstacles the Chief Executive Officer (CEO) of SABIC may encounter along the way. After going through a list of recommended solutions that could enable the CEO avoid foreseeable business expansion problems, other possible challenges and business opportunities associated with this project will be tackled in details. To address the possible business problems related to entering a joint venture plan in China, the research for this report was completed by going through a list of related books and academic journals which may directly or indirectly tackle some solutions or situations concerning the purpose of business internationalization projects. To ensure that the research for this report is up-to-date, recently published news reports will be considered discussing the business environment in China. Business Environment in China China has been named as a ‘Central Nation’ because of the strong practice of communism (Yue 1969, p. 163). The opening of China’s door for industrialization has invited a lot of highly respectable business people coming from the eight major continents all over the world. For many years, China has depended a lot on agricultural activities as their major source of livelihood. Since the millennium, China’s economic activity shifted from pure agricultural activities to industrialization and international trading. This major economic change triggered a significant effect on China’s culture and tradition aside from their business practices. For many years, entering into a joint venture with a Chinese enterprise was the only way for foreign companies to be able to enter the Chinese market (Buchel 2003). Even though China has opened its door to industrialization and international trading, the influence and control of the Chinese government over the local citizens remained strong. As a way of preserving the physical assets and state-owned companies in China, the Chinese government has been imposing a strong control over the business policies and regulations for domestic and foreign investors. In line with this, the foreign investment in 2009 amounted only up to 1.8% of its gross domestic product (GDP) as compared to 6% back in 1994 (Browne and Dean 2010). In line with this, the strong government control over foreign-owned business explains why China’s economy continuously increases but not the foreign direct investment. (See Appendix I – Foreign Direct Investment in China on page ) As part of today’s Chinese business regulation, foreign companies are highly encouraged to either merge with or acquire some of the existing Chinese enterprises provided that the company offers business opportunities related to the use of high technology. Although Chinese government promotes the merging opportunities with some of the existing Chinese enterprises, China is also allowing wholly foreign-owned enterprises to selected industries related with high-technology, modern services, new energy-saving technology, and environmental protection (Winston & Strawn LLP 2010, p. 4). When examining China’s business environment, it is necessary for us to examine the country’s macro-environmental factors that can significantly affect SABIC’s decision to enter into an international joint venture with a Chinese enterprise. Using the PEST framework, this report will provide brief information concerning China’s political, economic, social, and technological status. Strong Political Influences REACH Style Regulation for New Chemical Substances Inspired by EU’s REACH system which aims to protect the environment, China has recently introduced the REACH style regulation for new chemical substances which will be effective in October 2010 (Winston & Strawn LLP 2010, p. 1). In line with this new regulation, importers and manufacturers of chemicals are obliged to notify and register new chemicals with the Chemical Registration Centre (CRC) of the Ministry of Environmental Protection. This particular regulation also obliged all manufacturers of chemicals to observe proper labelling, packaging, transportation, and distribution of chemicals to the end users (Winston & Strawn LLP 2010, p. 2). In general, China implements a strict regulation with regards to the kind of industry or business a foreign investor has to offer. Since there are types of chemicals that can be hazardous to health and environment, China regularly and continuously add new restrictions when it comes to foreign investments related to chemicals (Winston & Strawn LLP 2010, p. 4). The China State Secret Law The China State Secret Law was formulated to guard the state secrets, security, and national interest needed to ensure a smooth economic progress after opening its economy to international trading (Congressional - Executive Commission on China 2003). For most foreign investors, the implementation of the China State Secret Law has been considered as a controversial issue since there were some foreign investors who unconsciously violated the grounds of the said law and were punished with nominal fines of not more than 1,000 RMB (Winston & Strawn LLP 2010, pp. 2 – 3). Other Significant Political Factors Although existing technology in China is competitive, Chinese government does not allow the registration of technology licences to foreign investors (Harris and Moure 2010). Upon entering into international joint venture with a Chinese enterprise, the fact that foreign investors are prohibited from registering technology licences makes SABIC at risk of losing its technology to its Chinese joint venture partner. Chinese government is also controlling the enforcement of higher taxes on foreign companies (Harris and Moure 2010). This strategy is used to enable the local and government-owned companies have more competitive