Hello, Alicloud

Hutong West
Last moments before Sundown
1950 hrs.

Rushing to finish up before I am obliged to go offline for my weekly sabbatical, the news from Alibaba about Aliyun, its new mobile operating system, is out. It is too early for a detailed evaluation of the operating system, but three articles you might find interesting include: my post from May 3rd about the rationale behind an Alibaba mobile OS; this pithy PDF analysis from Deutsche Bank laying out the challenges it will face; and my take on the coming mobile OS battle in China.


Understanding Xinhua

Xinhua News Agency
Image by xiaming via Flickr

Hutong West
Planning August
1943 hrs.

In an superb article on veteran New York Times media reporter David Carr, Tom McGeveran quoted legendary media watcher Gay Talese:

“I consider The New York Times news,” he said. “Fascinating news. It has been sitting in judgment of America for more than a century and it, too, should be looked at in detail with the same objectivity.”

As the New China News Agency, Xinhua, takes over a 60 foot by 40 foot billboard in Times Square in New York, the same could be said for that media outlet. Xinhua is news. It has been the media mouthpiece of the world’s largest nation for over six decades, and it should be looked at in objective detail.

Why Xinhua is Important

This is more than just China-watcher or media maven esoterica. As we move into the fifth generation of Party leadership in the coming 24 months, we will be taking a further step away from the rule-by-individual that characterized the first four post-revolutionary decades. We are well into an era where China’s single-party state is run by the construction of a consensus on an issue-by-issue basis. Where once sat rubber-stamp toadies now sit leaders whose support is required for every significant initiative and action taken by the central government.

The consensus-building usually takes place behind closed doors, but when a particularly contentious issue arises, or when a relatively small group is trying to champion an initiative and is having a hard time building support, the process bursts out of those rooms and into certain government media in the form of an isolated quote in an innocuous article, in an editorial, or in an analysis piece.

The challenge for those of us trying to navigate our way through China’s political fog is deciding whether one of these journalistic tidbits means we should sit up and take notice, or whether it is so much positioning. To understand this, we have to understand how Xinhua’s role is changing.

Not Just Aparatchik Heralds Anymore

Is Xinhua a government mouthpiece to the extent that its positions reflect those of the Party? Is it more independent, and thus free to post articles like this without regard to policy? Or is it somewhere in the middle: that Xinhua is a tool used at will by various Party leaders to incite or test wider support for a possible policy change?

While it was once the former, I suspect that it is becoming a combination of both the former and the latter. And for that reason Xinhua demands study. We have to understand when Xinhua is floating a trial balloon on behalf of, say, a vice-minister of Finance, or when it is presaging a critical policy change. Regardless of your vocation, if China touches you or your work, that is an essential distinction.

So rather than continue to dismiss Xinhua as a hand-in-glove extension of the Party (which I have to confess I have long done myself), we need to recognize that it is becoming one of the most important media companies on the planet, offering more than just prepackaged propaganda for the Chinese masses, but actionable insight into the Chinese polity and society. The microscope that media watchers once turned to The New York Times, The Washington Post, Time-Warner, Disney and News Corporation must now be focused on the most enigmatic specimen of all.

Any takers?

The Winds Are a Changin’

Russian communist in China to set up Chinese C...
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Hutong West
Staying awake for a conference call
2259 hrs.

In making the case that the business climate for foreign businesses in China is changing for the worse, I have been challenged by people I respect greatly to “prove” it. There is no shortage of large foreign enterprises doing well in the PRC, something I have to admit as a few of them are my clients. As such, it seems that the complaints of the various foreign chambers of commerce that there is a tilt against foreign companies should thus be dismissed as the groundless whining of a privileged and ungrateful elite.

Yet while there is no shortage of success among foreign companies in China, only willful ignorance would allow anyone to deny that the winds are shifting in China, and in Beijing in particular. A case in point comes from an article I read recently in The China Daily about how Unilever was slapped with an RMB¥2 million fine for making statements that caused panic buying of staples in some parts of China. Reading through the article, I was initially struck at how clearly the government’s case was laid out, and how reasonable the action seemed.

Then came this paragraph, completely out of context:

“Foreign companies get too many benefits compared to local companies, it’s time to make a change,” Pan Ping, a white-collar worker at a private company in Shanghai told China Daily.

