Joint Venture and Wholly Owned Subsidiary in China - Case Study Example

Topic: For a Chinese firm what are the advantages and disadvantages of JV (Joint Venture) and WOS (Wholly Owned Subsidiary) with a foreign company in China? Name Course Tutor Date Table of Contents Table of Contents 2 Introduction 3 Joint Ventures 5 Shanghai Automotive Industries Corporation (SAIC) and General Motors Joint Venture (GM) 6 Advantages of Chinese firm entering a joint venture with a foreign firm 7 Advanced technology 7 Increased demand due to growth 8 Reduced risks 9 More capital/ technology upgrading 9 Improved management system 10 Easy access to foreign market 10 Government support 11 Employment 11 Disadvantages of joint venture 11 Diluted profits 11 Disputes 12 Easily affected 12 Competition between partners 12 Imbalance in the level of expertise and assets 13 Wholly owned subsidiary 13 Lenovo IBM 14 Advantages of wholly owned subsidiary 15 Financial 15 Operational 15 Gaining cross cultural experience 16 Internationalization 16 Acquiring skills and technology 17 Brand acquisition 17 Access to new customers 18 Disadvantages 18 Problems in integrating cultures 18 Higher risks 18 High exit cost 19 High cost of operation 19 High political risk 19 Conclusion 20 References 21 Introduction Chinese economy growth has been positive since adoption of open door policy. The Chinese government allowed foreign firm’s to invest in the country through partnership with local firm (Wong, Tjosvold & Yu, 2005). Most of the international firms have entered into Chinese market for business opportunities through Foreign Direct Investment (FDI). The main aim of the foreign multinationals in the Chinese market is to maximize quality at a low cost. For foreign firms, having a Chinese partner helps in creating larger home market, acquiring new assets and ease of business operation in china (Lee, Pae & Wong, 2001). The Chinese government encouraged foreign firms to form joint ventures with local firms. This was meant to help the local companies in acquiring technology and management skills (Ding, 2011). Initially, most of the partnerships in Chinese market were joint ventures. The government had set up policies that ensured foreign firms entering the market formed joint ventures. Wholly owned subsidiaries started gaining prominence from 1997. The type of partnership that is taken by the Chinese firm with foreign firm is determined by several factors (Yiu & Makino, 2002). These factors include the government policy, management and the type of investment. For the Chinese firm to fully benefit from partnership with a foreign firm, the advantages and disadvantages of the two methods of market entry have to be looked at. The increase of foreign investment in the country and the expansion of the local industry has led to increase in joint ventures and wholly owned subsidiaries (Chang, 2013). One of the most successful joint venture was formed between General Motors and Shanghai Automotive Industries. This partnership was formed as equity joint venture with each firm contributing 50 percent of the interest. Wholly owned subsidiaries have also been formed and succeeded. One of such wholly owned subsidiary in China was between Lenovo computers and IBM-PC which is an international firm. This report will look at both Joint Ventures and Wholly Owned Subsidiary in China and disadvantages and advantages of a Chinese firm entering into a joint venture or wholly owned subsidiary with a foreign firm. This will be achieved by looking at characteristics of both ventures and analyzing those using examples of Lenovo and IBM for WOS and Shanghai Automotive Industry partnering with General Motors for joint venture (JV). Joint Ventures A joint venture is formation of business between two partners through a strategic alliance. The alliance involves sharing of risks, combining the resources and being quick in response to changes in the market. The Chinese government encouraged joint ventures with incentives such as tax breaks, low labor costs and reduced production costs. Through joint ventures, the operation cost of the business was reduced through the government initiative. The Chinese government favored the joint ventures due to transfer of technology, skills and job creation (Deng, 2006). There are three types of joint ventures. These are contractual joint venture, corporate joint venture, and unincorporated joint venture. Contractual joint venture involves an agreement on terms and conditions of transacting the business. This form of joint venture offers the best solution for the short term venture. The venture does not require dissolution procedures as with other types of joint ventures. A corporate joint venture requires the setting up a corporate that is separate from the ventures. This makes venture to have its own legal entity (Hill & Charles, 2003). The unincorporated joint venture also requires setting up the venture with a separate legal entity from its owners. The main difference from a corporate joint venture is the type of legal