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EXPERIENCE HBR.ORG

Case Study Katherine Xin is a professor of management, an assodate dean atChina Europe international Business School (CE105), and the editorof HBR China. Wang Hillife is a senior editor at HBR China.

The Experts

Xu Muth* is the formerCEO of TNT mainlandChina's subsidiary TNT Moan.

Mang Tianbing is theglobal vice president andthe director of the ChinaResearch Center at A.T.Kearney.

MR Heft fictionalized case studies present1.4J dilemmas faced by leaders in real compa-nies arvi of solutions from experts. This one isbased on a teaching case at China Europe Inter.national Business School in Shanghai.

T

he room was already packed whenLiu Peijin walked in. His flight fromShanghai to Chongqing had been de-

layed„ and he had fretted about missing thetraining. But fortunately he'd gotten therein time. Liu knew his presence was impor-tant As the president ofAhnond China, hewanted to show his Chong** colleagueshow much he cared about the topic underdiscussion: ethical business practices.

Taking his seat, Liu nodded at thehead of HR, who was running the train-ing. The two went way back: Both hadbeen with their German parent company,Almond Chemical, since 1.999, when itfirst established operations in China. Sincethen Almond China had set up two jointventures with local partners--the only wayforeigners could do business in chemicalsin the country. Almond controlled 70% ofthe stock in one of them. The other was aventure with Chongqing No. 2 ChemicalCompany, in which Almond had a 51%stake and theChinese directors were veryactive.

Liu sat next to Wing zhibao, the vicepresident in charge dales for the Chong-qing joint venture. Wang looked skeptical.He was good at his job, having closed sev-eral key deals that had kept the businessafloat during its early years. But he wasalso at the center of a conflict between theventure partners: The Chongqing execu-tives were increasingly vocal about howdifficult it was to operate according toEuropean standards, particularly the rulesagainst gifts and commissions. Such incen-tives were commonly accepted in Chinaand routinely employed by Almond'scompetitors. Trying to do business withoutthem, Wang argued, was foolhardy. "Thisis China, not Europe was his refrain.

But the line between these practiaesand brealdng the laIN was a fine one. Al-mond was headquartered in lviunich andlisted on the New York Stock Exchangeas well as the Frankfurt Stock Exchange.,meaning ft was required to adhere to theU.S. government's Foreign Corrupt Prac-tices Act, whidt specifically forbade the

110ternber 20ii Harvard atitimiss Review sag

Should a German-Chinese joint venture followthe ethical rules of the parent company or thecountry of operation? by Katherine Xin andWang Hoyle

CultureClash in theBoardroom

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EXPERIENCE

bribing of foreign government officials byU.S.-listed companies.

Liu kept an eye on Wang as the HRdirector explained Almond's ethicsregulations and the legal consequencesofbusiness bribery. Liu knew the rulesmade sales more difficult, but Almond'spolicy was dear, and he wanted to makesure that every member of the sales teamunderstood it.

He had taken the same hard line onsafety and environmental practices. Theproduction facilities in Chongqing hadbeen built according to German nationalstandards, and all the safety equipment—helmets, shoes, and protective clothing—had come from Europe. The Chinesepartners had called these investments

"wasteful" and "frivolous"—"luxuriousexpenditures" that the young venturecouldn't, and shouldn't, afford. But, withbacking from the head office, Liu hadstood firm. Similarly, he'd insisted thatthe factory's MDI (methylene diphenyldiisocyanate) waste be treated as a dan-gerous substance and processed with aspecial de,aning vont, in accordance withEuropean standards, even though Chineselaw didn't mandate it. His partners hadbeen dismayed at the millions of yuanthis would cost. But Liu refused to com-promise, because he had witnessed theconsequences of lesser standards firsthand.Years before, when he was working foranother Chinese chemical company, anaffiliates chlor-alkali plant had suffered anexplosion, injuring 200 staff members andresidents of the surrounding area and halt-ing production for more than a month.

