navigating china's changing economy: strategies for private firms

Navigating China's Changing Economy: Strategies for Private Firms

David Ahlstrom, Garry D. Bruton, and Steven S.Y. Lui

C hina presents a paradox to both entrepreneurs and investors. Its economic growth continues to be strong, having

averaged nearly 10 percent annually for much of the last two decades. During that time, its GDP has increased more than tenfold, and hundreds of millions of Chinese citizens have been lifted out of poverty. Some parts of the country have experienced sustained economic growth for the first time since the Song Dynasty nearly a millen- nium ago.

At the heart of this rapid economic growth are the large numbers of private enterprises that have sprung up in China over the last two decades. By official definition, private firms include joint ventures (JVs) between foreign and Chinese firms, wholly owned foreign enterprises, and domestic businesses not owned by the government. To illustrate the growth of this sector, since 1979 the Chinese government has approved more than a quarter of a million JVs with foreign firms. Some 500,000 private businesses were begun in southern Guangdong province alone between the late 1970s and 1984. Currently, nearly one million private enterprises are operating in China, with more than 111,000 in rapidly growing Shanghai.

The paradox, however, is that despite China's rapid economic growth and the role private firms have played in it, many such companies have experienced numerous problems. Beamish (1993) has documented that the average performance of international JVs has been less than expected and has actually been declining in some sectors. Simi- larly, although no public data are available on the performance of most domestically funded private firms, anecdotal evidence from Miller (1999) and others suggests that such firms have had great difficulty.

At the root of many of these performance problems are operational difficulties that commonly plague private firms in China. Such difficulties stem from the fact that the concept of private enterprise is still not well accepted in China, where as recently as the 1970s people would be imprisoned for selling a few stalks of surplus sugar cane on the street.

Managers in more developed economies tend to take for granted the universal existence of institutions that support and legitimize private enterprise, such as clear property rights, contract laws, and numerous commercial conventions. But these institutions are still largely lacking in China, which can frustrate private foreign firms. Com- mercial traditions that Westerners take for granted are just taking root in China. For example, in the West it is common practice to phone a vendor, get a standard price list, and order on a net 30 or net 60 basis. But in China, this is quite uncommon, unless one has a long-standing relationship with that vendor. Such a tradition can be especially difficult for new private firms, even for large JVs.

Specifically, the absence of commercial ground rules results in bureaucrats and powerful individuals interfering with private firms' operations. These individuals have the power to order a firm to stop selling a certain product or to exit a given industry altogether, and there are few

Navigating China's Changing Economy: Strategies for Private Firms "~

well-established institutions to prevent them from doing otherwise.* Enforcement of existing legal and regulatory codes can also be selective and arbitrary. Regulations tend to be interpreted by whoever has authority over a given geographic region or by one of many governmental departments that has jurisdiction over the firm. This, coupled with private firms' insecure status, limits their ability to ensure that many simple day-today business activities occur, including enforcing contracts, arranging protection for assets, acquiring market information, securing supplies, trans- ferring funds, and receiving timely payment for goods and services. These various difficulties at a basic operational level add to the cost of what is already a complex business environment fraught with hazards.

With their lack of both legitimacy and institutional support of laws and property rights, what can private firms do to successfully negotiate China's rapidly growing yet highly unsettled commercial environment? Recent research on China, such as Wong and Maher (1997), has identified a

number of success factors for firms that have entered the Chi- nese market. In addition, many prior writ- ings focus on the rec- ommendat ion that firms need guanxi (connections) to func- tion effectively there. The typical advice given is that a company needs connections with top central government officials to prevent potential

problems. But guanxi with a top official is both difficult for many private firms to secure and may prove inadequate. Our research suggests that a growing number of individuals and organizations in China can affect commercial activity and com- mand the attention of private firms. Moreover, there are so many levels of government to take into account that a generic admonition to build relationships with top government officials is not as rich an insight as may be needed.

In this article, we build on the work of Wong and Maher, Scarborough (1998), and Yeung and

*Editor's note.. The recent case of direct marketers such as Amway and Avon being ordered to stop their direct- selling activities in China are but two of many such examples. For a good discussion of this problem, see Ricky Y.K. Chan, "At The Crossroads of Distribution Reform: China's Recent Ban on Direct Selling," in the September-October 1999 issue of BH.