entity that is formed. This type of joint venture is in some cases restructured as a limited liability partnership, limited partnership or limited liability company (Douw & Chan, 2006). Joint venture is associated with limited liability which makes it attractive to many of the investors. Before embarking on the advantages and disadvantages of joint venture, there is a need to analyze an example of one of the most successful joint venture in China. This will involve looking at the joint venture between Shanghai Automotive industries and General Motors. Shanghai Automotive Industries Corporation (SAIC) and General Motors Joint Venture (GM) General Motors (GM) and the Shanghai Automotive Industries Corporation (SAIC) formed a strategic partnership with each of the firm contributing 50% of the equity. This led to formation of Shanghai General Motors. The joint venture was regarded to be the biggest foreign investment in China in 1997. The Chinese company entered into this agreement where none of the partners had absolute control of the business. The Chinese automotive industry is supported by the government through subsidized taxes. According to Chinese government regulations on Joint ventures, both companies must benefit from the partnership. The joint venture has to consider rules and regulations that govern partnership in the country. This was the case when Shanghai Automotive Industries corporative entered into partnership witch General Motors. For SAIC to become an international automotive manufacturer, the company had to partner with General Motors. SAIC had been involved in other joint ventures with Volkswagen in 1980s. This led to the company early success in the automotive industry. This success motivated the Chinese company to form joint venture with General Motors. The formation of joint ventures with foreign firms marked the company internationalization procedure (Tao & Ho, 2005). Apart from joint venture with General motors, the company has been involved in several expansion strategies through joint venture. The Chinese company has been a key player in acquisition of Korean motor company Daewoo by general Motors. In the year 2004, the company acquired a 48.9 % stake of another Korean company Ssang Yong (Tao & Ho, 2005). These efforts show the aggressiveness of the Chinese motor company in entering into joint ventures. The Chinese company has been able to gain knowledge from the Western companies on the vehicle manufacturing technology. This has led to the company expansion to the Europe and Asia. On the other hand General Motors benefited from the Joint Venture. Being a foreign company, entry to Chinese market led to a lot of benefits. The company operation in the United States was faced with problems due to high labor cost and competition. To enter into the Chinese market, the company needed a partner who knew the market dynamics in china. SAIC had been in operation in china and was more acquainted in the Chinese market. This is one of the most success joint venture between a Chinese firm and a foreign firm (Tao & Ho, 2005). Advantages of Chinese firm entering a joint venture with a foreign firm For a Chinese firm to partner with a foreign company, there are several advantages that are associated with it. The Chinese firm is able to benefit from the following. Advanced technology The Chinese partner is expected to gain advanced technology from the foreign company. This was the case that SAIC expected to benefit from ion their joint venture with General Motors. The General motors have helped SAIC in improving and developing the company facilities. This has been evidenced through general motors efforts to modernize SAIC sourcing operations. SAIC have benefited from the relationship through gaining a competitive sourcing that is used by the General motors. According to the Chinese law on joint venture, the partnership is supposed to help the Chinese company with technology through a mutual benefit principle. The Chinese law on joint venture requires the foreign partner to contribute advanced technology and equipments which are in line with the Country needs. The law is also clear that if the foreign firm uses outdated technology or materials, it is supposed to pay compensation. From this, SAIC have been able to benefit from the advanced technology provided by the joint venture partner. General Motors worked in making sure that SAIC were able to get the advanced technology. This led to highly advanced manufacturing in china. By looking at the GM-SAIC joint venture, it’s evident that SAIC was able to get its side of bargain in technology (Tao & Ho, 2005). GM started by setting up training programmes in the Chinese Universities. These programmes were meant to train the local talent into high technology vehicle manufacture. General Motors was also able to set up a research and development firm. This was meant to help the Chinese Engineers achieve the latest designs used by General Motors. The local research and development center set up by the General Motors costed them 50 million