I have lived in China too long to believe that this was an accidental inclusion, and I know too much about The China Daily to think this is some reporter or editor playing a prank. The China Daily is the English-language mouthpiece of the Chinese Communist Party. If the quote attributed to the worker was not a statement of policy, it was certainly a statement of position.

I have argued in these pages that despite all efforts to establish a consensus-based orthodoxy, neither the Party nor the Chinese government is not as monolithic as they are often portrayed. What articles like this suggest is that even if the government has not reached consensus about the future role of foreign companies in the Chinese economy, at the very least there are those in positions of power who question whether they have been too successful for too long here.

Be assured that the raison d’etre for foreign firms in China is one of the issues that will be addressed in the coming changeover in Party leadership, and is another reason why foreign enterprises, journalists, trade associations, and bloggers will be spending so much time reading the tea leaves in the coming months.

What China’s Online Companies Can Learn from the MySpace Implosion

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The Patio, Hutong West
Hawks screeching overhead
1215 hrs.

In what has to be one of the best almost-postmortems of an Internet company I have ever read, Bloomberg BusinessWeek’s Felix Gillette’s June article on “The Rise and Inglorious Fall of MySpace” offers a set of insights that apply far beyond the doors of the benighted (and recently sold at a 94% write-off) social network pioneer. I have extracted three lessons that I think are particularly germane for online companies in China.

Perception is Reality

Social networks are sufficiently new that they are still a little scary to your average consumer, less so than space tourism, perhaps, but more so than a trip to the grocery store. Fears about privacy, identity theft, stalkers, pedophiles, and a host of unseen and unimagined dangers lurks in the subconscious of even the most adventurous user. As willing as we are to flock to something new, we will take flight like spooked ducks if our sense of security is credibly threatened, leaving a once-hot network foundering. As Gillette notes:

One of the reasons social networks are so combustible is that they have proven to be particularly sensitive to public perception. In February 2006, Connecticut Attorney General Richard Blumenthal announced that he was launching an investigation into minors’ exposure to pornography on Myspace. The subsequent media frenzy helped establish the site’s reputation as a vortex of perversion. “If you have a teenager at home, odds are they’ve visited the blog site myspace.com,” Hannah Storm warned CBS News viewers in 2006. “And there are fears that this popular social networking website, and others like it, have become places where sexual predators easily prey on children.”

Researcher [Danah] Boyd of Microsoft believes that alarmist press ended up crippling the company. “The news coverage of teenage engagement on Myspace quickly turned to, ‘Oh my gosh, there are all these bad teenagers doing bad things and this is crazy!’ ” says Boyd. “Quickly, it turned into a big narrative about how this was a dangerous, dangerous place.”

This situation brings to mind an editorial that serial entrepreneur and Mahalo.com CEO Jason Calacanis wrote in 2008, suggesting that Internet startups didn’t need PR people, and that the CEO can and should be the PR guy for a company. I am inclined to agree with Calacanis to the point where the CEO is the chief spokesman for a company with media, bloggers, analysts and the general public, presuming of course that the CEO is not a reclusive nebbish who gets flop-sweat in front of reporters (and there are plenty of those.)

What the MySpace case suggests, however, is that somebody on staff or on retainer needs to be spending his or her days anticipating and addressing potential scares and other reputation busters, because waiting for such things to happen and then responding is already too late. As quickly as MySpace reacted, reaction was not enough, and in a world with five-minute news cycles it never will be. Besides, a CEO has far more things to worry about. And how IS Mahalo doing these days, Jason?

If It Does Not Look Broken, You Aren’t Looking Hard Enough

The old expression that “a rising tide raises all boats” has an unwritten corollary that applies to fast-growing businesses: “a rising tide covers all rocks.” High growth can mask a huge range of fundamental problems, and smart companies like Amazon go and dig them out even when they aren’t real problems. They understand that failure to do so will only mean problems later, when the growth slows, the tide goes out, and the rocks start sticking holes in the boat.

MySpace did not. As Shawn Gold, former head of the company’s marketing and content efforts, told Gillette, “when you’re growing at 300,000 users a day it’s hard to imagine that you’re doing anything wrong.”

In retrospect, that sounds almost delusional, but you have to be in one of these organizations to realize how dead easy it is to overlook or ignore critical problems. Hubris is as easy to catch as a cold when things are really good and you are being lionized by media and users alike, and even those immune to the hauteur virus are likely to be so wrapped up in just keeping the wheels on such a fast growing organization that they set “important but non-urgent” problems aside.