The training was reaching its end, andthe HR director signaled to Liu that it washis turn to speak. Liu hesitated slightly ashe looked at his Chongqing colleagues. "AtAlmond, ethics are nonnegotiable; he said.

"We need to remember these laws as we goabout our business. We are not just a Chi-nese company; we're a global one:' Solemn,blank faces stared back at him.

As he left the room, he couldn't helpfeeling that his remarks had fallen ondeaf ears.

no Harvard . Business Review September saw

; "We Cannot Concede"; Two weeks later, Liu was back in Chong-

ging for the second-quarter board meeting.As he walked into the lobby ofthe Hilton,he ran into George Ho, the finance directorfor the joint venture. Ho looked flustered.

"Are you all right?" Liu asked in Wish.Ho was from Hong Kong and didn't speakfluent Chinese. He held a unique position:He reported to the general manager of thejoint venture but also to the finance three-tor at Shanghai headquarters.

I'm worried about this meeting, Liu:"Flo said. "I hal a disnirbing conversationwith Wang last week."

"We are not just aChinese company," Liusaid. "We're a globalone." Blank facesstared back at him.

Liu nodded, not surprised.Ho continued. "Wang is close to making

a huge sale-30 million yuan—but the cus-tomer's purchasing manager is insisting CM

a i% commission. He says that's what he'sbeing offered by other companies."

"We can't do that; Litt said."That's what I said. But Wang was

insistent. He said that if we can't do that,we should at least be able to offer themanarr a trip to Europe, a visit to Almondheadquarters!'

"What did you say to that?" Liu asked."No—of course,"Ho replied. "But he

accused me of jeopardizing the venture.He said that we 'foreigners' have so muchmoney, we don't care about the perfor-mance of the business."

"You did the only thing you could do;Liu said.

"I can't believe Wang thought thatsuggestion would fly, especially after thetraining," Ho said. He walked dovin the halltoward the boardroom. Liu followed,

The meeting had barely begun whenthen Dong, the chairman of the joint

venture and a Chongqing No. 2 Chemicalexecutive, raised the commission issue.(His leadership position was one of themany concessions Almond had made tolure his company into the joht venture.)

That was fast, Liu thought. He satquietly while DorSchulman, the vicechairman of the venture and AlmondChemical's senior vice president of busi-ness development, fielded the question.

"Chen, we cannot concede on theseissues; Schulman said. "There are noexceptions to be made. Almond mu.st be alaw-abiding corporate citizen—as shouldevery Ahnond employee!'

Ho looked up and nodded at Liu. ButChen was not ready to end the discussion.

"To the best of my knowledge; he said,"many foreign-owned companies rewardChinese customers for their business.Some companies organize overseas visits,some provide rnartagetnent training, sornearrange golf outings. This is good businesspractice in China. We need to be flexible inorder to compete. If we can't provide thecommission, let's at least consider a visit toMunich headquarters."

This was typical behavior for Chen. Hehad a tendency to develop very strongopinions but keep them to hhnself untilthe board met. Schulman waited for thetranslator to finish; then he hesitated, try-ing to come up with a suitable response.Liu knew he needed help,

"Commission or trips, it's ali the samething: business bribery; Liu said. "We canget orders without these tactics."

Chen picked up the al financialstatement that had been distributed atthe beginning of the meeting and said,

"Orders? What orders? We made only 60%of our target for this quarter. When we setup this joint venture, we assigned our verybest people to it--our best technidars,best salespeople, best managers. Why?Because we believed we could manufac-ture some of the best chemical productsin the world and, in turn, get more orders.But look at this!' He threw the statementdown on the table. "Our performance issinking fast. This joint venture has done

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September 2011- Print Pages

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HBR.ORG

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Chen paused to let the translator catchup but then thought better of it. 'All youdais make us spend, spend, spend—onGerman goggles, unnecessary wasteprocessing, and ridiculously high salaries!'He turned to Ho, who looked bewildered.

"And now I hear rumors that you areplanning to launch SAP's ERPsoftware tosynchronize with headquarters. When willthe spending stop?"