advantage within the domestic and global markets. Economic Factors Inflation rate in china has increased from 2.40 in March to 2.80 in April 2010 (Trading Economics 2010). The problem with higher inflation rate is related to the increase in the general prices of goods and services. In line with this, a very high inflation rate could cause negative impact on SABIC in terms of competing in domestic and international markets. (See Appendix II – Inflation Rate in China between January 2006 to May 2010 on page ) Exchange rate is one of the major economic factor that can significantly affect SABIC’s ability to compete in the global markets via export. In line with this, a senior Chinese trade official reported that “any further appreciation of the Chinese currency can be risky on the part of Chinese exporters” (Browne, The Wall Street Journal, 2010). For this reason, SABIC should carefully watch out for any significant changes in the value of Yuan. Social Factors As of July 2010, the Central Intelligence Agency reported that China’s total population has reached 1.3 billion (CIA, 2010). Specifically the high population density in China creates demand for petrochemicals related to olefins, oxygenates, and aromatics aside from chemical and fibre intermediates like Ethylene Dichloride, Monoethylene Glycol and Caustic Soda which are commonly used as raw materials by other manufacturing companies (SABIC, 2010b). Since 4.20% of the total population of China is currently unemployed, searching for highly competitive employees at a low price is possible on the part of SABIC (Trading Economics 2010). With regards to socio-economic issues in China, the practice of Chinese communism for the past few decades narrow down the gap between the rich and the poor. In relation to the fact that the mentality and goal of a communist government is to create ‘one-for-all and all-for-one’ way of living (Drislane & Parkinson, 2002); China as a country can be considered as a non-bias society when it comes to social status and social class. Therefore, China can be considered as a potential target market for SABIC. Technological Factors Since China was aggressively opened to foreign investors, the number of chemical manufacturers in China has significantly increased. Because of the tight competition within the petrochemical industry, technology in China becomes highly competitive not only within the domestic market but also in global markets. To remain competitive in domestic and international markets, existing chemical manufacturing companies in China continuously invest on new technology to improve the quality of products they sell in the market. Potential Business Opportunities and Threats behind the Joint Venture Plan with a Chinese Enterprise Business Opportunities Even though China is becoming a less friendly place for multinationals to expand their businesses (Browne and Dean 2010), the fact that Chinese population has reached a total of 1.3 billion sugggest the high demand for SABIC chemicals (CIA, 2010). By entering into a joint venture with a chinese enterpise, it is possible for the company to expand its market and widen the scope of SABIC’s business opportunities. Pushing the company’s plan on going through the international joint venture will enable SABIC enter the market of China possible within the shortest time possible (Meschi and Riccio 2008). Other than increasing the potential market for SABIC’s chemical products, entering into a joint venture with a Chinese enterprise could somehow increase the speed of technological change and its competitiveness in the global markets (Huaning, Colin and Barry 2008). In relation to economies of scale, SABIC will be able to expand its business internationally without the need to invest a large sum of money (Le and Nhu 2009; Huaning, Colin and Barry 2008; Shrikhande 2001) or provide SABIC with more loans for joint ventures’ short-term revolving fund (Ouyang 2005). As a result of good management, it is expected that SABIC be able to increase and maximize its profit gain by diversifying its risk management, facilitating inter-organizational learning, improved market power and competitive advantage in the global markets as compared to SABIC’s major competitors in the chemical industry (Le and Nhu 2009; Huaning, Colin and Barry 2008; Meschi 2005). Through coalition, entering into international joint venture project can empower SABIC by defending itself against other more competitive players within the chemical industry (Child and Faulkner 2009). Likewise, choosing this particular business expansion strategy can make the market entrance to another country easier despite the domestic restriction of foreign investment and trade barriers related to cultural, economic, and financial issues. Considering the differences between the business culture in China and a GCC country, entering into international joint venture is likely the best business expansion option since this type of expansion strategy could enable SABIC bridge their cultural gap with a Chinese enterprise. Aside from learning more about Chinese business culture, this strategy will also reduce possible investment risk (Lee 2006). Business Threats Chinese governments’ strict implementation of policies, rules and regulations increases SABIC’s risk for business opportunity loss and failure. In line with this, the implementation of the REACH Style regulation for new chemical substances on top of the China State Secret Law forms as a trade barrier for foreign investors such as the case of SABIC (Winston & Strawn LLP 2010, p. 2). Because of the Chinese government’s strong support to government-owned and national companies, the research findings of Lu and Xu (2006) revealed that going