In his ongoing series for Splash looking at how to conduct business in the People’s Republic, Charlie Du Cane, the head of Clipper (Hong Kong), today looks at the nation’s state-owned enterprises.
State-owned enterprises (SOEs) are a hot topic at the moment as the current Chinese government struggles to deal with how much overcapacity there is in certain sectors, normally with over subsidized, over staffed, and over protected SOEs as the main culprits. A quick search of the internet will show much hand ringing on how to effectively combat this, with mergers, lay-offs and forcing them to face market realities all emerging as possible solutions.
This post is not going to focus on these attempted reforms, but rather give some pointers on how one should engage with the SOEs as a foreign business in China. Attempts at reform aside it is apparent that they are going to be central to business in China for decades to come.
Same bed, different dreams
An old China hand pointed something out to me on the website of a Chinese steel mill recently. In English, its front page spoke about quality, profitability, vision, mission and values. All normal for a listed company. In Chinese it spoke of capacity, the need to fulfill its mission laid down in the latest Five-Year Plan, and other political goals. It’s vital to understand that, whilst the English version is what they increasingly strive for, the Chinese version is where their soul is. A Financial Times article highlighted this issue neatly, asking why the almost permanently loss making Chinese state-owned shipowners are building ships, harming the chronically over capacitated sector further. It’s a product of fulfilling targets on how much cargo should go on Chinese vessels, using up space in that perennial job creation scheme, the Chinese shipyards, and taking advantage of all the perks SOEs enjoy in terms of cheap financing. In other words, decisions aren’t made for business reasons alone in SOEs and it’s easy to get burnt if you ignore the political surrounding scenery.
How do foreigners get into that bed?
Scare stories like Tim Clissold’s Mr China aside, there are many long-term successes that foreign companies have made in China, and SOEs have been central to that success. Look at the motor industry for example. Following Volkswagen’s lead in 1984, successive companies have come in and, eventually, made successes of it. Always they are in JVs, always with an SOE. The success here has been about technology transfer, introduction of management techniques and the access to brand value coming from the foreign partner, which is given market access in return.
These are all normal things that can be taught in a business class but sometimes what the SOEs want is not about business but about a longer term political view.
About 10 years ago I was a struggling young chartering manager in a Hong Kong listed shipping company. One day I unexpectedly received a call from an SOE. “From now on we are making you exclusive on all our cargoes from X port to China, as long as your freight is competitive.” For a period of months so it was, rescuing my flagging career in the process. Afterwards I discovered that there had been a corruption unearthed within the SOE resulting in one person going to prison for a decade. They had then decided the freight traders could only sign freight deals with reputable international companies.
Another anecdote about this is the managing director of a foreign company in China had overseen the creation of a JV that quickly became a cash cow for the parent, embarrassingly profitable. He approached his counterpart in the Chinese entity and said: “Is there anything we can do for your company as a gesture of appreciation?” He expected to either hear them say please give us more of the profits, or an uncomfortable request for personal advantage. The answer given surprised him. “Your company has the best training programme in the world. We want to put 20 new graduates from China through it every year. Afterwards they will return and work for us.”
The danger zone
If one looks at the trajectory China has taken in the last 40 years, one cannot fail to be impressed, and no one can deny the value the SOEs have played in this. To misquote a Chinese phrase, there would be no new Chinese economy with the SOEs. However, there is a philosophical problem with SOEs and it is vital to understand. Where the business they are involved is more domestically focused, more around manufacturing or technology, the more successful they have been. However, the more commoditised, the more international, and the more need for trader mentality that is required in a sector, the more they have consistently come up against difficulties. There have been some disastrous purchases of commodity assets in foreign countries over the years, some hedges that have spectacularly backfired on various derivatives markets, and terrible overcapacity in most raw material refineries now exists. It comes down to the philosophy of the SOE being an instrument in the building of the nation. As an institution, they are geared to going long in whatever they are doing, and when you are in a business that requires one to trade short and long in equal measure, sooner or later you will always get into trouble.
The aftermath of such troubles can often be brutal for the foreigners involved. It’s not so long ago that the Chinese government supported defaults on losing derivatives trades, claiming these trades were too complicated for the innocent Chinese players to understand. Chinese carriers, such as Cosco tried to get away from high charter rates by withholding hire from owners to pay ‘domestic taxes’. Most sinisterly of all people’s lives get destroyed when things go wrong. Most people remember the Stern Hu/Rio Tinto arrest as a corruption scandal. Whilst corruption may well have played its part, I remember it as a reaction by the Chinese buyers to their inability to control fast increasing iron ore prices. Ten years in prison is a tough price for anyone to pay for a negotiation going wrong.
The SOEs accurately represent the stunning growth of China over the last few decades. However, they also represent some of the great contradictions of modern China. Nimble and bureaucratic, commercial and political, modern and sclerotic, they are difficult to understand even for seasoned China watchers. What makes them especially difficult to understand is that they are not acting as rational businesses that thrive or die based on market forces. Rather they are, in part, tools used by the state for the creation of the modern Chinese economic superpower.