Tung (1996) by offering additional operational insights for companies attempting to meet the challenges posed at the local level by Chinese bureaucrats, regulators, and other individuals interested in the activities of private firms. We detail how managers in China can deal with the resulting interference that private firms must expect, and focus on how firms can acquire and use guanxi with a range of organizations and individuals, including but not limited to various levels of government. To build these insights, we interviewed executives in a dozen successful private firms in China, ranging from foreign direct investment by multinationals to local start-ups in several different industries. We asked them to discuss the sort of interference they face in China, the type of connections needed, and with whom. And we asked how they went about building or acquiring the needed connections to ensure smoother day-to-day operations.

E c o n o m i c R e f o r m a n d Private F i rms in C h i n a

Prior to the economic reforms initiated in the late 1970s, the Chinese economy was almost totally owned by the government. Beginning in the early 1950s, the central government took over nearly all productive activities through a manda- tory central plan for all enterprises (zhilingjihua) based loosely on the Soviet model of central planning. Enterprises had to fulfill the output quotas assigned by the government, and received their budgets and material allocations from central and local authorities. There was little room for negotiation except for production quotas. Some government officials were able to enrich themselves by controlling resources and distributing them as they saw fit. But the number of individuals in w h o m such corruption could occur was low due to the strict hierarchy of control and very limited resources. The general standard of living for most people was poor and the economy was stagnant.

In the late 1970s, China's economic policy began to shift from strict central planning to one in which central government plans served more to guide enterpr ises--hence the term "guidance planning" (Lee 1987). This system included sug- gested performance targets and economic levers such as interest rates, taxes, and credit allocation. By 1980, thousands of state-owned enterprises had attained some degree of control over their own marketing, production, management , and profits. Many collective firms were also created and granted a measure of autonomy while tech- nically being owned and directed by the village or township in which they were located. The general aim in China was to decentralize--giving increased autonomy to firms to pursue efficient policies based on rational economic objectives,

6 Business Horizons /January-February 2000

rather than focusing exclusively on maximizing production or employment .

In addition to decentralizing decision-making, another intent of the reforms was to gradually increase the amount of productive assets in private hands. To do this, the central government progressively reduced its hold on economic ex- changes, first in agriculture and later in the industrial sector. While this was reasonably successful, overall, for most industrial concerns, this influence did not disappear. Instead, some of it de- volved from the central government to provincial and local governments, and even to powerful individuals. For example, some two decades after the reforms started, reports Naughton (1996), the provinces had gained control over about one-half of the total PRC budget, with only 20 percent controlled by the central government.

The absence of well-developed divisions of power between the central, provincial, and local governments, coupled with vague or absent laws and unclear property rights, has created numerous new opportunities for opportunistic behavior among government officials and other powerful individuals, often at the local level. China's provinces, counties, townships, and other government entities can simultaneously assert their influence over firms within their jurisdictions. China has been called the "Wild East" due to the wide varia- tions in law enforcement by various levels of government all claiming to possess principal authority over productive resources.

The result for private firms is that they face numerous requests from government officials and well-connected individuals for special taxes, pay- ments, fees, plane tickets, and access to the firm's assets and personnel. It is common for officials from local municipalities and village councils to regularly visit foreign-owned factories in their jurisdiction to "make sure" firms are complying with local safety regulations. Any small infraction, in the eyes of an official, can result in hefty fines or even a suspension of company activities. Firms can be given permission to operate in a certain market, and a year or two later that permission can be withdrawn arbitrarily to make way for another firm. Corporate assets (and even personnel) can be seized and held while disputes are being resolved. If a court judgment is obtained in favor of the private firm but local officials do not agree with the ruling, they may refuse to comply. In such a case, the firm has little official recourse to regain seized assets or have contracts fulfilled.

The Study

To learn how private firms in China are coping with this rapidly changing and often chaotic environment, we identified 12 companies in a variety of industries. They are private in the sense that

they are not state-owned enterprises or township and village enterprises; governments and bureaus have no ownership stake or direct control. We focused on private firms because they face a different set of challenges than do state enterprises. In addition, they make up the most rapidly growing sector of China's economy and include the means by which foreign firms enter the Chinese market.

The 12 firms in our sample represent a mix- ture of international ventures and locally owned enterprises. Two were started by domestic Chi- nese citizens; three are joint ventures between U.S. companies and domestic Chinese firms; one is a U.S. wholly owned company; one is a Hong Kong-PRC joint venture; and the remaining five are privately owned by Hong Kong entrepreneurs operating in China. (Although Hong Kongers are considered Chinese citizens, the city is a special administrative region of the country and its inhabitants are considered "foreigners" in a commercial sense.)