Companies have to build such organizational debugging into their culture and allow time and resources to address those issues. MySpace, by the admission of both Gold and its founders, were more seat-of-the-pants, and they paid for it.

Leaders Must Be Users

MySpace co-founder Chris DeWolfe made a point he felt was critical to the company’s long, slow slide to the middle of the social network pack:

“After we left, the guys that took over were never Myspace users,” says DeWolfe, who now runs a startup called MindJolt. “They didn’t have it in their DNA.” According to a source familiar with the sale, DeWolfe is also a finalist to buy the company. DeWolfe declined to comment.

This might be so much positioning, or even a bowl of sour grapes given the rough handling News Corporation dealt to the MySpace founders when they were shown the door. Let’s resist the temptation to get all ad-homenim for a moment and look at his point.

The owner or executive of a media company has to be in the audience, and for social media he or she has to be a participant. There is simply no other way to understand or manage the business. The idea of a newspaper executive who cannot read or a movie mogul who won’t watch films is ludicrous. It is the same for online companies, and especially social media.

This is particularly relevant for foreign companies setting up online businesses in China. You do not want to put someone in charge who is not a user, or, worse, who because of a language or cultural barrier is unable to be a user. The experience for these companies, not the content, is everything, and if you cannot evaluate the experience you have no business being in charge.

Don’t Go There

The history of social media and the Internet is sufficiently short that we should be squeezing as many lessons as we can out of every case. We will be analyzing the MySpace story for years, but Gillette gives us an excellent starting point. This is a superb article that should be mandatory reading for anyone putting their money into an online company, particularly in China, where we enjoy a surfeit of engineering talent and suffer from a dearth of capable managers.

The Alipay Warning

Hutong West
Watching the Overcast Burn
1120 hrs.

Sometimes, when the Chinese government is considering or planning a policy change, they will make some sort of formal announcement in advance. But not always: often, they will signal their intentions more subtly. That is the kind of behavior that keeps policy analysts in business, and that keeps all of us watching for statements and remarks that may signal a warning of an impending change.

VIE another day?

Xinhua may have issued such a warning to foreign investors in Chinese online companies a few weeks ago. In an article examining the Yahoo!-Alipay dispute, Xinhua suggested that the structure Yahoo! used to invest in Alibaba – and that is used my a number of overseas investors to circumvent laws restricting foreign investment in the Internet – may no longer escape government scrutiny.

The structure, called a variable interest entity, or “VIE,” is essentially a set of technical service agreements between a foreign entity and an internet company in China, allowing a foreign company to be paid for its “services” based on the performance of the Chinese company. One hard look at how these deals actually work would reveal them to be what my mentor Jeanne-Marie Gescher calls “functional equivalents,” in that they are the functional equivalent of an investment. While keeping within the letter of the law, they stray outside its intent.

And that is the problem. As Xinhua notes:

Fang Xingdong, founder of blog provider bokee.com, said that there is tendency among Internet companies and foreign investors to gamble on whether the government will actually enforce its rules.

The Alipay case shows that the VIE structure may not be safe for foreign investors anymore and it is hurting the credibility of Chinese regulators, according to Fang.

Remembering Zhong Zhongwai

Those who are skeptical that the government would step in this way would do well to recall (or look up) what happened in the case of another functional-equivalent structure used during the 1990s to siphon foreign investment into the restricted Chinese telecommunications sector. That structure, called a “sino-sino-foreign” (SSF) arrangement, circumvented the letter of the law by creating an onshore equity joint venture between a local company and a foreign investor. The joint venture, ostensibly a Chinese company, would then make the investment in the local telco.

After ignoring them for several years the government pulled the plug on those entities in 1998, declaring them to be illegal under the law restricting foreign investment in Chinese telcos. The government required the local companies to buy out the foreign investors, most of whom were large global players like Deutsche Telekom, and rode roughshod on the process to make sure it happened. The denouement of SSF was ugly, a distraction for all involved, and an unequivocal warning from the Beijing aparatchiks: you may sneak around the law, but eventually we’ll catch up.

When Will the Bell Toll?

