State-Owned Enterprise
of China
The People’s Republic of China (PRC) government acts with great freedom
and latitude where domestic ownership rights are involved, but has less freedom
where foreign ownership interests are at stake because intrusive interference
with these interests may raise legal, political, or diplomatic issues not
present in a domestic context.
policy of fostering a market economy within an overall framework of socialism
has been described as a form of state-controlled or state-managed capitalism.
Certain sectors of the economy are permitted to develop and operate under
market principles of supply and demand, but the state retains ultimate control
of business enterprises either through a majority ownership interest or through
regulatory powers. This system allows the state to carefully monitor and
control reform, to periodically tighten or loosen controls, and to enforce
retrenchment or austerity measures when necessary. When the PRC government
considers extreme measures necessary, government control over the economy may
become intrusive or overwhelming. These mechanisms allow the state to prevent
reform from spiraling out of control and avoid the resulting problems of
hyper-inflation, economic chaos, and political instability.
The performance of state-owned enterprises (SOEs) in
state enterprise reform has attracted much attention in the discussion of the
Chinese economy. Inspired by the success of rural reform, the Chinese
government introduced similar reform measures to its SOE sector. The gist of
state enterprise reform is the gradual relaxation of the role of central
planning, the introduction of a free market system and various kinds of
profit-sharing schemes, and the increased autonomy in decision-making granted
to SOEs (Huang and Duncan 1997, pp. 68-9). While some of the pre-reform legacy
still lingers including the problem of soft budget, the enterprise reform is
generally believed to have injected the fresh blood of economic rationalism to
an ailing sector of the Chinese economy. Some even go further, arguing that
profit maximization is now the most significant goal of SOEs both in practice
and in the perception of the managers of SOEs (Perkins 1994, Groves et al.
1995, Yin 1998). According to Western standards, SOEs have performed reasonably
well since the reform.
A number of authors have proposed various explanations for the poor
performance of SOEs. Three leading explanations are the erosion of monopoly
position due to the entry of other firms, accounting manipulation, and the
lingering legacy of a soft budget constraint. The first explanation is not
entirely satisfactory when one considers that not only SOEs but other forms of
enterprises have experienced a similar increase in competition. While the explanation
based on accounting manipulation does have bite as evidenced by Woo et al.
(1993) and Sicular (1994), it bypasses the key incentive aspect of the reform,
and is thus unable to offer an explanation as to whether SOEs were led to make
efficient production decisions. Much attention has been paid to the problem of
soft budget in enterprises in transition economies in general (Schaffer 1998),
and SOEs in
in particular (Bai and Wang 1998, Li and Liang 1998). It is true that a soft
budget constraint can significantly undermine incentives, an d without directly
tackling this problem, further reform could well prove to be ineffective.
According to government statistics, state-owned enterprises are the key
drivers of
industrial economy, accounting for almost half of industrial production and
more than two-thirds of fixed assets. Although most of them are in
capital-intensive sectors, some are trading companies, service monopolies like
airlines, and emerging business conglomerates. The very biggest are truly
world-class in scale: their sales would comfortably place them among the US
Fortune 500s. Further, above the individual enterprise level sit national
corporations that oversee entire industry sectors. In the case of the Beijing
Automotive Industry Holding Corporation, it currently suffers from an
inflexible manufacturing system that grossly wastes capital investment. This
makes production lead times lengthy and unreliable, and undermines the quality
of products. The immediate need of these laggard producers is to learn from the
proven production practices of the company to adopt serious lean-manufacturing
initiatives, and to avoid the usual expedient of increasing capital investment
whenever operational inefficiencies threaten to constrain capacity.
Since most global carmakers have had large investments in
since 1999, it may seem odd to advocate scaling back the industry's capital
investment now. Competition has been tight among the producers of automobile in
the country. In the part of Beijing Automotive Industry Holding Corporation,
they made a rapid transition from protected and subsidized operational units
into full, standalone businesses. Thus, they are subjected to a situation where
they must earn a profit or potentially face bankruptcy. Now responsible for the
full range of business functions, from product development to distribution and
sales, they are largely free to succeed -- or fail -- on their own. Similarly,
the company has realized that obstacles to interprovincial trade disappear and
import restrictions and foreign investment barriers collapsed when PRC signed
the accession agreement with the WTO. The company realized that they must
contend with active new competitors, both local and international. In the old
days, the company would simply build its automobiles and then sell 85 percent
of its output to the local state distributor, which covered only the city's
western districts. Now, a local collective is stealing away share,
international companies are entering the market, the state distributor has been
disbanded, and the brewery has to repay the substantial debts incurred for a
recent acquisition, manage its own distribution, and build a marketing function
from scratch. It's a different world.