All the firms examined have been in business for many years and have significant operations, such as multiple retail outlets or major manufacturing or assembly facilities. The sample was chosen to include both service industries and manufacturing. In the service sector, a hotel, several major retailers, and a trading firm were interviewed. The manufacturing side included makers of toys, light electronics, communication gear, and garments. Their size ranged from small, single-factory firms to mul- tinational retailers and For-

t u n e 500 companies. In-depth, semi-structured interviews averag-

ing about 90 minutes each were conducted with 12 executives of these firms. In all cases but one, the interviewee was Chinese, either from Hong Kong or Southern China. The non-Chinese interviewee headed a wholly owned U.S. firm. Every executive was either an owner or responsible for China operations. One had recently retired from his position as managing director of a Hong Kong-PRC JV.

The interview questionnaire consisted of 16 open-ended questions dealing with basic company information and history, the interference and related challenges the firm faced, the nature of the firm's connections, what they were used for, how they were built and maintained, and any other challenges the firm was facing. More details about the questionnaire, interview results, and sample are available from the authors.

Navigating China's Changing Economy: Strategies for Private Firms 7

II.I.USTRATIONS OF PROBLEMS FACING PRIVATE FIRMS

I n East Asian business, it is often said that connections rather than product, price, and quality represent the most important factor

in business criteria. The role of guanxi in China can be especially vital for private firms, which lack the privileges accorded to state-owned enterprises as well as the protection afforded by laws or other well-established commercial conventions that companies have in the West.

Private foreign firms starting operations in China are thus told regularly that they need guanxi to successfully negotiate this challenging business climate. In particular, they are told to establish connections with top central government officials. That is certainly reasonable as far as it goes. But such a broad statement falls short of addressing the rich nature of connections that private firms need, or how they might acquire and cultivate them.

China's sweeping economic reforms have empowered numerous resource controllers outside the central government. These departments and individuals can be part of provincial governments, municipalities, or even outside of government altogether. Who these entities are can vary significantly from region to region and even from town to town within China. Thus, rather than focusing exclusively on central government officials, executives in private firms must understand the wide network of important resource controllers--both people and organizations---that are present in their setting and establish connections with them. These connections should involve not only individuals from different levels of government but also quasi-governmental institutions such as banks and state-owned firms that can be principal suppliers of various goods and services to a private firm.

To illustrate the importance of a range of connections, several basic company activities will be examined. These activities were chosen to highlight some of the most common challenges facing private firms and determine how they cope with these problems.

Land P r o c u r e m e n t

Property development and land use has remained a central concern for many private firms in China. The hundreds of regulations concerning land and buildings can prove to be a major stumbling block for private firms. Land for private ownership first became available in China in 1986 as part of the early economic reforms; investors bid for it through auctions. However, the land available through this method remains limited; the majority of it is still distributed through govern-

mental administrative planning and supervision. Thus, a firm may find it virtually impossible to find land to start operations in a given region without relationships with the government officials responsible for land distribution there.

To illustrate, through 1992 (the most recent comprehensive data available on this topic), only 5 percent of land purchased was through competitive auction. In Guangdong, one of China's fastest growing provinces with the largest con- centration of private firms, government agencies have retained control over the distribution of nearly all land, and often use this leverage to maximize their own interests. Thus, the price of land depends less on location or market than on who controls access to it. To acquire land for property development, private firms in need of a new location must often pay hefty fees to the agency that controls the land. Difficulty can also lie with determining who the influential individuals are, once the relevant government agency has been identified. Official titles may not mean the same thing everywhere. Reflecting on this challenge, one general manager of a large retail chain with over two dozen shops in China commented:

It is best to build connections with the people who control access to the good land. That person can help you secure a good location. But it isn't always clear who this is--titles can be misleading .... You need to learn who controls what first to get things done. It takes time to learn this, and the right people can sometimes be found at a variety of levels in the government. Then you may have to pay a number of fees to close the deal. It's part of the cost of doing business.

The official role of most government officials is fairly clear, but the unofficial roles and actual power of many such officials are not. Sometimes a top official's secretary (misbu) may be a key source of influence.

