Television Regulations: New Bottle, Same Wine (With Corrections)

State Administration of Radio, Film & Televisi...
State Administration of Radio, Film & Television offices in Beijing (Photo credit: Toby Simkin)

In the Hutong
Black Lung Control
1047 hrs.

In the Valentine’s Day edition of The New York Times, Andrew Jacobs describes the new regulations issued yesterday by the State Administration of Radio, Film, and Television (SARFT), most specifically including two key restrictions: the prohibition of foreign programming during prime time, and the limitation of foreign programming to no more than 25% of the total air time on a channel.

There is some new content in the regulations issued yesterday, but contrary to the NYT headline, the major issues addressed vis-a-vis foreign content are not new: indeed, they harken back to regulations that have been in force since 1995. From the unpublished manuscript of a guidebook on Chinese television that I co-authored with William Soileau and Jeane-Marie Gescher in 1998, according to regulations then in force:

Foreign programming must not be distributed between 6:00 p.m. and 10:00 p.m., although actual enforcement varies according to the broadcaster.


Foreign programming must not take up more than 25% of total broadcasting time on a station basis.  In reality, while the rule is nominally honoured, many networks apply the quota on a channel by channel basis. Unofficial figures indicate that foreign programming may account for as much as 50% of programming.

The rules governing television are not increasing, as the Times suggests. What seems to be increasing is the degree to which they are openly flaunted by broadcasters. Let me explain.

China has had a wide range of laws and regulations restricting media (and many other industries) in place for a long time. What varies is not the regulations, but the degree to which they are enforced. Laws and regulations, as such, are not de facto restrictions of behavior so much as they are tools for the government to use when political conditions demand it. For that reason, what SARFT does on a fairly regular basis is issue notices designed to remind broadcasters that the regulations exist, and signal to them that enforcement looms. Usually, such initiatives come either when things get too far out of hand (i.e., 25% becoming 50%, as suggested above), or when something happens to make it an issue (Chinese producers complaining about access to TV time, or, say, a  leadership change.)

This is not dissimilar to the way I get my ten-year old to clean his room: I let him know an inspection is coming, and by the time I get there, behold! A clean room! The requirement to keep his room clean always existed. What was lax was the enforcement. What caused me to issue the edict to my son was either the room was getting too messy, or guests are coming over.

Jacobs quoted one Chinese citizen posting his disgust with the regulations on Weibo:  “They should really put Sarft in charge of food safety and have the State Food and Drug Administration regulate TV shows — that way we’ll have safe food and good entertainment.”

I would wager the person posting this was either very young or unborn when the regulations were actually issued. The issue that has provoked SARFT (an underfunded, undermanned, out-gunned agency if there ever was one) is the same that caused the food problem: China is ruled less by policy than law, and political expedience trumps enforcement – until the political expedients change.

UPDATE: Please read the comments conversation between Li Yuanyuan and myself. He raises some excellent points to rebut my point of view. He disagrees that enforcement was ever lax, suggests that it was always tight, and he explains why. We do not share the same memory of events, but he does point out that the prime time ban on foreign programming and the restriction of quantity of content was not in the 1995 Regulation #549.

Will China Actually Import “The Hunger Games”?

‘The Hunger Games’ In China | ThinkProgress.

“The Hunger Games” is apparently scheduled to show in China, according to this piece (h/t to Jacqueline in HK, aka @lantaumama for this.)

This movie, based on the first book of a trilogy telling the tale of a hardy young woman who inspires a rural uprising against a brutal repressive urban dictatorship, will either be pulled at the last minute when the censors actually WATCH the darn thing, or it will be the most subversive piece of democratic propaganda ever to sneak onto Chinese screens.

Or, as occasionally happens, the Chinese audience will take something entirely different from the experience than we would.

The Hunger Games (film)
Image via Wikipedia

Either way, it will be fun to watch what happens.

Apple’s China Strategy: Venturing to the Edge of Coolness


Apple Inc.
Apple Inc. (Photo credit: marcopako )

IPhone Scarcity During Chinese New Year May Give Samsung a Happy Holiday – Bloomberg.


Right before Chinese New Year, Bloomberg’s Ed Lococo interviewed me for this story, asking me how much I thought iPhone sales would be affected by the company’s decision to sell the newest version of its handset via online channels only. The quote in the story is a good one, but there is more to what I told Ed.

First, I do not expect Apple unit sales to suffer severely from this shift in distribution. When the Chinese people want a product that is difficult to get, they tend to find ways to get it, as evinced by the huge gray market in iPhones that existed long before they were introduced in China. The Chinese consumers who can afford these devices are net-savvy, and the online store will not present a major obstacle, and they should continue to be available through China Unicom’s retail outlets.