Chen continued, his voice rising. "Weneed a: tighter control on costs. We can'tpossibly meet our profitability target whenour expenses are so high. We want tochoose the finance director going forward,so we can give this venture a real chance atsucceeding. We see no other option:*

He sat back in his chair and crossed hisarms. Schulman.was squirming in his seat.Ho was pale with shock. Liu wasn't surewhat to say. He was astonished that Chenhad brought up the safety standards—he'dthought that issue was settled long ago—and astounded by the slap at Ho, But heneeded backup If he was going to opposethe, joint venturet chairman.

Finally Sduriman spoke. "Chen, thankyou for being honest about your concerns,"he said. "At this point I think all these is-sues are still open for discussion."

Lin almost choked. What was Schul-man a/hiking? Seeing Liut expression,Schulman looked at his watch and said,

"Should we take a is-minute break?" Withthat, he stood up.

"This Venture Is Critical"As Liu walked out of the room, Schulmangrabbed his elbow and steered him towarda smaller meeting room down the hall.Once the door was dosed, Schulman'sshoulders slumped.

"Liu, what should we do?" he asked. "Doyou think we should concede to these de-mands? This venturers critical for us—youknow that."

Liu did understand how high the stakeswere. China accounted for only 3% of Al-mondt current business, but the company

was depending on the country for futuregrowth. The Chongqing operation was sup-posed to prove that.Almond could expandfurther in China, and the company wasalready planning additional acquisitions.But Liu was shocked that Schulman wouldeven consider bending the company'sstandards regarding ethics and safety.

"We need to stand strong," Liu said, "notgive in." He was thinking about Almond'sreputation as well as the future in China.He had joined the century-old Germancompany not only because it boastedthe workt's leading chemical-productiontechnology, but also because of its values,management approach, and safety ethic,which he'd hoped would serve as a modelfor Chinese industry.

"But we shouldn't annoy them," Schul-man said. "We need Chen. And he's right

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about the numbers. We could be in troublewithout Wang's sale. Besides, where do wedraw the line? Is a golfgame bribery? Wedo that in Germany all the time."

Liu realized that Schulman wasn'tasking for his opinion. He was asking forpennission to give in. Suddenly Liu felt likea kid stuck between ma warring parents,The break time was almost up. Theyneeded to get back to the meeting andrespond to Chent demands.

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Xu Sham is the former CEO of TNTMainland China's subsidiary TNT Hoau,

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13a Harvard Business Review September 2011

engineer,gn:00,

September 2011- Print Pages

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EXPERIENCE

I EMPATHIZE with Liu and the others inthis case. Devising an operations strategythat is suitable for, and successful in, theChinese market is difficult. At TNT Hoau weare up against several of the same chal-lenges: Many of our competitors have dubi-ous business practices, such as offeringkickbacks. As a globally traded company,should we follow suit? Can we still getorders if we don't? How can we respond tothe pressures on our salespeople?

We have learned two lessons that Liumight heed. One: There is no room forcompromise on ethics. Two: Creating sten-dardized processes allows you to outper-form the competition.

In regard to ethics, we accept that wemay lose some clients because of ourrefusal to give kickbacks. But we also knowthat ethics can be good for business. Infact, one of our clients asked our Shenzhenbranch for a 'to% kickback. The branchgeneral manager declined, saying, "We arenow wholly owned by TNT. a Fortune so°company. We will never offer bribes." Theclient excitedly responded, At last I'vefound a company that refuses." He thenplaced an order worth millions of yuan.

Almond should tbcus, as we have, ongaining target customers, such as large

international firnis, that share its values,and not go after companies that insist onbribes and commissions.