The Beijing Automotive Industry Holding Corporation works with an
uneconomic configuration of almost 20 plants in nine locations plans to
consolidate and upgrade its facilities using the proceeds from the sale of
valuable real estate assets. Indeed, as a company owned by the government, Beijing
Automotive Industry Holding Corporation is learning that market-oriented
competition means paying strategic attention to issues of scale.
Another challenge is provided in a more microlevel of SOEs. The
managers, who are considered powerful and most influential in the fate of a
government owned corporation. For the SOE managers, specifically for Beijing
Automotive Industry Holding Corporation, the changes meant that capital
budgeting and investment decisions are no longer a government-driven exercise,
but very much their own prerogative. So, too, with only minimal central
government review, are the decisions to establish alliances or joint ventures
with foreign companies and to make internal organizational and restructuring
decisions are incipient. Nevertheless, provincial and local governments still
have an important influence on these decisions, and constraints remain on
hiring and firing. Along with these broader managerial rights come weighty
financial responsibilities. The Beijing Automotive Industry Holding Corporation
no longer able to depend on government handouts, thus they are now seeking
alternative funding sources, including bank loans and equity investors. In this
company as in others, distribution and other infrastructure bottlenecks may delay
consolidation, but individual companies cannot put off the need to plan how
they will participate in more economically rational industry structures.
In much the same spirit,
vision is to have its automotive industry become a world-class contender and
major exporter, taking advantage of the scale of its domestic market and
competitive cost position. An ambitious program is under way to consolidate and
upgrade the industry around a few leading production centers, each with a key
foreign partner. As part of this effort, the government is restricting both new
entrants and component assembly operations by existing players, and encouraging
production of small, affordable cars for domestic consumers. At the provincial
level, the Beijing Automotive Industry Holding Corporation has devoted much
effort to assessing whether, how, and through which company, if any, it can
make the transition from producing low-end items toward making higher-value,
globally competitive products. Among the sectors for which it has developed
scenarios are auto parts and electronics. Similar initiatives are under way in
other provinces as well as at the national level.
The Beijing Automotive Industry Holding Corporation, however, will not
be able to stand up to the challenges of a more competitive market and will be
forced to sell all or part of their assets. In some cases, policymakers will
actively encourage such sales to reduce debt, rationalize industries, and
improve the scale, quality, and efficiency of the players that remain. Where
SOEs enjoy meaningful cost advantages, they may well become serious competitors
and/or global suppliers.
Joint Venture in
ventures can be defined as legally and economically distinct organizational
entities created by two or more parent organizations that collectively invest
capital and other resources to pursue certain strategic objectives (Pfeffer and
Nowak, 1976). Joint ventures have long been a favored mode for entering foreign
markets (Beamish and Banks, 1987). PRC law provides that the joint venture must
be established under principles of equality and mutual benefit. The purpose of
the joint venture law is to create independent business enterprises in the form
of partnerships between foreign investors and local enterprises in order to
promote the sharing of management techniques and technology with local
enterprises and in order to foster the long-term development of
economy.
example of a joint venture in china is between
and UGS; and Chinese firm Chang'an
Automobile Company. The venture is an initiative of the latter to
sell small automobiles through the World Wide Web. Thus,
e-business. Nevertheless, the company confirmed the continuing
economic disparity between central, regional, and local governments and the
effect it is having on partner compatibility in terms of orientation and
government approvals. Although the central government has introduced economic
reforms intended to reduce its dependence on local governments, its influence
over them remains limited. This is complicated by a Confucian/Communists-based
administrative system that is known for its bureaucratic, rigid, hierarchical
structure at all levels. It is often difficult to identify the person or agency
with the authority to give necessary approvals or authorizations so that work
may proceed. Although the central government has now introduced tax reforms
intended to reduce its fiscal dependence on local revenue processors, the
consequences of its Open Door policy have diminished the influence it once had
over local governments.
the given joint venture, the Chinese partners continue to be a problem because
they still attempt to dominate the foreign partner, knowing that the latter is
heavily dependent on them. As board members, they tend to insist on a
wait-and-see approach because of the uncertainties in
and its still unproven ability to sustain its Open Door policy. Short-term
oriented, Chinese partners stand in the way of progress. Foreign partners also
see their Chinese counterparts as self-centered and motivated primarily by
greed. Moreover, the Chinese partners tend to have political agendas that
affect their attitude toward the joint venture and reduce the level of
reciprocity that one would normally expect. An important reason for this is the
Chinese belief that they have not been dealt with fairly over the decades and
that now is time to even the score. This has exacerbated their cultural propensity
to relentlessly pursue the addition, modification, or elimination of
contractual terms already agreed upon rather than focus on compliance. At the
same time, they show little flexibility during original negotiations or in most
decision-making processes because they are predisposed to the mandates and
guidelines of their government's latest Five-Year Plan.
managerial problems in joint ventures among the five companies are extensive.