through an international joint venture project in China can lead to a lower growth rate in terms of the business profit and business survival of foreign-owned companies. Another potential business risk can be related to the differences on ways in which Chinese people do business. For international joint venture project to success, SABIC should work together with its joint venture partner in terms of achieving a single organizational goal. As a result of poor business control and coordination among the staff of SABIC and its joint venture partner, miscommunication and tension within the business organization may arise in the future. In line with this, it is possible for both firms to have serious problems in relation to conflicts of interest (Lee 2006). For example: It is possible for SABIC to concentrate purely on its own business interest rather than working with its joint venture partner and vice versa. Based on the experiences of other businesses that entered into international joint venture in China, business partner may be reluctant to transfer or relocate part of their business operations to China, problems related to business expansion, or difficulty in transferring the principles of its marketing and distribution network and its organizational structure or work concept to China (Ilari and La Grange 1999). Employee involvement is crucial to the success of an international joint venture as the practice of unity within the workplace could positively increase the level of employees’ commitment towards reaching the organizational goal. In relation to the implementation of the international joint venture plan with a Chinese enterprise, the inability of SABIC’s manager to effectively control resistance-to-change may lead to a series of internal problems. The problem with going through an international joint venture can be related to the inability of the business leaders to develop a strong organizational culture that is open to organizational change. In line with this, failure to handle future managerial conflicts between SABIC and its joint venture partner could lead to business failure (Lee 2006). Since there is increasing number of multinational companies in China, the business environment in this country has become very competitive. Even though China can be considered as an attractive market, its market for chemical industry is already crowded. Therefore, it is possible for SABIC to go through a case of price war aside from problematic issues related to industry overproduction and/or problems related to the need to deal with Chinese government measures (Li, Clarke-Hill and Davies 2004). Recommended Internationalization Strategies Analyzing the Current Social, Political and Economic Situation in China One of the core business strategies that SABIC should use when expanding its business in another location or country like China is to know more about the current political and economic situation of its target market. This particular business strategy is crucial behind the success of SABIC’s business expansion plan. By determining the key and most current economic, social, and political factors that can significantly affect the success rate of foreign investors, SABIC’s top management can easily determine whether expanding its chemical manufacturing business in China can be a total success or failure. Becoming more familiar with China’s current social, economic, and political situation will be useful not only in making sound decision-making on the part of SABIC. Likewise, knowing information related to the business environment in China will enable SABIC’s top management to foresee any possible danger involve upon pushing the international joint venture project with a Chinese enterprise. Therefore, reduce the amount of unnecessary project expenses (Ouyang 2005). Selecting the Right Business Partner The key behind the success of an international joint venture project is to select the right business partner (Ecommerce Journal 2009). Given that SABIC can gain competitive advantage from international joint venture through transfer of technology, the company should be able to select the right partner to enable the company to maximize the use of its business advantages. A strong and reliable joint venture partner can effectively assist SABIC when dealing with sensitive business policies and regulation in China. When selecting the right business partner for an international joint venture, SABIC should consider not only the size of the company which includes the company assets, sales force, and total number of employees but also the target partner’s international experience, technology advantages such as research and development, marketing and product differentiation, and the size of the country (Alvarez 2003). Taking the given determinant factors into consideration will increase SABIC’s chance of finding the right business partner. Proper Cross-Cultural Management A good cross-cultural management is necessary to avoid organizational conflict between SABIC and its chosen joint venture partner. Aside from building a stronger relationship between the top management and employees of both companies, establishing an organizational culture that practice a two-way communication between the two groups could strengthen the flow of business processes and minimize operational errors (Eisenberg and Witten 1987). Communication among the staff of SABIC and its joint venture partner may occur in the form of business meetings or other information communication regardless of whether verbal or nonverbal method is used. Regardless of the type of communication used, there will be a better chance for SABIC to prevent the occurrence of unnecessary organizational conflicts. A good