The second lesson for Liu is the roleof standardized processes in beating thecompetition. He was right to fight for

Almond should focuson gaining targetcustomers that shareits values and not goafter companies thatinsist on bribes andcommissions.

higher safety standards. We have suc-ceeded in large part because we imple-mented processes that have long beenused in Europe and the United States butare still relatively uncommon in China.For example, very few domestic road'transportation companies guarantee timelydelivery. We are able to do that becausewe adopted time standards for each stepin our process: loading, client notification,and soon,

Almond needs to lead the way by set-

ting the standards for safety and ethics. Acompany may achieve short-term successif it bows to hidden rules, but in the tongterm it will eventually fail. The businessenvironment in China is very differentfrom what it was 30 years ago, and it willcontinue to evolve. Over the next to yearswe can expect to see more regulation andthe development of new criteria for doingbusiness in China. ft will pay to be aheadof that curve.

To resolve this specific conflict. Liuneeds to identify other areas of compro-mise. For example, if the joint venture'sproducts are for export, the high Ger-man standards should be upheld. But ifthe products are for domestic sale only,guidelines that comply with Chinese tawmay suffice. Or, if SAP is too expensive* thejoint venture can implement cost-effectivesoftware as long as it is compatible withthe global Almond system.

Both sides are right in these debates.The Chinese should not be faulted for theirpursuit of profits, and the Germans shouldnot be faulted for standing up for theirvalues. Both profits and values matter. Thekey is to find a solution that compromisesneither,

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tit 3,),1

JOINT VENTURES are never easy and needto be set up properly from the start. Thekind of misunderstanding and mistrust thathave erupted in the Chongqing venture canbe avoided by establishing reasonable expectations of future investment and returnearly on.

Liu fills an important role as the presi-dent of Almond China. His position requireshim to serve as a liaison and interpreterfor the two sides. He can help both partiesto the joint venture better understandtheir differences of opinion. As a Chinesenational" he should clearly explain toSchulman what is behind the Chineseside's thinking, while making it explicit tothe Chinese what underlies headquarters'insistence on German practices.

Both the Chinese and the foreign manag-ers need to be more open-minded aboutthe other side's perspective. Their prob-lems will not be solved if everyone focuseson what his side stands to gain. The twosides should figure out together what isbest for the venture as a whole, over thelong term.

The business environment in China ischanging fast. Many Chinese manufactur-ing companies have begun to standardize

production processes, but most of themstill think standardization is unnecessarywhen it comes to safety. However, as Liuremembers well, only one mishap can undoa company. Now there is greater pressureon companies to consider environmentalprotection and safety issues. I think compa-nies like Almond are right to adopt higherstandards than Chinese law mandates,because in the long run the costs will bemuch greater if problems become serious.Environmental protection is a necessity inChina. And without adherence to safetyprotocols, China's economic success can-not be sustained.

Ethical issues should be treated thesame way. in China, because there areno explicit laws regarding bribery, foreigncompanies typically have three choices:They can do what domestic companies do;they can strictly adhere to Western rules;or they can navigate the gray areas byoffering a variation of the typical kickback.In deciding which route to take, joint ven-tures need to impose higher standards onthemselves. Since the 2009 financial crisis,surveillance over foreign-listed companieshas become stricter, and China, like mostother countries, has paid greater atten-tion to business ethics. Liu must be surethat the Chongqing venture does not gainshort-term benefits at the expense of itslong-term reputation.

To move forward, Liu needs to helpthe parties communicate better with oneanother. Because they come from differentcultures, they have distinctive approachesto work and cooperation. The Chinesebelieve in "emotion, reason, and law,"whereas the Europeans tend toward "law,reason, and emotion.* The Chinese estab-lish relationships by getting to know oneanother's families, for example. Europeansbelieve work relationships are limited to

work. Neither side knows how to relate ef-fectively with the other. Liu can advise theGermans to build up personal trust withthe Chinese before talking about the rea-sons for the standards. In order to establisha functional relationship, each party needsto communicate in a way that makes theother feel respected and comfortable.

If Liu remembers that he must persuadethe Chinese side with emotion and the Ger-man side with mason, his job of mediatinga resolution wilt be far easier,

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If Liu persuades the Chinese side with emotionand the German side with reason, his job ofmediating a resolution will be far easier.

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