Chinese partners are often affiliated with the government and are assigned by
its as managers of the joint venture. Worse still, they are generally rotated
to other assignments every three or four years. Thus, they are not only
short-term oriented but they have developed no managerial skills specific to
the joint venture. Accordingly, decisions on the Chinese side tend to be based
on political factors made by people who prefer to merge themselves in the group
and who have little or no knowledge relevant to the joint venture. They are
inflexible, prefer the status quo, and tend to concentrate on the
micro-management of minor matters. They also harbor an order taking deference
towards the central government.
foreign partners also realized that the Chinese partner in the joint venture is
often more than 50% overstaffed and tends to employ workers of a very low
educational level. Quan xi ("connections") among the Chinese, which
the foreign partner feels obliged to respect, is largely responsible for this
phenomenon. Also, training such employees is a direct cost to the joint venture
because universities and technical institutes are not sufficiently subsidized
to provide it. Thus, quality control of items manufactured by local suppliers
has provided an additional cause for concern. Naturally, local sourcing is an objective
of most foreign investors because it reduces transportation costs. However, is
not only expensive but requires a relatively long lead-time to establish.
Quality control of services has also been difficult to maintain. In fact,
quality in both services and goods remains the foreign investor's primary
concern in
because much of its technology is obsolete, and the training of its workers is
mostly theoretical. Further, workers lack hands-on experience with machinery
and are not conscientious about equipment maintenance.
employee loyalty is difficult to come by. To illustrate, the joint venture
among the five companies reported that its Chinese partner used the company's
name without authorization and "loaned" it to two of the company's
major competitors in
To prevent other loyalty breaches, the foreign partner now disguises important
information. All of the companies knew of similar examples, and they viewed
this problem as symptomatic of a culture-based, negative attitude toward the
joint venture.
Foreign Firms Based in
The selection process is important for another reason. Due to the
central government's belief that private firms should be absorbing excess
workers from the state-owned sector, overstaffing can be a concern. As a
result, foreign partners in joint ventures often find excess personal can be
assigned to the venture, sometimes composing as much as 50% of the venture's
employees (Wong et al., 1999). Extra employees can be removed from the
organization, but this is time consuming and must be done with care.
number of well-established institutional elements that can be traced to its
long history and rich culture, but formal institutions such as codified laws
and case precedent were not parts of the institutional fabric (Jenner, 1992;
Tuchman, 1971). In addition, certain normative and cultural elements and
taken-for-granted conventions complicate doing business in
relationships, the low level of trust in the society, and lack of respect for
the formal rule of law (
1995). While trust building, connections, and alliances with key individuals
and organizations remain important, firms should not attempt to do business in
formal contracts. One consultant argued that this was similar to managing human
resources in
where foreign firms need to carefully explain exactly what is expected of local
employees, including as many details as possible (Bruton, Ahlstrom and Chan,
2000). Similarly, when doing business in
contracts need to spell out each party's obligations as carefully as possible.
foreign firms because it greatly affects the way they do business (Peng, 2000).
Many firms and investors do not completely comprehend the unusual institutional
and legal structures enveloping the Chinese commercial environment. The large
numbers of foreign firms entering
understand the legal environment, especially in parts of the country with less
commercial tradition and few formal rules governing firms and business
transactions.
While a significant private sector has been created, private firms in
face a number of problems in the conduct of their day-to-day operations.
Despite the government's declaration that private businesses are an important
component of the socialist market economy, the playing field is not yet level.
This can be particularly acute for foreign private firms (including both joint
ventures and wholly owned firms) that are still acclimating to the local
commercial and institutional environment (Wong, Maher, Jenner, Appell &
Herbert, 1999).
long isolation and command economy virtually eliminated several commercial
functions until recently. One must also reiterate the presence of guanxi or
connections, which have historically been critical to facilitating business
(Tsang, 1998). These informal social networks are developed through natural
relationships such as family, marriage, schooling, and work (Wank, 1996).