dollars. The Pan-Asia Technical Automotive Center (PATAC) was meant to work with SAIC on design and reengineering. Under the General Motors initiative, Chinese engineers had the chance to be sent to North America where they were supposed to observe and learn on the start-up operations used by the General Motors (Tao & Ho, 2005). Increased demand due to growth Joint ventures with a foreign firm lead to growth of the partners. The expansion is expected to bring in high demand for the products. When SAIC partnered with GM, the company was able to expand in China and also establish business connections in world market. The joint venture was able to reach the set four years target and surpass it. In 2007, Shanghai general motors became the largest Chinese vehicle manufacturer. SGM was able to capture 11.7 percent of the local market. The joint venture helped SAIC gain resources such that it has been able to purchase other firms. During 2004, SAIC was able to acquire Nanjing Automobile group. The company has also been able to acquire MG rover brand as well as the intellectual rights on two of its rover platforms. Other acquisitions that the company has been able to achieve are Korean SsangYong Motor Company, where it took 49 percent of the company stake. Joint venture if well executed helps both partners to expand in the business (Tao & Ho, 2005). Reduced risks Joint venture helps the business to minimize their risk while expanding. The companies that are involved in a joint venture share their resources which make the risk much lower. The partners have different types of resources. A foreign firm is endowed with resources such as technology, capital and intellectual rights. The local firm has access to the market and labor. The local firm may also have property, but facing problem on expansion. Though joint venture, the firms reduces their risks. The local firm is able to benefit from partner technology while the foreign partner is able to access the market easily and is able to gain cheap labor. GM joint venture with SAIC helped the partners reduce risks. This is due to fact that the companies could share the business risks according to their contribution. In case of loss, the partners are able to share as opposed to a wholly owned subsidiary (Douw & Chan, 2006). More capital/ technology upgrading The joint venture helps the local firms acquire more resources and upgrading of the technology. The joint venture between GM motors and SAIC led to SAIC gaining more resources and upgrading of its technology (Douw & Chan, 2006). Improved management system Joint venture is able to equip the local firms with new management techniques. This was evidenced by the joint venture between GM and SAIC. During the joint venture, there was increased competition in the Chinese market. GM took the mandate of managing the distribution network in china. This helped in establishing a robust network in the country. The joint venture had given the rights of establishing the distribution network to General Motors. General Motors were able to set up a distribution network that was similar to the one it used in United States. The distribution network management style helped the venture to maintain the local market despite the competition (Douw & Chan, 2006). Easy access to foreign market A joint venture with a foreign firm can enable the Chinese partner to enter into global market more easily. This was the case of SAIC and GM joint venture. Through the joint venture, SAIC has been able to enter into international market. Initially, SAIC was a local company with its operation mostly based in China. The company has become a multinational through forming joint ventures with multinational companies (Yan, 2000). Government support In china, the set laws favor joint venture. According to the set laws, the joint venture are subsidized by the government and are able to access help financial help from the government. Having government support is important especially during financial problems such as recession. The Chinese government control on joint ventures favors the local partner. Thorough the joint venture SAIC was able to get support from the Chinese government which has enabled the company to expand (Tao & Ho, 2005). Employment The formation of joint partnership with a foreign firm leads to employment of the local population. This is evidenced with the joint venture between GM and SAIC. The company employees were retained and retrained to get the market skills (Tao & Ho, 2005). The expansion of the joint venture between the two firms has led to more jobs being created. This has helped the government reduce the rate of unemployment in the country. Disadvantages of joint venture Diluted profits The profits that are gained through partnership are shared. This sharing of the profit is shared by the partners depending on their contribution to the venture. In the case of SAIC and General Motors, the two firms have to share the earnings they make (Douw & Chan, 2006). Disputes Joint ventures in most cases are prone to