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China’s legal and business differences

by Dan Harris

The other day, I spoke with a North American company that was seeking to get its tooling back from its former Chinese manufacturer.  This company’s domestic American lawyer had drafted a manufacturing contract with the Chinese manufacturer that was completely silent regarding ownership of the tooling/molds.  When the American company started getting bad product from its Chinese manufacturer, the American company requested the manufacturer return the tooling/molds.  The Chinese manufacturer claimed to own the tooling/molds.  The American company claimed that was not possible because it had the tooling/molds made by someone else and it had proof of payments that would prove this.

On top of this, the American company kept telling me that its lawyer insisted that it owned the tooling/molds.  He stopped saying this when I asked whether the lawyer claiming this was the same lawyer who had represented them when it contracted with the Chinese manufacturer.

I told the American company that it essentially had three choices.

  1. Get new tooling/molds made.  The American company told me that would take months and was unacceptable.
  2. Sue the Chinese manufacturer to try to get the tooling/molds back.  I said that would take months and since the American company did not have written and signed proof (preferably in Chinese) making clear that the tooling/molds belonged to it AND not to the Chinese manufacturer, I did not know who would prevail.  Either way, this would take many months. The American company told me that this was not acceptable.
  3. Try to negotiate a purchase price for the tooling/molds from the manufacturer, maybe at half their value.  The North American company let me know that having to buy its own tooling/molds back from its Chinese manufacturer was incredibly unpalatable, as compared to its other options, this was its best one.

What should the North American company (or more particularly, its lawyer) have done to prevent this horrible situation?  They should have explicitly (because if it isn’t explicit it pretty much doesn’t exist when it comes to China) put in their agreement with the Chinese manufacturer that the tooling/molds belonged to them and they should have explicitly put in the contract that the Chinese manufacturer would sustain liquidated damages of $10,000 for every day that it failed to return the tooling/molds. And they should have done this in Chinese and they should have gotten the contract sealed/chopped by the Chinese manufacturer.  This is what Chinese manufacturers understand and, more importantly, this is what Chinese courts understand and will enforce.  And because of this, as far as I know, we have never had a client whose tooling/molds have been held for ransom.

Early this evening, I listened to the last two minutes or so of a BBC radio show that seems to have been about a book writing anthropologist who writes about Papua New Guinea’s hundreds of tribes.  I got to hear him essentially sum up by saying that the tribes of Papua New Guinea deal with modernization/materialism one of the following three ways:

  1.  Seeking to reject it entirely and stick entirely to their old ways;
  2.  Seeking to integrate it into their existing ways, creating a synergy between the two:
  3.  Seeking to have it replace their ways, whole hog.

The North American company and its lawyer are not too dissimilar from the Papua New Guinea tribes that insist on sticking to the old ways no matter what they face.  Both essentially insist on going on with their lives as though nothing new had been introduced to them.

I received the following email this morning:

Your blog is interesting because it talks about project failures at the operational level. I bought couple of books you reviewed on your blog and the anecdotes of success they contain have been interesting and inspiring. Now, I am more interested in some material (in addition to your blog) that will provide insight on spotting major flaws in the operationalization of a project.

I’m in consumer research and I often tell clients how they should target a specific segment, what they need to do next. I have never been able to educate them on what NOT to do, and what major mistakes they need to look out for. That’s because I’ve never actually worked in their position (ie. actually executing a specific strategy).

It would be great if you write your own book or post more about failures. Case examples are much more insightful than ideological or CEO-level visionary “stuff”.

Seems this person realizes that China is different and that learning comes from this recognition.

The South China Morning Post recently ran an aptly entitled article by INSEAD Professor, Micheal WittBusinesses often fail overseas because the world is much less ‘global’ than they assume. The article is subtitled, “Key decision-makers often underestimate just how big, and important, global differences are.”

Its premise is that “many companies do not reach their full potential abroad” due to “incomplete preparations.”  It states that “surprisingly, many companies, even large multinationals, do not analyze the competitive landscape of the local [Chinese] market to determine whether it is possible to operate profitably.”  Foreign companies end up being surprised by the level of competition in China simply because they went into China without ever analyzing it.  Sort of like the North American company/lawyer who were surprised at losing their tooling/molds simply because they never even considered seeking to determine whether the rules on such things might be different in China than in North America.

The article notes the irony that “the tendency to fall for the fallacy that the world is indeed ‘flat’ increases with corporate seniority.”  Though the reason for this is “natural, as senior executives extrapolate from their own experiences within a confined international elite,” it also is ”highly problematic, because it leads key strategic decision-makers to underestimate just how big the differences are. And as the international business literature has shown time and again, what kills companies abroad is their inability to handle these differences and deal effectively with the attendant ‘liability of foreignness.’”

It goes on to discuss how institutional variations occur between countries and at “the most fundamental level, they show themselves in what a society accepts as the legitimate purpose of doing business.”  Western business schools generally teach that firms exist to maximize shareholder value, but according to Professor Witt’s research, few societies and senior managers outside the Anglo-Saxon world accept this view:

To simplify very crudely, Hong Kong firms exist to produce family wealth; German firms, to produce needed goods and services for society; Japanese firms, to provide benefits to their employees; and South Korean firms, to keep highly conflictual demands by controlling families and hostile stakeholders in balance.

Few companies ever pause to consider these issues and their implications when expanding abroad. Many an international partnership was, foreseeably, doomed from the beginning because fundamental objectives did not match.

Do you think about such things?  I do all the time.  I mean, why do some companies seem to just coast into China while others stumble in and never recover?  What more should we be writing about to help those seeking to do business in China or to sell to China?  For what it is worth, I would say that the knowledge North American companies looking at doing business in China is both considerably higher today than it was even five years ago and considerably higher than the knowledge Chinese companies have about doing business in North America.  Do you agree on that?

Dan Harris is founder of the Harris & Moure law firm, a boutique international law firm focusing on small and medium sized businesses that operate internationally. China is the fastest growing area for the firm. Dan writes as a source of China legal and business information.

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