Guanxi is important not only for individuals but also for firms. Businesses
with connections, especially at various levels of government, have good access
to people and resources that can enhance their ability to get things done
(Ahlstrom, Bruton & Lui, 2000). But for foreign firms new to
be a challenge.
As a result of such difficulties, foreign firms in
typically sought to aggressively develop their own social networks rather than
depending on those of an alliance partner alone. Shenzhen-based economist
cities in coastal China advertisements for new employees openly state that
preferred candidates should have good relationships with certain government
departments and officials. Thus, foreign firms have found it is important to
try to hire managers that already have connections with important local
officials. Given the level of interference that foreign firms can face, the
employee selection process can be particularly crucial to the firm's success
(Mann, 1989).
Nevertheless, a recent development as an immediate result of WTO entry
increased the flows of foreign direct investment into
(Panitchpakdi and Clifford, 2001). The WTO agreement will also give foreign
firms' more freedom to operate in a variety of industrial sectors and regions
of the country (Nolan, 2001). Restrictions on retailing and distribution will
ease as foreign retail firms are able to set up wholly owned outlets; no longer
will most goods sold have to be produced in
distribution will be phased out over three years (Panitchpakdi and Clifford,
2001). In automobile industry, foreign players will be able to buy up to 50% of
the carriers. A number of other regulations will be loosened, opening up a
range of previously closed industries. In addition, the Chinese government is
encouraging firms to locate in the country's more remote areas (Schevogt,
2001).
The Volkswagen Automobile Co Ltd office in
experienced a cumulative effect of the relaxation of restrictions on foreign
firms with the WTO not only bringing more foreign firms to China, but will
offer them unprecedented access, particularly in industrial sectors and
geographic regions that have seen few foreign enterprises of any kind. Prior to
WTO accession, foreign firms such as Volkswagen were compelled to enter
strict guidelines and were limited to certain sectors. They typically chose to
locate in the more developed coastal areas of the country where regulations
were codified and commercial traditions well established (
1998). Therefore, a foreign manufacturer could expect to encounter fairly clear
(if not always logically consistent) laws and commonly accepted commercial
practices in the most likely locations for businesses in that sector (usually
manufacturing). As significant numbers of foreign firms enter
WTO, they have unprecedented access to different regions and industrial
sectors. However, these are locations and industries with less established
commercial law and little experience in commercial practice. The institutional
environment will differ from what foreign firms are familiar with (Bruton and Ahlstrom,
2002). Competing in
involves big money: a capital investment of $1.7 billion for the two facilities
of VW'. Thanks to protection of the industry, this investment has largely paid
off: with tariffs ranging from 80 to 100 percent, models bear price tags up to
150 percent higher than those in the
States
levels of profitability not seen anywhere else.
Initially, Volkswagen is considered as a wholly foreign-owned enterprise
(WFOE) where the MNE is freed from any constraints imposed by a partner are.
Under current PRC laws and practice, government approval of wholly-owned
enterprise status may be difficult to obtain. WFOEs are completely prohibited
in some industries and restricted in others. As a result, this path is simply
not viable for a number of MNEs. In other instances, the foreign investor may
obtain approval for a WFOE only by satisfying certain onerous conditions such
as high export requirements. Even when Volkswagen obtained WFOE status, it may
still be advantageous to the MNE to be the control group within a joint
venture. The chairman of the joint venture's board, who is appointed by the
local partner, may have close relationships with local government and may be
very effective in helping the joint venture obtain favorable government
treatment, in navigating the joint venture through government requirements, and
in obtaining contacts that are required of every business venture in China. In
addition, a joint venture is closely identified with Chinese participation, and
because the local partner is often a state-owned enterprise, the state is
considered an owner of the joint venture. These elements are missing in the
case of a WFOE. An optimal strategy may be to first establish a series of joint
ventures under a wholly foreign-owned management company and to gradually add
Volkswagen to the network in strategic locations where the MNE has particularly
strong local connections. Over time, the MNE may seek to convert some of the
joint ventures into Volkswagen by purchasing the Chinese partner's equity
interest. Under ideal conditions, all of the business entities under the
management company would eventually be converted to wholly owned entities. It
appears unlikely that political and economic conditions will allow this
arrangement in the near future. The current strategy of establishing what
amount to limited partnerships with Chinese partners comes closest to achieving
the objective of corporate control.
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