The bell will probably ring at some point for the VIEs, and it might be soon: the Alipay case could serve as a first warning shot, and it need not require some sweeping, high profile legal or policy change to end the validity of these arrangements, just a small change in the administrative rules of a single ministry. In the Alipay case, according to Xinhua:

The central bank created a rule last September that requires all payment-service companies in the country to obtain a specific type of business license, which can only be granted to Chinese-owned entities.

For online entities, the axe could fall from any of a number of directions: the Ministry of Commerce (MofCom), the State Administration for Radio, Film, and Television (SARFT), the Ministry of Industry and Information Technology (MIIT), or a player to be named later. If history is any guide, the only real question is “when?”

Right Soon, Probably

For many companies, operating in the gap between law and enforcement is the only available way to participate in the market, and when your competitors are doing the same thin, it is hard to resist the opportunity. Many of us have done it, and it is more common that any of us would care to admit. But that is no justification for complacency.

There are varying degrees of regulatory risk in China, but when you count on either lax enforcement of the law or enforcement limited to the letter of the law, you place your money at the mercy of bureaucratic whim. Regulators tend to get very jumpy during times of political change, looking for ways to clean up their patch to show the new leadership that they are on the case. As we approach 2013 and the handover to a new generation of national leaders, we are on the cusp of such a change in China.

So the Alipay case and Xinhua’s response to it should be construed as a warning. Companies depending on a VIE for an investment in China or for a local business operation need to start thinking about those two magic words: “exit strategy.”

The Advertising Sales Problem

Hutong West
Laying low
1824 hrs.

I have spent a lot of time at Internet industry conferences in Asia over the past year, meeting, speaking with, or hearing from companies seeking to start or grow internet or mobile businesses in China. One thing that amazes me about the current flock of China online hopefuls is how many of them plan to rely on advertising to pay the bills.

To their credit, most of them understood from their experience elsewhere that this was going to be a difficult task, and they were ready for the challenge. What most did not know is that there are a couple of reasons why running an ad-supported online business is going to be tougher in China than elsewhere.

Moneyball Advertising

First, it is common knowledge in the ad industry that many (if not most) of the advertising dollars spent in China are allocated based on habit, fear, ignorance, longstanding relationships, or corrupt practices like kickbacks and under-the-table payments. Even if you can prove that what you offer is the most efficient way to spend ad dollars since the Romans invented graffiti, do not expect a warm welcome. Most Chinese marketing managers are more concerned about creatively enhancing their personal income or avoiding potentially job-threatening risks than about demonstrating how much bang they’re getting for the buck.

Second, making an effective pitch to advertisers in China depends on doing three things really well:

— Identifying the precious few intelligent and creative marketing managers who care about efficiency and effectiveness above all else;
— Framing the sale in terms of what the advertiser needs, not what you want to sell; and
— Finding advertising sales managers who can do both of the above.

The last is the toughest one of all, and is the bottleneck restraining the faster development of online business in China.

The Ad Sales Manager Crisis

I have worked with online firms in China for over a decade, from foreign brands to local start-ups, and the one speed bump each of those companies hits is the problem of finding a good sales manager. Initially, the CEO serves as the chief salesperson, and most large advertisers and agencies won’t negotiate with anyone else. The boss winds up going on all but the coldest of sales calls.

Unfortunately, the CEO of a startup or high-growth Internet company has a lot of other things demanding his or her attention, like actually running the business. Given the importance of revenue, however, either those other things start to slip, or the CEO starts working 18 hour days for months on end. Not even the most enthusiastic CEO can last long with that kind of schedule.

The solution is to hire sales managers who are intelligent, experienced, and trustworthy enough for the company to grant them considerable latitude in framing the creative (and legal/ethical) deals, and who close business or do everything but the final handshake.

Unfortunately, good ad sales managers are rare and hard to find, and those willing to shift to the uncertainty of an internet startup are even rarer. What this means is that the internet business faces a bottleneck that is likely to last for years, and that the good ones will become the subject of virtual bidding wars, jumping to new jobs for higher pay and titles until they are out of reach to all but a fill well-funded startups.

Fishing in a Bigger Barrel

Until the current crop of young ad salespeople has had a chance to mature, and unless some higher power starts air-dropping highly qualified ad sales managers over Beijing and Shanghai, companies are going to have to start addressing the problem more proactively, and more creatively.

Pulling experienced sales people from other industries might help, although like many industries the ad sales game demands some specific skills, knowledge, and familiarity with the sector that would require some intensive mentoring and a 9-12 month apprenticeship. That may be a better approach, however, than trying to turn a 25 year-old ad salesperson with 3 years of experience into a sales manager.

