With the 2008 US presidential campaign already in full swing, the recall has provided instant ‘China, bad!’ fodder. For weeks, the blame has been on China and Chinese manufacturers and lack of controls and the quality of all Chinese imports including pet-food and toothpaste has come under severe criticism. As an example, friends of mine who are parents in the US have even re-inventoried their children’s toys and disposed of the ‘Made in China’ ones regardless if they were part of the recall or not.
However, in a surprising turn of events, last Friday, Mattel fell on its sword and, in front of media and key Chinese leaders, said to the Chinese government that it was Mattel’s design shortcomings, not lacking Chinese manufacturing standards, which prompted the product recall. They admitted that they “could have done better overseeing subcontractors in China.” Was it really Mattel’s fault? Was it poor China manufacturing? The real answer likely lies somewhere in the middle.
Mattel’s admission comes after intense pressure from all sides. The US government, despite all the sabre rattling, ultimately doesn’t want a trade war with China. The Chinese government likewise is concerned about global ‘face,’ but would also like to avoid disrupting trade with the US, one of their largest trading partners. Mattel also faced some serious business risk as upsetting the Chinese government is essentially giving your Chinese business an early funeral.
So last week Mattel became the poster child and with hat in hand, Mattel’s EVP of global operations, Thomas Debrowski went to China and met with Li Changjiang, the Director of China’s quality control. After listening to a litany of criticism of Mattel’s action, Debrowski read a prepared statement of apology. Not only will it take Mattel awhile to rebuild the relationship with the government, the admission will open up the potential for hundreds of lawsuits due to defective toys.
The event by itself is a great example of one of the challenges of doing business in China: face. The idea that other people see the reputation of someone or some group based on the interactions of that person with others around him/her. By putting the blame on China, Mattel caused the Chinese government and indeed Chinese made goods to lose a lot of face. For a company that sources 65% of their products from China, that was a terribly risky position to be in. The Chinese government controls everything related to production and if you’re in their bad books, you’re stuffed.
The other caution in the entire incident is the management of the China subcontractor. Now, we don’t know details of the oversight that Mattel had over the local producer, but my guess is that at the beginning there was quite a bit of due diligence and then over time, perhaps due to overconfidence, the weekly reviews turned into bi-weekly and then bi-monthly which lead to design and production issues.
Investment Banking Joint-ventures: Morgan Stanley and Goldman
All of the major investment banks have always salivated over the possibility of doing business in China. With government controls however, it’s always had to be through a joint partnership with a Chinese company. Morgan Stanley was the first Wall Street firm to establish a joint venture (JV) in China in the 90s with a company called China International Capital Corp., (CICC).
Fang Fengli was the architect from the Chinese side behind the JV and the relationship was not always smooth. There were disagreements between the Chinese and foreign management on the way that business should be done and that led to some botched deals. In 1997, for example, Mr. Fang arranged the IPO for China’s first real i-banking deal. Management at Morgan expressed little interest in the deal so Fang did the deal with Goldman Sachs instead, which was a huge embarrassment for Morgan. Today, Morgan Stanley still maintains a 34% stake in CICC, but exerts little control over the day to day operations.
Mr. Fang remained a force in the China Financial Services industry and in 2004 setup another joint venture with Goldman Sachs and Gao Hua Securities. Recently however, this JV been in the news as well, as Fang might be leaving to setup his own private equity fund. Questions now being raised are whether Goldman will have the same control over the JV after Fang leaves and indeed whether they will want to continue on the JV at all.
In both situations, the respective i-banks have invested greatly in a joint venture only to find themselves essentially sidelined and subject to the whim of their Chinese partners.
All three companies provide excellent case studies on doing business in China. Morgan Stanley and Goldman both wanted to get into the market and had to do so through JVs. After some initial success, they found themselves in a profitable position, both earning great returns on their initial investment, but one where they had little of the control that they were used to from any of their other joint ventures. Mattel has found itself at the centre of an incredibly sticky political situation and has had to do a sharp backtrack to save face and its business.
What they all have in common is the incredible need for companies to have a firm hand on their operations in China. Before entering the market, foreign companies need to have a very clear understanding of what they’re looking to accomplish and how they’re going to do it. Key in all of this is either having someone on the ground in China or a partner you can 100% trust to represent your interests and help you keep an eye on the business.