Bingsheng Teng, a professor of business strategy, dissects the origins of the Danone-Wahaha implosion.
One of the most rancorous spats in the history of China's joint ventures finally wound down in late September, when French food giant Danone agreed to sell out its majority share to its estranged partner Wahaha, the Chinese beverage firm.
We spoke to Associate Professor of Strategic Management Bingsheng Teng, who wrote a case study on the dispute, about what led up to it and what it says about the potential risks of JVs.
Strategic alliances, including Sino-foreign JVs, are among Teng's research interests – though, as he notes below, he's also become increasingly interested in Chinese business model innovation and the growing trend of Chinese firms going global.
Teng, who's also an associate dean at Cheung Kong, was previously a professor of strategic management at George Washington University. He earned his Ph.D. at City University of New York.
Q: Which aspects of the Danone-Wahaha case do you cover when you teach this case in class? And how did a disagreement between two JV partners ever get so complicated?
A: When the two parties first formed the JV about 12 or 13 years ago, Wahaha didn't have much to contribute. But one of its valuable assets was its brand, which was valued at 100 million renminbi at the time.
The JV was set up as 51-49 percent deal where Danone along with a Hong Kong investment firm had the majority stake. But the government felt that a good Chinese brand should not be transferred to a foreign-controlled JV. So in order to make the deal happen, Wahaha had to do something creative.
In the end it signed two different contracts. One was a very simple contract that said the Wahaha Group would license its trademark for the JV. The other was a gentleman's agreement that said that only the JV can use the brand. So there was a de facto transfer of the brand. The feeling was that if no one complained, everything should be okay.
But then Wahaha started to create additional subsidiaries using the Wahaha brand that competed directly with the JV itself.
Q: Wasn't that the problem, at least as Danone saw it?
A: Well, over the 10-year period, Danone also acquired or invested in other Chinese companies that competed against the JV. Danone argued what it did was legal, but said its partner Wahaha shouldn't have used the Wahaha trademark.
One complicating factor is that Wahaha had been in a joint venture with Danone for over a decade. Normally an alliance would not last that long. Part of the problem is that when a relationship goes on for a very long time, the relative positions of the parties will change, but the original terms of the deal don't reflect that.
This kind of case gets very exciting when students discuss it in class. Some view it from a patriotic angle -- they want to support Chinese business versus foreign business. But you hear people arguing it from all different sides.
Q: In the past, people paid a lot of attention to Sino-foreign JVs and other partnerships. But as Chinese companies get bigger and more ambitious, are you starting to see more purely domestic alliances?
A: In a few industries in particular, domestic alliances are becoming pretty popular. Quite a few real estate companies will join with their competitors to lower risk, combine resources and so on.
I would say that domestic alliances tend to be better defined – people on both sides are more realistic. For international deals, Chinese companies have historically needed the foreign party more than the foreign party needed them, so they've ended up getting sucked into a relationship over a long term.
Q: As an academic who's studied strategic alliances, what have you learned about how to make them more effective?
A: One of my most-cited articles is on the role of trust in of strategic alliances. In the article I specify two different types of trust. One is related to the other party's competence, and the other dimension is goodwill. Goodwill has to do with whether you believe the other party will protect your interests and not do things to hurt you. These two types of trust are separate, but both need to be paid attention to.
You need to use the right structure to deal with any perceived problems of trust. For example, if you trust in your partner's competence but not in their goodwill, you'd want to make sure the structure allows you to check up on them rather easily. In that case, the deal structure should be based on equity so you can make sure both of your interests are aligned.
Q: I understand another one of your research interests is business model innovation in China. What's your take on the extent of innovation happening now?
A: I believe we're at the turning point regarding business model innovation. Up to now, a lot of business models have been imported from the U.S. For every successful U.S. model, you can probably find an imitator in China. Home Inn copied Comfort Inn, and the original idea behind Focus Media was from Canada. Ctrip copied Travelocity, and Taobao was modeled on eBay. That's how a lot of companies succeeded in the past ten years. But my view is that in the next ten years, Chinese companies will have to do better than just be copycats.
Q: What do you consider to be the most fertile area for innovation in China?
A: I think e-commerce, especially related to consumers, is probably the area with the most potential. E-commerce in general has been an area where Chinese companies excel – you have Chinese firms like Baidu and Taobao dominating in each of their market segments.
Also, Chinese companies probably have a better understanding of Chinese culture and consumer behavior. Think about Taobao versus eBay. The Paypal model doesn't work in China because of trust issues. Instead you have to send money to the seller before you can buy something online. So you sometimes have to change the model for China, and local companies understand how to do that better.
Q: I know you're also interested in Chinese firms' global strategies. In the wake of the financial crisis, some market watchers were predicting we'd see a lot of outbound M&A, but that hasn't really happened. Is that a surprise?
A: Chinese companies used to be more aggressive, in the sense that a number of them believed they could conquer the global market with brand technology products at low cost. Representative of that kind of thinking would be TCL and Lenovo and Haier. But I think these companies now realize that it will be a long way to get their fair share of the global market. Haier's approach was: if we can make it in the U.S., all the other markets will be easy. But they've had a tough fight in the U.S., and even now they can't claim to have achieved success.
Most Chinese firms have realized they need to be more creative and go for an incremental approach. That's more Huawei's approach – Africa, South Asia and South America first, then Europe, then the U.S. In China we call this moving from the country to the city, [laughs] like how the Communists took over the country. The initial strategy is, do what's relatively easy and where the risk can be contained.
Also – and you've seen this during the crisis and even before -- a number of Chinese firms are now focusing on acquisitions as a way to gain needed resources, rather than global market share. That's a really significant change in their mindset. You see this in the number of natural resources acquisitions that have taken place recently. But even companies outside the resources sector have made this type of acquisition, like [Chinese automaker] Geely purchasing Drivetrain Systems, the Australian auto parts company. Geely wanted to get the technology so it can advance on its own.
I participated in a TV show recently where some analysts were warning that it would be suicidal for Chinese companies to start making overseas acquisitions left and right. My point is that they just have to be very careful and do their due diligence well. Acquisitions may be an evil, but they're a necessary evil. After all, no Fortune 500 company ever got so big without making strategic acquisitions along the way.