G o v e r n m e n t Approvals

Government agencies and connected officials not only control land allocation, but also fund trans- fers and the approval of many major and minor projects. They can also involve themselves with a number of day-to-day transactions that would be outside the government purview in the West. The number of departments and bureaus seeking to influence the operation of private firms is prodi- gious. Offices such as the labor department, the worker safety department, the fire department, the health department, and even the postal service all have their own approvals to give and the


power to levy fees or disrupt business operations. Observed one trading firm executive, "You can- not believe how many approvals are needed for simple projects such as a renovation. One pro- posal cover page had more than 30 different chops [departmental stamps] on it. You could barely see the form; it was so covered with the chops of different departments."

Several managers emphasized the importance of having people in the f i rm--of ten more than o n e - - w h o have established relationships with a variety of government officials, such as individuals from various departments or village councils. They stressed that connections in Beijing may not be helpful with the sort of interference that local officials can cause. Connections with government officials at various levels, not just at the top, are important for getting things done. A company that relies too heavily on a few high-level connections can suddenly find itself without many friends if the configuration of top government officials shifts. Recent problems at Hong Kong's property development and infrastructure firm Hopewell Holdings illustrate this problem, as shown in the sidebar below.

Protection

Company protection is another area in which guanxi is crucial for private firms. Managers have reported that without connections to the proper agencies, or even with powerful local individuals, the firm's assets or even operations may be at risk. These threats can come from a variety of angles. For example, it is not uncom m on for "fees" to be assessed suddenly against private firms, such as cleaning fees, night guard fees, and assessments for planting trees in urban areas. Trees have also been known to suddenly "ap- pear" on planned highway routes or building sites that were thought to be clear. In this case, officials were able to assess fees for uprooting trees. Officials in various departments can issue fines, order firms out of certain markets, and even close them down if not satisfied with their compliance. They tend to make regular visits to private firms to ensure that regulations are up- held. Firms have little recourse if they feel the official's assessment is unreasonable or the fee is unjustified. Explained the managing director of one electronics manufacturing firm:

There are many officials from various departments that pay our plant regular visits. They come with seven or eight other colleagues with the stated purpose of checking to see if we are complying with their regulations. Of course they will find something wrong if we let them, so we try not to let them. One person in

our firm, who is nominally the factory manager, is responsible for maintaining a relationship with these officials. When these people show up at our plant, he will immediately bring them to a nice restaurant for a banquet. There may be some gifts or favors involved as well. They will show up half a dozen times a year, always around 6:00 p.m., expecting this sort of treatment. It is expensive, but the alternative is more costly. And they are only one department. You can expect to get a similar series of visits from a dozen or more departments and bureaus over the course of a year.

Problems with law enforcement also illustrate the protection issues faced by private firms. Com- mented one toy factory owner:

When we first started a number of years ago, in our first month of business we had eight large production machines s tolen-- i t was probably an inside job. Some people you hire will be very dis- honest, but since they are from far away it's difficult to know who can be trusted. There are local toughs that can also ex- tort money if you do not have any protection. The police do not provide us with much help; either you need to provide your own security or you have to find local people who can help you.


R e g i o n a l i s m

China has a long history of something sinologists call "regionalism"---different regions of the country are isolated from one another, and evolving laws, protectionist measures, and other differences tend to favor one region over others. In addition to formidable geographic barriers, regionalism also developed because of major lan- guage differences among the various regions. Although the central government 's strong encour- agement and support of the Mandarin dialect has eliminated some communication problems within the country, a number of other dialects are still commonly used, adding to the communication difficulties between regions.

Today, regionalism in China continues to flourish as several provinces and even cities have erected types of trade barriers against other regions of the country. Reynolds (1984) likens provincial meetings to those of the European Com- m i s s i o n - m o r e like a meeting of sovereign states. Different provinces and municipalities can also have quite varied laws and regulations. The result is that a private firm wishing to expand into another region can face a commercial environment very different from the one it came from.

A firm's connections with one top official in Beijing may do little good in very independent regions of the country, such as Guangdong or Hainan Island. As with different levels of government, a private firm must often develop new connections in different regions as it expands geo- graphically. For a retail chain, a different region may literally be the next county, where regulations may be completely different and a host of new officials must be satisfied. For industrial firms, provincial governments may be more of a concern than local ones.