disputes. This is experienced especially if the management philosophies of the partners collide (Makower, 2001). The partners may later discover that they are not compatible to each other leading to a dispute. Some of the disputes lead to dissolution of the company. The joint venture between SAIC and GM has also been speculated to be in dispute. This was when SAIC started expanding out of china independently. Though these allegations were later denied, this is an example of how it is easy for joint venture to have dispute despite its success (Yan, 2000). Easily affected Joint ventures are easily affected by factors such as economic performance, the type of regulations, technology matters which makes them venerable. Lack of proper strategy can lead to the venture failure. There is need to have adequate efforts focused on having a good strategy and proper planning. The SAIC and GM joint venture had a proper strategy that enabled the venture to survive and thrive (Douw & Chan, 2006). Competition between partners Joint ventures are prone to creating a competitor among the partners. A Chinese firm entering into a joint venture may find that the foreign partner is a source of competition. This issue is addressed though making legislation during formation. The legislations should forbid the partners from competing, soliciting and have confidentiality provisions (Douw & Chan, 2006). Imbalance in the level of expertise and assets Joint ventures include the members contributing to the venture in terms of assets and expertise. A partner may find that their contribution to the partnership is low which leads to lesser control. A Chinese firm entering into a partnership may find that they have less expertise than the foreign partner. Unless addressed during formation of partnership, this can lead to collapse though disputes (Yan, 2000) Wholly owned subsidiary Wholly owned subsidiary is a venture in which a company is fully owned by parent company. The parent company takes the charge of all the subsidiary assets and has the mandate to select the board of directors. For a Chinese company to enter into this arrangement with a foreign company there is complete ownership of all its assets and management. The Chinese company can choose to be the parent company or the subsidiary depending on the arrangement (Yan, 2000). This was evidenced in the Lenovo IBM case. Lenovo was able to take full control of IBM which is a foreign company. In wholly owned operation, the company has a complete ownership in the foreign company. The company takes higher risks as compared to the joint venture. This type of venture is a foreign direct investment. This acquisition requires the Chinese company which has taken up a foreign company to be accepted. The acceptance of the parent company by the host company determines a lot in success of the wholly owned subsidiary (Hofstede & Hofstede, 2005). If the Chinese firm is to act as a subsidiary to the foreign firm, it’s wholly absorbed together with its assets. Gaining legitimacy is one of the most difficult issues that wholly owned subsidiaries face. In China, wholly owned subsidiary has been popular where foreign based companies have used it as an entry mode. Through analyzing the wholly owned subsidiary between Lenovo and IBM, the benefits and limitations of this type of venture for a Chinese firm with a foreign firm can be well understood. Lenovo IBM Lenovo is a Chinese company that made a successful acquisition of a foreign company IBM. Lenovo has been in the computer industry for a long time and is the leader of the PC market in China (Ling & Avery, 2006). Lenovo is based ion Beijing China. The company before acquisition of IBM PC was ranked as number nine globally in the personal computer industry. On the other hand, IBM is a personal computer company based in USA. The decision to fully acquire the IBM personal computers division was deliberated in 2004. The company entered into the personal computer industry in 1990. The company was able to achieve great success within six years, which made it the leader in Chinese market. IBM has a longer history being founded in 1896 (Mo & Mei, 2004). Before Lenovo acquired IBM, the company was having a world market share of 2.2 percent. The acquisition of IBM made the company to rise in the global market. Lenovo had tried to become a global player through several ventures such as diversification without success. The merger with IBM helped the company expand into the PC industry (Terence & Jerome, 2005). The acquisition was one of the china investments into foreign markets. Acquisition of a company is associated with uncertainty for the acquired company. There is poor communication which, in some cases leads to chaos. This was not experienced in the IBM-Lenovo scenario. The Chinese firm took advantage of the IBM strategic and powerful global sales and distribution network. Lenovo was able to take care of cultural integration which made it possible to enter into a wholly subsidiary mode of business with IBM. For a Chinese firm entering into