How to Establish and Sustain a Joint Venture in China

MARKETS

Building confidence

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As one of the largest recipients of foreign direct investment (FDI), China is clearly recognised as a great source of business opportunities for multinational medical device companies. Table I [5] provides a quick overview of its health care market. The fact that China’s social, legal and financial systems are becoming clearer and more transparent, make investing in this country particularly appealing. The availability of skilled labour, quality infrastructure and investment friendly initiatives also enhance investment attractiveness. Similarly, China’s gradual transition to a free market economy, accession to the World Trade Organisation and liberal trade policies provide further incentives for medical device companies to do business in China.

A growing middle class with access to increasing quality of health care, lower labour costs and changes resulting from almost three decades of continuous economic reform are also among the main reasons foreign companies are flocking to China. In addition, changes to the patenting laws in full compliance with requirements of the Trade Related Aspects of Intellectual Property Rights agreement have also opened the door to new business opportunities for many foreign companies.⁴ This growing confidence is further fuelled by recent Government initiatives to strengthen intellectual property rights laws and the means of policing compliance as China becomes more established in the global trading system.

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Table II [6]: Sino-foreign joint venture tax incentives. (click image to enlarge)

The fact that the Chinese Government levies low taxes on enterprises with foreign investment and offers preferential tax policies to certain sectors and regions to encourage investment makes doing business in the country even more attractive to multinational health care companies. More importantly, China is a massive market with gaping differences in health care standards. This ensures significant demand for medical devices/equipment. This and the lower distribution costs to market make it appealing for foreign companies to establish themselves in China. Table II [6] provides details of tax incentives applicable to Sino-foreign joint ventures.

Among the different FDI options that are available, joint ventures provide foreign entities with some of the most lucrative business opportunities and help to limit exposure and risks in a new market.

Benefits and challenges of joint ventures

Because of the advantages that joint ventures offer over other types of FDI, many companies are choosing to exercise this option to gain a foothold in the Chinese market. Some of the benefits that joint ventures offer over other types of foreign investment in China such as wholly foreign-owned enterprises include:

• central or local government support, brand reputation, land, licences, distribution and access to suppliers
• the flexibility to arrange business relationships in a way that benefits both parties
• the opportunity to gain a cultural understanding of China through local partners
• greater ease in obtaining capital, technology and local society and Government support
• a higher degree of marketing control and a localised approach to efficaciously reach targeted audiences that shortens the time needed to obtain and disseminate local market information
• no need to set up a new corporation in China
• tax incentives from the Chinese Government (see Table II [6]).

For all the benefits that joint ventures offer, there are also some drawbacks to establishing and operating this type of business model. For example, compared with licence and contract manufacturing in China, joint ventures may require greater investment from a foreign enterprise. This may result in higher risks with uncertain return or negative returns for a significant period of time, because it can be difficult to repatriate profits from China. However, China’s rapidly evolving business environment promises a significant return on investment and a strong foothold in one of the world’s largest economies for companies that invest in China now.

In addition, cultural differences and profit sharing issues can arise if correct communication techniques are not used. This is where partners’ relationships, personalities and synergies come into play. As with any joint venture whether in China or elsewhere, involved parties do not have the autonomy of a sole proprietorship in the decision making process.

Two types of joint venture

There are two main types of joint venture that international and Chinese companies can consider: equity joint ventures (EJVs) and cooperative (also known as contractual) joint ventures (CJVs). In China, most joint ventures are EJVs, although the two types of joint venture are similar in many respects. The Chinese Government’s approval process, approval authorities, format of agreements, tax breaks, legal standing, and the means, laws, and authorities for dispute resolution are largely similar, if not often identical. The general management structure and governance procedures are also similar.⁶

However, in an EJV, the distribution of profits has to be equivalent to the ratio of the capital contributions made by the parties; profit distribution in a CJV can be according to the commercial terms agreed between the parties. A CJV is, therefore, more flexible than an EJV and would depend on what was negotiated and subsequently mutually agreed upon.