There is another pool of talent that is worth considering: mid-level Chinese advertising agency executives.

Here is a group of people who are used to thinking creatively, at least compared to most of their peers. They are not only accustomed to selling to advertisers, they are used to crafting campaigns for clients based on the specific needs of that individual rather than a lump of inventory that needs to be sold. Another plus is that they understand how advertising agencies think and operate, giving the organization insight to how to frame, time, and pitch campaigns to media and creative agencies.

There are plenty of these folks as well, and their availability is not necessarily a reflection on their abilities. Large agencies have become adept at hiring young people and putting them to work, but many are having trouble keeping people happy after about 7-10 years in the game. By this point in their careers, most advertising executives have been promoted to Account Executive, pushed up by a combination of title  inflation and two decades of double-digit growth in the advertising industry. Once they reach this stage, however, they plateau, constrained by the rapidly shrinking number of positions above them, and held back by their own fairly narrow scope of experience from taking enterprise leadership positions. At about this point, the really good ones are looking for other options, and it is time to snap them up.

Time for Creative H.R.

This is not a panacea: the ad sales manager problem is not going to disappear overnight simply because the industry goes searching in different quarters. The key takeaway is this: the lack of strong advertising sales managers is a hidden choke point in the growth trajectory of an online enterprise in China; the problem must be addressed proactively, and ideally in the earliest planning stages; and the best way to address it is with a creative approach to recruiting, development, and retention.

With apologies to the IT and product people, the ad sales manager is the second most important position in the online enterprise behind that of the CEO, and it demands as much attention and focus from H.R., from boards, and from investors. Failure to give this role due attention at the very least will mean lost revenue and an overstretched and burned-out CEO at a critical point in the development process. At the worst, it could become a key factor in the failure of the business.

Getting Real about the News Corporation Scandal

Rupert Murdoch
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Hutong West
Back in the saddle
2137 hrs

As the world is treated to daily revelations centered around the defunct British tabloid News of the World, I am slowly crawling out of blog hibernation here at Hutong West, so to get things going a few comments on the News of the World scandal are in order. While analyzing this unfolding train wreck would be premature, there are several points that need to be made right now.

Before I begin, however, for the sake of full disclosure I must say that I am not in the pay of any organization with ties to News Corporation, nor am I a fan of either News Corporation or any of the Murdoch family. My writings should give ample support to that contention. As such, what is written below is meant as neither defense nor condemnation of either the company or its controlling family.

To The Grave Dancers of Fleet Street

Yesterday, the editors of The Wall Street Journal, in a sanctimonious, blame-shifting editorial defense of News Corporation that ill-serves the paper and its outstanding journalists, manage to make one point that strikes home. The media establishment is doing neither itself nor the public a service when it allows schadenfreude to seep into coverage of News Corp’s troubles.

One need only read headlines to imagine the gleeful editors and publishers who composed them: “The Tables are turned on Murdoch” crows Joe Nocera at The New York Times; “Just deserts for Murdoch” shouts Richard Cohen from the pages of The Washington Post. The blog and online coverage is downhill from there. As for the Times, once the standard-bearer of American journalism, Nocera goes so far as to try to make a virtue of a vice, explaining:

Well, yes, the schadenfreude is pretty darn thick. Who would deny it? The whole thing reminds me a little of the ending of Ian McEwan’s wonderful novel “Solar,” in which the many awful things the central character has done in his long life suddenly come together to bury him in an avalanche of comeuppance. I’m O.K. with that.

Joe is okay with that. And that is a worrisome problem.

Rupert Murdoch has made his share of enemies in the process of building News Corporation, many of them in the media industry, and some of these among the ranks of those with the power of the printing press. There is no shortage of people who have waited for a very long time for Rupert and his empire to get their requital. Further, I’m all in favor of companies sowing truth-based fear, uncertainty and doubt about competitors.

These are, however, extraordinary circumstances. If this scandal is as serious as it appears, the media have an especial duty not only to get the story right, but to maintain both the reality and appearance of balance in its coverage given that the target is a successful rival. The appearance of balance is eroded when you are reporting the story on page 1 while sticking it to Ol’ Rupert on the opinion page. Once that happens, it starts to smell like someone is settling scores, and the credibility of an important media outlet is undermined. That’s not serving the public or the media.