this type of business entry arrangement with a foreign firm, there are pros and cons (Quelch, 2006). Advantages of wholly owned subsidiary Financial A Chinese company entering into a wholly owned subsidiary is able to gain more finances. The company acting as the parent company has a chance to consolidate all the returns from the subsidiary into a single financial statement. The revenue that is obtained from the subsidiary can be used in expanding the parent company, business or investing in other areas. The integration of two firms leads to pooling the funds together with technology systems which helps in saving the company’s cost. By becoming the parent company, Lenovo was able to consolidate the funds from IBM and help in its expansion. Lenovo acquired resources such as information technology system used by Lenovo PC which helped the company to reduce the cost (Quelch, 2006).. Operational The parent company has the full direct or indirect control of the subsidiary. The parent company is able to make decisions to the subsidiary and can initiate management changes. The combined venture can use its large size to have a bargaining power with suppliers (Stanwick, 2000). After attaining the position of the third biggest PC producer in the world, Lenovo was able to bargain for supplies at a lower cost. This leads to better terms of services with the suppliers. The wholly owned subsidiary can take advantage of each others knowledge on management and technology which leads to reduced cost. Lenovo was able to benefit from the IBM management style and technology. Upon acquiring IBM, Lenovo maintained the IBM structure of management in the subsidiary. This helped in reduce conflict which could have arisen from the management of the employees (Quelch, 2006). Gaining cross cultural experience By acquiring a foreign firm, a Chinese company will be able to benefit from culture integration. The merger of two companies from different culture leads to culture integration. The cross cultural experience helps the parent company in understanding the global business environment. For Lenovo, acquisition of IBM led to the Chinese company being introduced into the Western country management culture. Lenovo did not fully integrate the two companies but encouraged a separate management mode. This enabled IBM to maintain its own management style despite being a subsidiary. An intercultural team was set up by Lenovo to make sure that the two management teams were communicating in the right way. Lenovo has employed accommodation principle to manage the crisis that has come out between the two teams (Pioch, 2007). Internationalization Acquiring a foreign company is an easy way for a Chinese firm to become a multinational. This is because the firm is able to reach the global market easier through using the foreign company network. Looking at the Lenovo computer acquisition, the company was able to increase its sales after acquiring IBM. Lenovo global market position increased and the global scales became high. The liberalization of Chinese market had led to increased competition from other multinationals. This had led to price wars between the PC sellers in Lenovo home market. This meant that for Lenovo to maintain a competitive edge in the computer market, it had to venture into the global market. The acquisition was the best route for Lenovo to become a computer market leader (Quelch, 2006). Acquiring skills and technology Acquiring a foreign firm has an advantage in gaining new technology skills. The parent firms have the rights to use the technology skills that the subsidiary has for the business expansion. Lenovo was able to access the IBM technology and skills through acquisition. The research and development skills that were utilised by the IBM become part of Lenovo. By combing the skills with the parent companies, the integrated firm has the capability to become one of the world biggest PC Company. Technology and skills were the biggest benefits that Lenovo was able to gain form the integrating with IBM. The acquisition was a key player in making Lenovo a global company (Quelch, 2006). Brand acquisition Building an international brand is an uphill task. Mostly of the companies that enter into wholly owned subsidiaries understands this. For a Chinese company that wants to become a global leader, there are several challenges that must be overcome. For Lenovo, the company needed to create a brand name so as to succeed in the international market. Lenovo signed a deal in which they were supposed to use the ThinkPad brand for a period of five years. This was the first step in making sure that Lenovo entry into the global market was successful. Using a well known brand helps the company to gain a good impression from the customers. This helps the parent company to push sales higher and marketing the products as high end to the consumers (Quelch, 2006). Access to new customers For a local Chinese firm, accessing new customers is a hard task. The company has to internationalize its operations so as to gain new