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Capital Agenda Insights, March 2011 - Focusing on JV value creation - EY - Global

Capital Agenda Insights, March 2011

Focusing on JV value creation

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Reaching a common understanding of priorities is the first step of a successful partnership.

Summary: 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 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
(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.

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 — 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.

Keep a local mindset

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.

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 decision-making 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.

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