leadership skill is necessary in making the implementation of organizational change and cross-cultural management successful (Burke 2002, pp. 240 – 241). In line with this, effective leadership skill can make a big difference when managing and preventing the occurrence of organizational conflicts. Considering that the application of effective leadership style could effectively motivate employees to work towards a single goal, there is a stronger possibility for SABIC to increase the success rate of its international joint venture plan. As a common knowledge, an effective leadership style contributes in increasing the morale to both the leaders and his/her subordinates. This will enable SABIC create a peaceful working environment necessary to enhance the progress of implementing the joint venture plan. In general, the application of transformational leadership style is more beneficial in the implementation of a discontinued change process in a business organization rather than the use of a transactional leadership style. (Burke 2002, pp. 201 – 203) On the other hand, the transactional leadership style is more effective when applied for a continuous organizational change process. In order to avoid wasting time, money, and effort in going through the socio-economic consequences of organizational change failure, SABIC top management should be able to combine the use of transformational and transactional leadership style. Selecting the Best Options in International Joint Ventures One of the most serious problems that a business person can encounter when entering into an international joint venture agreement contract is the management and acquisition of the company’s equity. In line with this, any future business expansion could result to disagreements between SABIC and its partner when discussing issues related to the company’s equity. Transaction cost is referring to the cost of entering into an international joint venture agreement with a Chinese enterprise. In most cases, transaction cost theory is often used as a tool when analyzing the potential business success or failure of a joint venture project (Tsang 2000). Because of the possible business disagreement between SABIC and its joint venture partner, Reuer and Tong (2005) suggest the need for SABIC to carefully draw on the real business options such as business agreement for future business expansion plan and other related transaction cost arguments before closing the deal. Doing so will minimize the risk of misunderstanding between SABIC and its joint venture partner in case the need for future business expansion arises. Importance of Entering into Joint Venture rather than an Acquiring an Existing Chemical Company in China The business expansion of SABIC should focus expanding its business opportunity outside GCC because of the possibility that the business could eventually saturate the local market. In line with this, expanding the business of SABIC globally is necessary to ensure that the company will avoid becoming stagnant. Between entering into international joint venture and acquisition of an existing chemical company in China, it is best to choose joint venture option because of the Chinese government strict regulation on foreign investors. Aside from the fact that entering into a joint venture with a Chinese enterprise could reduce the risk associated with business failure, having a Chinese business partner could enable SABIC easily deal with other Chinese businessmen. It only means that SABIC’s chosen joint venture partner will be able to guide the top management and staff of SABIC about the Chinese business culture and government policy concerning the chemical manufacturing industry. Entering into an international joint venture with a Chinese enterprise is a preferred choice than going through the process of acquiring an existing chemical enterprise in china since this option is more effective in terms of removing the language and cultural barrier between SABIC and the Chinese market. Likewise, SABIC may have a bigger risk of facing legal problems in China if they choose to do business in that country alone. Considering this point-of-view, it is best on the part of SABIC to strengthen its joint-venture with a Chinese enterprise. Conclusion The best entry option for SABIC to penetrate the market of China is to push through its international joint venture plan with a Chinese enterprise. Acquiring an existing chemical company in China may not give SABIC a competitive advantage in terms of technology transfer, product diversification, shared risk, cheaper entry to establish a business in china, better economies of scale, increase profit by diversifying its risk management portfolio, improve SABIC’s market power and competitive advantage against its global competitors as compared to taking advantage of joint venture option. Although the strong government control in China on top of the market saturation and the differences in the way Chinese people do business could lead to a long-term business failure, having a Chinese enterprise partner could help SABIC minimize the risk of doing business in China. To enable SABIC improve its internationalization strategies, the company should carefully analyze the current social, political and economic situation in China aside from selecting the right business partner, implementing a proper cross-cultural management, and selecting the best options for international joint ventures. *** End *** Appendix I – Foreign Direct Investment in China Source: Browne and Dean 2010 Appendix II – Inflation Rate in China between January 2006 to May 2010 Source: Trading Economics 2010 References Alvarez, M. (2003, May). IEB. 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