customers. Looking at Lenovo case, the company had already captured the local market and had reached a peak position. The company needed to have new customers from the international market so as to be successful. By acquiring IBM-PC, the company widened its customer base internationally (Quelch, 2006). Disadvantages Problems in integrating cultures Acquiring a foreign company involves acquiring a different culture in management and operation. Integrating the two cultures proves to be a great task for the parent company. In the case of Lenovo, the company had to integrate the two different corporate cultures and the national cultures. The IBM corporate culture was totally different from Lenovo corporate culture. If the parent company lacks skills in managing the different cultures, it may lead to failure of acquisition (Stanwick, 2000). Higher risks Wholly owned subsidiaries have more risks than joint ventures. The risk is not spread between the companies. If the business fails, the parent company has to absorb the whole amount incurred in losses. A Chinese firm that enters into a wholly owned subsidiary takes a higher risk. For Lenovo, the acquisition of IBM was a risky venture. If the venture did not succeed, the Lenovo would have lost their bid and could not share losses (Stanwick, 2000). High exit cost Wholly owned subsidiaries face high costs if they have to switch their operation form a certain region. If there is political instability or another condition that leads to problem in maintaining the busssiness, the wholly owned subsidiary may be forced to close down. The cost of exit in such a situation is high and the company may not be able to recover from the losses. For Lenovo, incase such a situation arises, the company will have to bear the loss of both itself and the subsidiary. There is no sharing of the losses (Stanwick, 2000). High cost of operation The parent companies have the responsibility of planning, marketing, organizing, and resource allocation. The parent company has to invest heavily on the subsidiary and have to pay for the investment in the host country. This makes it more costly and risky to manage a wholly owned subsidiary. The high cost of the investment in the wholly owned subsidiary makes it hard and risky to switch operations. For Lenovo, the parent company had to invest heavily on IBM PC business. This was in form of paying for the total coast of the IBM pc assets and management in the host country. In case Lenovo failed, they would have suffered high costs (Stanwick, 2000). High political risk Wholly owned subsidiary are highly affected by the political situation of the subsidiary. If the host country goes under instability, the parent company faces high chances of dissolution. Joint ventures are supported by the host countries, unlike the wholly owned subsidiary. Though the entry of wholly owned subsidiaries has been recently supported by the Chinese government, more support has been accorded to joint ventures. The case of Lenovo acquisition of IBM did not face political risk. This is due to fact that the host country for IBM was in a stable state and offered a good business platform (Schraeder & Self, 2003). Conclusion For a Chinese firm, each market entry mode has its advantages and disadvantages. Entering in to a joint venture has been one of the most supported business entry mode in china. The advantages that a Chinese company can get from joint venture are many as explained. The company will be able to gain new technology, employment for locals’ skills and access foreign market. The main disadvantages are disputes, competition among partners, diluted profits and imbalance in level of investment. Despite the disadvantages, SAIC and GM joint venture has been very successful. Using wholly owned subsidiary as the market entry mode, the Chinese firm is set to gain from new market through acquiring new technology and internationalization, new customers, brand acquisition among others. This mode of entry is associated with higher risks, high operation costs and exit costs. Lenovo and IBM are an example of wholly owned subsidiary which has been able to succeed through this market entry method. Lenovo being a Chinese firm, its choice to buy a foreign firm have proved that wholly owned subsidiaries can succeed if well managed. From the discussion, it’s evident that whichever mode of entry a Chinese company will choose, there are both advantages and disadvantages that have to be evaluated. There is no market entry mode that is optimal as business environment is dynamic and unpredictable. Chinese company has to evaluate its resources, strategy and objectives before choosing an entry mode. References Chang, S.-J. 2013. Multinational firms in china: entry strategies, competition, and firm performance. Oxford, Oxford university press. Deng, P. 2006. ‘Investing for strategic resources and its rationale: The case of outward FDI from Chinese companies’, Business Horizons, Vol.50, no.1, pp. 71-81. Ding, Q., 2011. 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