In a CJV, as well as contributing registered capital, a party may provide so-called cooperative conditions, for example, market access rights.⁷ In addition, unlike an EJV, a CJV does not need to be a separate legal entity under Chinese law. A CJV that is not a separate legal entity may benefit from lower costs, but may also expose the parties to greater liability than if they were legal entities. This is because CJVs with legal entity status confer limited liability on parties to the joint venture.⁸

Depending on the company structure and the capabilities, goals and appetite for risk of the parties involved, a company may find one option more desirable than the other.

Selecting the right partner

The success of a joint venture not only depends on business, market and staffing factors, but also on the cultural understanding and ability to achieve synergy between the two entities through proper integration. For example, partners should consider each other’s attitude towards collaboration and if they share the same level of commitment and congruence of business goals.

Relationship building and trust are also important. Mutual trust must be established before any business agreements are signed. Knowing what kind of reputation the partner has will help to build or diminish trust. Talking to a potential joint venture partner’s customers and suppliers about their trustworthiness and reputation is a useful and pragmatic place to start.

Guanxi (relationship) is a critical element of partner selection in China. Top management must learn to nurture close relationships with their local counterparts. Building strong relationships with business partners can aid in mitigating strategic and operational risks and facilitate the important process of integration.

The financial security of the partner company should also be explored to uncover any credit problems or other issues that may threaten the success of the joint venture.

Medical device companies should also gain a sense of the type of management team the potential joint venture partner has in place, and how the company has been performing over the past three years in terms of production, marketing and personnel.

Solid relationships

Although finding the right partner in China may require more time, patience and experience compared with doing business with companies elsewhere in the world, a successful joint venture is well worth the investment. Medtronic (www.medtronic.com [7]) and Johnson & Johnson’s (www.jnj.com [8]) continuing expansion in China through joint ventures and other forms of foreign direct investment are a testament to successful partnering and the value of doing business in China when solid relationships are formed. As an example of its latest foray into the Chinese market, Medtronic is in the final stages of negotiating a joint venture with device maker Shandong Weigao (www.weigaogroup.en.alibaba.com [9]) that could give Medtronic a 15 per cent stake in the company. The joint venture is aimed at boosting both companies’ orthopaedic device businesses in China and covering certain manufacturing and distribution operations.⁸

It is not only medical device makers that are benefiting from setting up joint ventures in China, but the medical device industry as a whole. The formation of Reed Sinopharm Exhibitions (RSE) in 2005, a joint venture between China National Pharmaceutical Group (SINOPHARM) and Reed Exhibitions, a leading events organiser, is just such an example. RSE produces the China International Medical Equipment Fair (CMEF), the medical device event for China and Asia Pacific that provides an effective market platform for those seeking joint venture partners. The next CMEF will be held on 18–21 April 2008 in Shenzhen, China. This joint venture is not only indicative of the growing international medical device market in China, but also of the value in pairing international and Chinese medical device expertise to realise a highly successful company.

A bright future

Currently, China accounts for only 2 per cent of global medical device sales, compared with 42 per cent by the United States.⁹ Yet, the country’s rise in heart problems and other diseases such as obesity and diabetes often associated with developed, wealthy societies, has made it a strategically important market for international device makers. As China’s health care demands increase, a growing number of foreign companies will continue to seek out Chinese business partners who can help them tap into the country’s burgeoning medical device and health care market.

This article is based on the author’s personal experience and knowledge. It is hoped that the discussion has captured the essence of joint venture matters in China, but it should not be used as an official guide. Readers are advised to seek professional advice from their lawyers, legal consultants, financial advisers, accountants and other relevant experts in their pursuit of factual information on joint

venture issues in China.

Paul Lee is Vice President of Reed Sinopharm Exhibitions, 11th–12th Floor, Sinopharm Building, No. 20 Zhichun Road, Haidian District, Beijing, 100088, The People’s Republic of China, tel. +86 10 6202 8899, ext. 3602, e-mail: paul.lee@reedexpo.com.sg [19], www.reed-sinopharm.com [20].