How to Avoid Getting Burned in China and India

The recently concluded Danone (DANOY)-Wahaha feud holds important lessons for any company on how to structure and manage strategic partnerships in markets such as China and India.

In the late 1990s, France's Groupe Danone entered into several joint ventures with Hangzhou-based Wahaha Group to pursue opportunities in China's beverage market. Although Danone held a 51% ownership stake in the JVs, it assigned only a handful of managers to work in them. As a result, its control over and visibility into their operations and finances appear to have been extremely limited. Real control rested with Zong Qinghou, founder and chairman of the Wahaha Group and, by all accounts, a brilliant entrepreneur. The feud surfaced in 2007 when Danone alleged that Zong's independently owned companies had been manufacturing the same products with the same trademarks as the JVs, selling them through the latter's sales and distribution channels. The dispute ended in October 2009 when Danone agreed to sell its stake to Wahaha at a 21% discount to the book value.

In emerging markets such as China and India, regulatory requirements and lack of local knowhow often compel companies to work with local partners without the ability to hold complete or even a dominant ownership stake in the local operations. Thus, the question is not whether Danone should have entered into the JVs in the first place. Rather, the relevant question is whether Danone could have been smarter at structuring and managing its partnership with Wahaha.

Cases: GM in China, Wal-Mart in India

Danone's is hardly an isolated case. Consider General Motors in China. Chinese government policy prohibits foreign companies from owning more than 50% of the equity in any vehicle assembly operation in China. Consequently, GM operates in China through multiple joint ventures, all of them with one or more units of Shanghai Automotive Industry Corp. (600104:CH)—one of China's largest auto companies with publicly stated global ambitions. GM's ownership stake in each of these operations is 50% or less. In every one of these ventures, SAIC has an equal or greater ownership stake. Importantly, more than half of what GM reports as its auto sales in China comes from one entity, SAIC GM Wuling Automotive, a joint venture in which SAIC is the majority owner.

Given these ground-level realities, might it be that it is SAIC which sits in the driver's seat when it comes to the two companies' strategic partnerships in China? It is hardly a surprise that, in December 2009, SAIC and GM agreed to a transformation of the ownership structure for Shanghai General Motors, the main joint venture between the two companies, from a 50-50 share to a 51-49 share with SAIC becoming the majority owner.

Consider also the case of Wal-Mart (WMT) in India. Indian government regulations do not permit foreign multibrand retailers to hold any equity stake in a retail operation in the country. There is no such restriction on wholesale operations, though. Consequently, Wal-Mart operates in India via two strategic alliances with Bharti Enterprises, one of India's leading business groups. One of these, Bharti Wal-Mart Private Limited, is a 50:50 JV that opened its first wholesale cash-and-carry outlet (branded "Best Price Modern Wholesale") in northern India in May 2009. The second is a contractual collaboration whereby Wal-Mart provides retail technology and knowhow to Bharti's own retail stores. Given Bharti's publicly stated ambition to become one of India's big retailers, it is difficult to rule out the possibility of a strategic conflict between the two companies at some point in the future.

These types of partnership arrangements in core business operations create a dilemma for multinational companies: how to exercise adequate strategic control in the absence of a dominant ownership stake? The goal can never be absolute control. In a rapidly changing economic and technological environment, absolute control may be neither desirable nor feasible. However, too little control over strategically important operations is also undesirable as it puts the company's future destiny in the hands of entities whose strategic agendas may be at best divergent and at worst in direct conflict with the company's own strategic agenda.

Four Proposals

In contexts where a controlling ownership stake is simply not possible (and, often, even when it is), companies face an important managerial challenge: how to build the ability to exercise adequate strategic control over the partnership? We propose four such mechanisms.

First, disaggregate your business operations in the host country and work with a different partner for each operation. Toyota offers an interesting contrast to GM in China. Unlike GM, Toyota (TM) has set up separate JV operations with two different local partners, FAW Group and Guangzhou Automobile Group. The separate JVs focus on different models aimed at different market segments. Our interviews with auto industry executives in China suggest that this disaggregated approach has made Toyota less dependent than GM on either of its JV partners.

Second, pick partners whose strategic agendas are likely to be complementary to rather than competitive with your own. Given Bharti's ambitions in the retail sector, it is not unlikely that the long-term strategic agendas of Wal-Mart and its Indian partner may be fundamentally in conflict. In contrast, consider the case of SABMiller (SBMRY), the world's second-largest beer company. Its China operations are run via a 49:51 JV with China Resource Enterprises (291:HK), a state-owned conglomerate whose primary goal is to earn an attractive return on investment rather than to become a global powerhouse in beer. As such, SABMiller is less likely to run into strategic conflict with its partner than may turn out to be the case with Wal-Mart in India.

Third, ensure that you have the formal authority to appoint some of the key managers to run the joint venture and have adequate visibility into the JV's operations and accounts. Clearly, this mechanism may be non-viable in situations where the multinational company has no equity stake in the partnership. However, as illustrated by the Danone-Wahaha case, there exist far too many cases where, despite a sizable ownership stake, the multinational company has been negligent in establishing these control mechanisms.

Fourth, cultivate indirect control over the partnership by controlling the ecosystem surrounding it. Here too, the differences in Toyota's vs. GM's approaches are illuminating. Unlike in the case of vehicle assembly operations, Chinese government regulations do not restrict foreign multinationals from holding a controlling ownership stake in operations that manufacture parts or subsystems to feed a vehicle assembly venture. Toyota holds a controlling 70% stake in its engine JV with Guangzhou Automobile Group. In contrast, GM owns a less than 50% stake in its engine JV in China. It is SAIC that appears to be in the driver's seat.

Given the rapid growth of emerging economies and the multiple regulatory as well as market challenges that these economies represent, companies have little choice but to deepen their engagement with them even if it means not having a controlling ownership stake. The future, however, will belong to those companies that can figure out how to do so smartly without losing their shirts.