Why Companies Entering China Must Carefully Consider Their Partners

 |  Includes: CAJ, CL, DELL, FLEX, MAT, WMT
by: Shaun Rein

I was just in Beijing helping one of our Fortune 100 clients in the chemical industry conduct interviews to determine a China expansion strategy. I was staying at one of my favorite hotels in Beijing, the Westin Finance Street (HOT), near where luxury retailer Lane Crawford’s new flagship in China is soon opening.

The traffic seems better in that part of Beijing than where other hotels like the Marriott (NYSE:MAR) or Hyatt are located. Anything that can minimize the unpleasantness of Beijing's snarling traffic and obscene pollution is welcome.

Anyway, I was sitting down to enjoy a glass of wine one night in the lobby lounge when the sound of smashing glass jarred my ears. I looked up to see a man gesticulating like Howard Dean and squawking like Jim Cramer.

I made my way to the crowd milling about to see what caused the hubbub. It seemed that it was a big celebration/ meeting for Canon (NYSE:CAJ) and its distributors. Although it was supposed to be a happy occasion, some argument about Japan-China relations had caused the outburst and left me interrupting my leisure hour to watch a group of security guards tackle a nut-cake like Lawrence Taylor tormenting poor quarterbacks in the heyday of the Giants.

This incident reminded me of a key point for doing business in China that we emphasize to our clients.

MNCs need to choose their distributors and supply-chain management partners wisely in China not just for QC, price, and intellectual property issues but also for the PR issues that can damage image and erode brand loyalty.

Mattel (NASDAQ:MAT) is only the most recent high-profile company to suffer from China’s piracy and quality control issues and be raked over the coals by the international press.

Part of the problem is that companies like Wal-Mart (NYSE:WMT) have been leaning on suppliers to provide cheaper and cheaper prices to fuel the consumption of price sensitive American consumers. With inflation in China skyrocketing (inflation is a huge problem as egg, pork, and metal price increases are starting to hit even the small vendors on the street who have increased their prices by 50% in the last 3 months), suppliers are trying to find ways to lower their costs. Unfortunately, many suppliers and partners do not focus on improving their processes but instead switch out more expensive ingredients for bad ones.

MNCs need to seriously think about their partners when they enter China from a corporate responsibility standpoint rather than purely from a price or intellectual property view. Aside from making sure the products one buys look good enough and are cheap enough, MNCs need to pick partners who are unlikely embarrass them in the future.

With the rise of the internet, Chinese netizens aggressively monitor corporations and when they perceive wrongdoing attack companies like Dell (NASDAQ:DELL) or Colgate (NYSE:CL) in chat rooms. Companies need to consider how a potential partner might damage their international standing. Last year when massive OEM manufacturer FoxConn was criticized by some of its employees for bad labor conditions world headlines focused instead on MNCs like Apple (NASDAQ:AAPL) even though Apple itself had not done anything wrong. And FoxConn is a better player than most OEM manufacturers that have dubious policies in place to protect their workers.

Although it might be more expensive in the short-term to work with these good players, the long-term benefits will become evident. I see a consolidation in the OEM sector with big players like FoxConn or Flextronics (NASDAQ:FLEX) gobbling up the little players. Investors should take note because MNCs will need to source from bigger houses with international standards or build their own factories and own enough of the supply chains themselves.

Just imagine the furor in the blogosphere if netizens had seen the fight over Japan-China relations with Canon’s logo in the background. Canon should have done a better job of working with distributors and preventing their partners from getting drunk and rowdy. Obviously it is difficult to control a large distributor, but MNCs need to spend more time vetting out partners and suppliers from an image standpoint.

In today's Internet era, reputations can be blown in a matter of seconds.

CMR Analyst Ben Cavender contributed to this article.