There will be plenty of time for schadenfreude when this is all over, and once more when the better reporters on this story line up to collect their Pulitzers. For right now, stick to the facts, folks, and take a little less public joy in the trials of rival: you’re starting to look exactly like the thing you hate the most: a pack of bloggers.

Rupert Is Not Going Anywhere

While there have been early reports that News Corp is considering replacing Rupert Murdoch as CEO, I would not give them much credence. Corporate watchdog Nell Minnow doubts the ability of the News Corporation board to do anything without the express, prior approval of Mr. Murdoch, so there are probably only two ways that Rupert will surrender leadership of NewsCorp: either at his own choice, or if they carry him out feet first under a sheet.

In a fawning editorial that compares Mr. Murdoch to Alexander the Great, Forbes publisher Steve Forbes promises us that Murdoch will survive and fight another day. In a rather less complimentary column in The New York Times, David Carr concedes that the News Corp. CEO still has his teflon armor:

Even as the flames of the scandal begin to edge closer to Mr. Murdoch’s door, anybody betting against his business survival will most likely come away disappointed. He has been in deep trouble before and not only survived, but prospered. The News Corporation’s reputation may be under water, but the company itself is very liquid, with $11.8 billion in cash on hand and more than $2.5 billion of annual free cash flow.

For better or worse, K. Rupert Murdoch is News Corporation. As long as there is a company, he will be calling the shots.

Aid and Comfort

What is most disturbing about this scandal is the impression it leaves in the minds of the people and government of China. In the west, we are fond of portraying a free and independent media as watchdog against lawlessness, corruption, and the abuse of power. As a whole, the media serves that function brilliantly around the world.

But if the allegations about News of the World are proven true, and worse, if the illegal and anti-democratic behavior extended beyond that single paper to elsewhere in the News Corporation empire, then the people and leaders of China can make the point that an overly independent media can actually become a vector of lawlessness, corruption, and the abuse of power. Under such circumstances, could China’s leaders not make a rational case that rather than have a media industry so powerful that government is in its thrall that it would be better for government to control the media?

You can bet China’s leaders will make that point, if they have not already. That can only be counted as a blow against progress in the world’s largest nation, a blow that must count against whatever good News Corporation did for media in China.

Facebook Redux: A Worthy Riposte

Hutong West
Counting the hawks
1945 hrs.

The debate over Facebook coming to China continues, and one excellent post written by Brian Glucroft over at Isador’s Fugue is notable in that it makes a passionate and people-based case in favor of the company’s possible foray into the PRC.

Brian’s post is worth reading because he touches on real people in China who actually need the connectivity of Facebook to put them in touch with the outside world. While his evidence is anecdotal rather than systematic, his primary point is that the local social networks, for all of the hype, do not meet the needs of all of China’s netizens, and that there is a market for Facebook here.

I will not take from Brian’s excellent post by rebutting it. Please take a look.

Business Ethics and Culture Clashes in China

Hutong West
Dodging the Heat Wave
1740 hrs.

When I used to take and read The Harvard Business Review, over time I found myself avoiding the case study section of the magazine. While fictionalized accounts of management challenges may be interesting to some, I found the cases almost unfailingly sterile.

I understand why the Harvard Business School teaches to cases, and the rationale behind fictionalizing them. It is important for students to practice addressing difficult scenarios, and “changing the names to protect the innocent” makes the case less gossipy and eases the challenge of getting tiresome permissions. When I realized that I was getting just as much out of good investigative business journalism that DID name the names, I stopped buying and reading cases.

To every rule there is an exception, and Adam Mezei forwarded me a link to a Harvard Business Review case that deserves to be read by everyone doing business in China. The case, “Culture Clash in the Boardroom,” delves into a common problem in China: operating an ethical business versus doing everything to get as many orders as possible. Making the case even more challenging, the business in question is a Sino-foreign joint venture. I won’t tell you any more – go ahead and read the case.

If I may, however, I’d like to make some general points for your consideration as you read through the case and put yourself in the shoes of the Hong Kong-born joint venture president.

Avoiding the Problem

Ethical conflicts are endemic to foreign businesses operating in China. Failure to recognize this represents either obfuscation or denial. The best way to deal with most of them is to avoid them altogether, and for the rest there has to be an iron set of principles to guide managers.