Ideally, a firm would seek to open or expand in those areas where it has established relations with officials from the region in question. That is why many Hong Kong businesses often establish factories in their ancestral villages in Guangdong province. Similar links exist in Fujian province for Taiwanese businesspeople. In both cases, relatives and friends may be present to help, and expansion to new areas often proceeds carefully with this in mind. Observed one retail executive:

We have to build new connections with local officials in each new location where we open a shop. One official can control land rights where we need to build our store. That person might also know ev- eryone in the area and have good connections with them as well, so some additional connections come with the land. If we open another store [some- where else], we will often need to estab-

lish connections with a different official, whether the new location is in another province or just across town. In China, so much business is local, and we have found that connections with one official are usually not enough.

Such officials also have an interest in the success of the private firm and can use their local connections to help it overcome any difficulties that should arise.

The challenge for private business executives in understanding with whom they need to build relationships becomes even more difficult when there is an unofficial network around government officials. Key resource controllers may have titles that vary greatly across regions and are thus difficult to recognize. Some relationships are obvious, such as when the children of high officials run a business. But other relationships, such as businesses in which an official has an equity interest, or important businesspeople who have a mutu- ally beneficial relationship with the government official, are not as clear. Commented another retail chain executive:

In one part of a province we have to deal with a local city official who also controls land. In another place just an hour up the road, we have a completely different set of people to deal with [in setting up retail operations]. Sometimes titles convey very little information; people with the same title in adjacent counties can have very different respon- sibilities. As we set up stores across China, the people we have to deal with are different, and the rules they enforce can be so different that you may have to make changes in your operations.

Thus, private firms must first determine the individuals who represent the most important resource controllers in a given region. It is quite possible that they are not all government officials; titles can be misleading, and simple regulations can vary notably from region to region. In each new area, it may be necessary to establish a fresh set of connections, and learn a new set of laws and regulations.

APPROACHES TO BUILDING THE NEEDED CONNECTIONS

G iven the varying power structures and idiosyncratic, personal, and local nature of law and regulation in China, the

importance of having a variety of connections both in and out of government is evident. That is fine, as far as it goes. But, as mentioned earlier,

10 Business Horizons / January-February 2000

many private firms, due to their newcomer status, may not have a ready list of connections to draw upon. Certainly, bribes and expensive gift-giving have been used as approaches to building the needed guanxi. But that is not the entire story. There are other approaches to building and maintaining connections that are more acceptable to the commercial customs and standards of West- ern firms. Moreover, because of regional varia- tions, the approaches highlighted may have to be conducted differently in each region where the firm is active.

Co-opting Strategies

Guanxi typically takes years to develop as individuals build relationships with others. Common sources include connections developed through kinship, sharing a hometown, or going to school together.

One means of establishing needed connections quickly is to co-opt government officials who may be able to impose fees or fines on the company. There are several ways to do this. First, the firm can offer shares to the officials. In such a case, the official's interest and that of the firm become directly tied together. In addition, sys- tems of formal profit sharing arrangements are sometimes developed between local officials and firms.

A second method is to actually hire people who already have connections, sometimes those from the government body in question. Further evidence for this is seen in the fact that personnel advertisements in coastal cities in China where private firms are most active often require appli- cants to be well connected with various government bodies and sometimes with key individuals within those organizations. As one director of a garment firm explained:

We regularly hire people from within the government. Sometimes they work part time for us and sometimes full time. But either way, they will be insiders who can get things done with the city councils. They can help get permits through or protect you from the com m on problem of sudden fee assessments and other interference. They spend much of their time taking officials out to dinner when they show up.

Third, firms located in smaller towns may hire the former village head (cun zhang). In China, the village head is a sort of elder who is entrusted with mediating disputes and making decisions on a number of local matters. Although the former village head may be retired, his influence with the people in the village will still be

quite strong. People in the area will listen to what he says and defer to his influence. Recalled one toy factory owner:

We hired a former village head to handle security and deal with the numerous out- of-town workers in our factory. Those workers are mostly from Sichuan and Zhejiang provinces, so they can be a challenge to handle. People in the village highly respect this man, and the workers know that. As a result, they try hard to give him face, that is, not to embarrass him in any way. Right after I opened my factory, a number of expensive machines were stolen, probably by employees .... Shortly thereafter, we hired the former head of the village and a couple of his old assistants to handle security. The workers do not want any trouble from the village residents, so they are careful not to do anything that would cause the village head or his assistants to lose face. In addition, the village head is linked to all the gossip in the area and this makes it difficult for people to steal things and then sell them off locally. He will hear about it and take action. We have not had any major problems since.

