by Michael Whelan via Andrew Hupert
China is a unique place with a culture, especially its business culture, that continues to confound western business people no end, and not just in obvious ways. There is nuance too.
Whatever ethical norms you’ve come to expect, they don’t apply in China. Why should they?
This is a truly different place. The more opportunity there is to profit personally from your operations through fraud, the greater temptation there will be to take advantage of you and your company – and in ways you would never suspect. Think unbridled Wild West.
Innumerable pitfalls await the unwary in China. But there are ways to safeguard yourself and your company. One practical way to do this is to keep an eye out for, and make note of, behaviors and circumstances that singly, or in combination, could indicate that something is amiss in your organization.
Treat these as caution lights indicating potential trouble, not proof of wrongdoing. If you notice several signs adding up, quietly raise your level of vigilance, get exploratory and start nosing around. Here are a couple of examples of what I am talking about.
Some years ago, I had an interesting conversation with the newly hired China Country Manager of a well-established US industrial systems manufacturer. The company made and sold bespoke pneumatic systems for factories to their industrial customers.
In this particular case, the company was number one in industry rankings in every other market on earth, but in China they were, and stayed, at number 3 and somehow, they never seemed able to catch up with their competitors.
And the market in China was absolutely smoking hot; demand was explosive due to the build-out of so many industries and the arrival of so many western companies, setting up their manufacturing sites all across the country.
The company grew steadily year-on-year, but revenue growth always seemed to lag its two global competitors, and margins weren’t quite what they should’ve been either.
We were called in to recruit a new Managing Director, China.
Among his first actions was to probe the company’s distributor / agent arrangements, a primary area for corrupt activity in China. Boom! For eight years, the company’s top man in China, the general manager, and his wife, the north China distributor, had creamed off a large part of the company’s China profits – made millions for themselves. They had used their positions to line their pockets, rather than push the business forward. The loss to the company — in excess of US$ 8 million. Nothing recovered.
Take pre-emptive precautions against this kind of fraud happening. Minimize tempting opportunities by employing internal checks and balances, a formal approval process, conducting physical audits, spreading authority, ensuring sensible reporting lines, being actively present and aware, etc. For your top positions, you might even consider having a due diligence check run by Kroll or one of the other such service providers.
Here’s another juicy area: if all or many of your suppliers have been identified and qualified by a single person in your organization, that’s a red flag. If they are all managed by the same person, even worse — exclusively handled, negotiated with, and renewed year after year by the same person, look out – that’s a big flapping red flag.
This all sounds pretty paranoid and ominous, I know, but I have been surprised at the number of companies, especially smaller operations in China, that neglect this area and fail to have any kind of system for guarding against and/or detecting fraud in a function known in China to attracts so much of it.
The bigger companies seem to do this as a matter of policy, dividing responsibility among several positions, requiring approvals at different levels, employing a formalized system for managing vendors, rotating negotiators/managers, and even so, because the potential for individual plunder is so great, even the biggies regularly get caught up in scams that surface.
Far more often, I suspect that the siphoning goes completely undetected, with commissions and other forms of payoff being made so discreetly that no crime is ever uncovered.
I was involved in one case where the general manager was hired at startup in China and had been there for nearly 10 years. Procurement of equipment, raw materials, component parts, tooling, and consumables, had fallen to him in the beginning and had naturally become part of his ongoing responsibilities. Even after he had a procurement department, he held on to final vendor contract negotiation and approvals. This seemed absolutely normal to everyone at the company.
Every year, the company purchased between US$ 30-40 million in materials equipment, etc., and the GM signed off on it all. No approvals, no extraordinary documentation, no muss, no fuss. Except the GM had negotiated his own 5% commission on the purchases with each of his suppliers. Nice. Let me see – 5% of US$ 30-40 million, uummmm, that’s US$ 1.5-2.0 million a year – tax-free, scrutiny-free. Wheee!!!
There’s a lot more gore and grief to this story but the short version is that the GM was thrown out after a long battle.
The happy ending is that virtually all the vendors professed relief when the regime fell and offered an immediate 5% discount on their pricing, saving the company US$ 1.5-2.0 million annually in procurement. New rules, competition and cut in the number of vendors netted the company even more gains. In my calculations, that immediate discount from all the vendors was the smoking gun, the tipoff that pointed to exactly what their deal was with the former GM.
Enforce a division of labor and responsibilities in procurement, a clear code of ethics, train against corrupt activity, monitor constantly, take special care in recruitment and vetting of procurement personnel, rotate routinely to limit vendor/buyer opportunities for misbehavior. Adopt formal mechanisms that physically and administratively separate activities, vendors, decision makers, and the items procured. This is the single most active area in China for collusive funny business, so be particularly sensitive to the goings on and the dynamics of this department. If you get hosed, it will only be because you let yourself be.
A third example: “Our GM is about the only guy in the operation who speaks any English.” I know, I know, how does this possibly present a threat to the company’s China operations?! Good question. And the answer? Well, it doesn’t necessarily, but it might. Here’s why I say that.
If this is true for your company, you are totally dependent on one person for everything related to the operation. That’s not a good practice anywhere, but in China, it is particularly dangerous.
Make sure you have more than one information source for data, information, news, and opinions – about your operation in China. Cross-check what you learn by using as many of your sources as you can.
Make it clear from the outset that your new hires at senior and mid-level will be English speakers expected to communicate with US-based counterparts regularly. Over communicate. You’d be amazed at what conversations take place over dinner, beers, etc. as opposed to formal settings such as management meetings.
So there you have it, three simple examples of behavior that might warrant further scrutiny of your China operations. But these are just the tip of the iceberg. Examples of misbehavior abound in China. It sometimes seems as though there is a scandal a day unearthed and I’m sure many more get buried and not reported.
Raise your level of awareness and vigilance in China. Protect yourself and your company by taking some simple, low cost precautions, putting in place policies & practices that remove temptations and make it harder to “game” the system for personal gain. With some attention and a little perseverance, you can gain peace of mind and avoid damage to your company. Listen to that little voice in your head and begin to explore if you stumble on something strange. You’ll learn something in the process.
Have you seen or sensed something lately in your China business that strikes you as odd?
Michael Whelan is Managing Partner of Beijing-based executive search firm The Palio Group.