The only way to avoid some of the more fundamental conflicts like the one in the HBR case is to address them at the time a company makes a decision about whether to go into China or not. As a part of that decision process, some of the questions that need to be addressed include:

  • What do our local competitors do to get and keep customer business? Is there anything that they do as a matter of habit that is simply out of the question for us?
  • What would our joint-venture partner really do if we had to make a hard choice between ethics and sales?
  • Can we turn our more ethical behavior into a business advantage, or indeed lead the industry to more ethical practices, or are we shooting ourselves in the foot by trying to play a “cleaner” game than our competition?
  • Are foreign companies held to a higher ethical standard in our industry than local companies?
  • Do our customers care whether we do things better? Or do they only care about price?

These seem to be tactical, but in a growing number of industries these questions can determine whether a venture will succeed or fail, and are thus strategic. Compellingly, the same questions need to be asked about quality, and whether customers and consumers really care about the value we see in our products and services, or whether price is all.

Once in a venture, however, the questions above become somewhat moot. All that is left is for the company to determine where it draws the line between sales and ethics. Managers will not only require a clear set of non-negotiable principles on matters ranging from worker safety to kickbacks to employee infractions, but a guarantee from the company that losing sales for reasons of ethics will not count against sales targets and budgets.

What this implies, of course, is that ethics in China can cost money. The smart way to approach this problem is to budget internally for these shortfalls, and count them on the ledger as a long-term investment in corporate reputation.

Of course, if doing business ethically is going to push a company into permanent losses, at some point it might make sense to cut those losses and run.

The Double Standard

One area not touched upon by the case is the issue of government and popular expectations. As I’ve discussed before, foreign and private enterprises operating in China are held to a higher standard of operational ethics than local and state-owned enterprises. The ethical playing field is not level, so behaving unethically just because the local competition does is not an acceptable defense. Indeed, the government is more likely to make an example out of the foreign enterprise that behaves badly than local companies that do so.

Operating in a joint venture is not likely to provide much cover, especially when the brand on the joint venture is – or includes – the name of the foreign enterprise. A joint-venture is as good as a foreign company when it comes to juicy targets for fines and other forms of prosecution. Any wise JV president would have that little tidbit up his sleeve to help mollify a bombastic local executive.

It Will Be Known

Another point that the beleaguered manager can toss at his joint venture partner is the inevitability that the unethical behavior will become public knowledge, and that such knowledge could be even more disastrous than missed sales targets. Some of the best investigative journalists in China have chosen to make a career out of catching unethical businesses in the act, and while taking on locally powerful SOEs can be tricky, they have editorial carte blache to target foreign enterprises. Add the media bulldogs to the prospect of a frustrated competitor or disgruntled employee, and engaging in unethical behavior looks plain stupid.

Some local partners, especially the larger, better connected ones, will protest that they have the ability to put the muzzle on the local media. This may have been the case a decade or more ago, but it is no longer. There are simply too many reporters and too many outlets, a growing number of whom seek to build their careers as either muckrakers or crusaders against shoddy business practices. Lenovo, Li-Ning, and Mengniu Dairies comprise a short list of notable companies who have discovered that the number of reporters in China who can be bought is shrinking, as is the number of reporters who will stay bought once they have been paid off.

Who is Working For You?

One final point that the case dodges is the matter of ethical hires. The case assumes that because a sales manager is a high performer, his ethics can be overlooked, or corrected by re-training from human resources. This is so much nonsense. An employee willing to play loose with ethics who is tolerated by his management will come to believe that his performance will protect him from meaningful punishment for his ethical lapses.

Ethics does not come from a training: you either hire people for their integrity and their performance, or you simply do not care enough about the former. In an environment like China, where good performers are always in short supply, the temptation to look away or to believe that somehow the corporate culture will change a person’s character can be overwhelming. Unless you are prepared to sack your highest performers for moral transgressions, you are creating an environment for ethical lapses.

Part of the problem the JV president faces is a human resources failure, which, in the world of Chinese human resources, means a senior management failure. The JV president is paying for it in this case, and part of the solution has to be a change in personnel. In the context of a JV, however, solving that problem is going to be tough: the JV partner often has a say, and if there is an ethical disconnect, an attempt to fire an unethical executive may sunder the JV.

All of which serves to reinforce the most important point: the time to deal with ethical problems in China is at the point of entry, not when the problem shows up like a letter-bomb on an executive’s desk.