Employees who have long-standing relationships with those in resource-controlling agencies where they used to work can help ensure that the treatment of the private firm is reasonable and predictable. Added the toy factory owner:

The presence of the old village head can reduce interference from certain local officials. Of course, he doesn' t have much influence with the bigger departments, such as Customs, because they are not local agencies. But for [handling] local issues, officials, and even local toughs, he is a very effective person to have on our staff, though he doesn' t do much actual work- -mos t ly he sits around smoking and chatting with the workers and other local officials as they visit. But his presence has made a big difference.

Company Alliances

Another potential source of such connections comes from the linkages among firms themselves. Private firms in China often seek each other out as suppliers and strategic partners because their underlying phi losophy and orientation are similar. It is not uncommon for them to join together in powerful and active associations. Taiwanese


managers have banded together in several business associations across China. One of the largest is in the municipality of Dongguan in Guangdong province, where more than 25,000 Taiwanese live and 4,000 Taiwanese companies have invested about US$2.5 billion to date. This association provides communal support to managers, and has even formed a fire-fighting team to protect Taiwanese factories located there. More important, it helps managers negotiate with government officials at the local, provincial, and central levels. On a 1996 visit to Beijing, the association's chairman received assurance from then-Vice Pre- mier Zhu Rongji regarding the safety of Taiwan- ese assets and interests in the PRC in the face of cross-strait tensions. Similar associations exist in Fujian province, where many Taiwanese and Southeast Asian Chinese have ancestral ties.

Sometimes an alliance with certain organizations can also help with protection or securing a reliable work force. Commented the managing director of the leather goods firm:

It is good to have a close relationship with an influential local organizat ion-- either within the government or outside, it does not matter, so long as they have local influence. This is especially important in locating reliable labor and protect- ing your assets. Some people you hire will throw things off trucks for relatives to pick up and resell. They will sneak their relatives into the factory to work for them and they themselves will leave to find other work. You have to watch carefully and even keep the door locked. One driver we hired drove our company van off to another province. There was nothing we could do to prosecute him. A locally influential organization can control these problems better by supplying us with supervisors and workers that are more reliable, so the problems can be minimized.

The links forged among small entrepreneurial Taiwanese companies in China has increased their bargaining power and facilitated the building of connections with key officials. Thus, Hong Kong and Taiwanese entrepreneurs and their foreign partners continue to favor these South China locations to benefit from established net- works and other local organizations that may be able to help them.

Trust Building

In China, securing reliable suppliers and distributors can be quite challenging. Quality can vary greatly, and it can be difficult to determine repu-

tations. Recalled the managing director of a trading firm:

It takes time to establish a network of suppliers and distributors you can trust. When we first got into business we had a lot of trouble. We got substandard com- ponents from suppliers, and our distributors were very unreliable. We had one distributor who accepted a big shipment from us and later claimed they never received it. Subsequently we learned that they sold the inventory through street vendors. Recently, we have rebuilt our supplier and distribution network slowly, transaction by transaction.

Several of the executives reported that, in addition to using connections to find reliable suppliers and distributors, a private firm could slowly "test the waters." It should start with small transactions with firms it has not worked with before. These transactions, no matter how small, can build trust through their successful repetitive complet ion over time. As one retailer explained:

In doing business, we try to do a little more than our customers and suppliers ask of us. We try to pay our suppliers early, even for small bills. We extend extra credit to customers that need it. We have even provided financing to suppliers so they could complete a large production run for us. This went a long way; they have become reliable suppliers for us. If we do these little things fairly, people in the area will start to trust us for larger things. We have tried to do this little by little in each new area in which we set up shop. Gradually we have built a reputation in the community of being a well-paying employer and a good customer, and we have fewer [delivery and payment] problems. But this can take a while, maybe a couple of years or more.

A second means is to give small favors where necessary. Sometimes this means holding regular banquets for local officials, which is part of the rapport- and trust-building process. Commented a managing director of an electronics firm:

You have to bring people to dinner. That is basically the job of our factory manager. He is out to dinner regularly. He complains that it seems that going out to eat is all he does. However, it is important work; otherwise these bureaucrats will find something wrong to give us trouble about. Our factory manager has


built a good relationship with these people and with other organizations in this area.

Such small favors at the organizational level help establish a firm's reputation. Like much commercial activity in China, reputation and trust are quite local in nature and must be built slowly, often region by region.

Charitable Giving

Private entrepreneurs have proven to be gener- ous to charities in China. Tsang (1996) reported that private entrepreneurs in Guangzhou donated over 700,000 yuan to the government on behalf of the East China floods in 1991. Though this was only about US$140,000, such a donation from businesses in a single city is a princely sum.

Private businesses usually make these donations very publicly, often using them to construct educational facilities and community cen te r s - - very visible facilities used by a large segment of the local population. Such donations build a reputation with local people, especially government officials. One wel l -known Chinese tradition holds that one of the best acts people can do is to help a person who is down and out. When the person recovers, the debt should be repaid with

significant interest. Thus, private entrepreneurs seek to help government officials when they are in greatest need and with the hope that later on such generosity will be reflected in interactions with the government. For example, entrepreneurs have found that donating educational materials to regions in which they were doing business is one effective way of building good relations with the government. One firm recently provided text- books for all the middle school students in a poor agricultural coun ty - -more than 100,000 books in all. It needed a great deal of land for its agriculturally related business in that county, and the donation proved to be a quick way to build its reputation there. Such donations are more consistent with charitable standards of giving in the West.

A s we have detailed, and as F igu re 1 summarizes, private firms in China have a number of means at their disposal to

meet the challenges of building connections to key resource controllers and other powerful individuals. These actions take advantage of the fact that private firms' transactions are not based on pure market, nor on pure planning, but on influ- e n c e - w h a t He (1997) calls "marketization of power." Key resources such as land and financial capital are often distributed based on how much

Figure 1 A Summary o f Boundary-Spanning Activities for Private Firms in China

Co-opting Strategies

Firm Mliances

Trust Building

Charitable Giving

Hire individuals (or their family members) who have influence in a given region.

Offer shares of stock to people who supervise the firm.

Offer shares of stock to the city government where the firm is located.

Form an association between firms in a given region.

Perform a small task well for a potential customer.

Entertain key individuals.

Publicly donate goods and services to support key regulators during time of difficulty or tight budgets.

Publicly donate goods and services to support daily actions of key regulators.

Links regional officials and important individuals to the success of the firm.

Provides negotiating power for firms.

Provides services local authorities refuse to provide, such as security for facilities.

Builds an initial relationship, which over time promotes guanxi.

Builds connections between the firm and regulators; creates a sense of obligation on the part of the regulators, particularly when the donation aids them in time of trouble.


administrative influence one has in the new economic system. The visible hand of government has not been replaced by the invisible hand of market, but by a somewhat opaque hand of power. Thus, private enterprises may need to acquire land and resources, secure approvals, and seek protection through a well-connected, interorganizational and interpersonal network, because market structure, contract safeguards, and even police protection are not yet well established in China.

Much of what has been written about doing business in China has encouraged firms to build guanx i before taking on its complex business environment. Sometimes businesspeople are advised that guanx i with a top government official is sufficient for conducting business in China, and new firms direct a lot of effort t o this end. Our evidence, however, suggests that this view, though correct in itself, is incomplete. It is certainly helpful to have good relations with top officials, but it may create a false sense of security. Central government officials are not the only ones with the power to either propel or obstruct commercial activity. Influential, interfering people abide at all levels of government and even outside of it. Because Chinese prefer to rely more on their contacts than on regulations or abstract principles to get things done, key connections provide a way for private firms to act while mini- mizing interference in those activities.

Private firms are the source of much of China's economic growth. They also stimulate innovation through information exchange and risk-taking that is difficult for state-owned enterprises to emulate. Yet the marketization of power by local governments or influential individuals compels firms to continue to spend a great deal of effort on building contacts with all levels of government so they can carry on their operations. The future indicates that the opportunities and tensions created by empower ing provincial and local officials will only increase in the near term as the legal system and law enforcement remain underdeveloped. Thus, it is likely that private firms in China will have to continue to "connect" by various means, carefully managing relationships with key resource controllers into the fore- seeable future. O

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David Ahlstrom is an assistant professor of management at the Chinese University of Hong Kong, where Steven S.Y. Lui is a doc- toral student in management. Garry D. Bruton is an assistant professor of management at Texas Christian University, Fort Worth, Texas. The authors would like to thank Chung Ming Lau and Justin Tan for comments on an earlier version of this article.


navigating china's changing economy: strategies for private firms

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