I also expect Apple will see a jump in iPhone sales through Apple’s channels in Hong Kong and other major Chinese New Year travel destinations for outbound PRC tourists. However, I noted:

A large portion of Chinese New Year sales are about having the gifts in hand right now, so I expect that Motorola, HTC, and Samsung, all of whom offer Android devices competitive with the iPhone, will benefit among buyers who are ambivalent about the brand of their device or who were on the fence about Android.

Ed also asked me whether I thought Apple would use this as a justification to expand its distribution in China, adding carriers or retail outlets. I imagine Apple will continue to expand its stores, albeit slowly, but I also think they walk a fine line between stoking demand and burning its mojo.

Apple owes much of its profitability in China to the perception that its devices are highly desirable yet difficult to obtain. The company is likely loath to tamper with that aura by significantly broadening its distribution, and that doesn’t even address the engineering challenges of creating an iPhone that will work on China Mobile’s TD-SCDMA network. Apple’s problem is that once two or more carriers offer the device and the phone seems to become ubiquitous, the mystique falls away and Chinese consumers will look elsewhere for their desirable device.

Make no mistake: most of Apple’s recent converts in China are much less emotionally vested in the Apple ecosystem than their counterparts in Japan or the United States. Apple is making a valiant effort to change that, but it needs more time, perhaps years, to develop in China the devoted following it enjoys elsewhere. Until then, it needs to remain in the business of making pretty, hard-to-get devices for prosperous people.

The Beginning of the End of Outsourcing

Apple’s iPad and the Human Costs for Workers in China –

In the Hutong
Working like hell
1530 hrs.

In what China-based business sustainability expert Richard Brubaker calls “the best piece to date on just how rotten [Apple’s] supply chain is,” Charles Duhigg and David Barboza of The New York Times have actually done more than that. They have written a piece that underscores the ethical risks implicit in both outsourcing and offshoring.

Control is the Issue

You could argue that this story and the reception it is getting is a function, in part, of the end of the Steve Jobs Reality Distortion Field, or, as I overheard someone say the other day in reference to Apple, “the King is Dead, the Gloves are Off.” That may be true, in part, but I think that this story is the harbinger of a wider issue plaguing the global manufacturing sector, and the challenges Apple is facing with its suppliers are simply the most visible examples.

The problem goes deeper than the conflict implicit in asking a supplier to give you the best price AND to manage its business in a way that increases its costs. The mater of working conditions is part of a bigger question about the value and importance of control over the means of production. (Don’t worry, I’m not about to go off on a Marxist tangent here. Bear with me.)

I started my career managing the output of 30-odd factories and suppliers in greater China making furniture, jewelry boxes, and small gift items for a medium-sized US importer. I learned a hell of a lot from that job, but the lesson that has stuck with me throughout my career is that you cannot change what you cannot control. We like to think that a customer like Apple would, by virtue of the size of its business, be able to strong arm its suppliers into complying with its codes of behavior, or even “incentivize” a supplier to go along by raising prices. In reality, it is nowhere near that easy. Any customer, even one the size of Apple, exerts influence over how a supplier is run, but not control. A customer can exact some concessions from a supplier on factors outside of product features and quality, but at some point, any self-respecting factory owner is going to push back and say “you may buy from me, you may be my biggest customer, but you don’t own me. I’ll give in to you on some things, but beyond that, you need to let me run my own business.”

Outsourcing and Reputation

As long as governments, NGOs, unions, activist shareholders, and bloggers aren’t looking over the customer’s shoulder, as long as the supplier is compelled to operate according to strict occupational health and safety regulations, or as long as the customer’s customers don’t care, that is an acceptable arrangement. But if the supplier operates in an environment that rewards risking health and safety, has the world watching them online, or has an activist bunch of end-users, the risks of outsourcing grows until it lands the customer and supplier in the hot water that Foxconn and Apple find themselves in today.

Barring an incident that disrupts production, the costs to Apple of its supply chain problems are in goodwill and reputation. Apple, arguably, has amassed enough goodwill and reputation to be able to afford to pay such costs for a while at least. The rest of us must live in a world where we must guard our goodwill and reputation as the corporate crown jewels, spending both with care and amassing more if possible. Indeed, if we replace “Apple” in the NYT story with Nokia, Dell, or Samsung, the report would have very real and unpleasant ramifications for any of those companies.

Apple notwithstanding, we are leaving the age when spin, messaging, great products, and generous corporate philanthropy are enough to pave over corporate practices that governments, shareholders, and consumers find objectionable. We are entering an age where the Spin Gap, the difference between a company’s reputation and the reality of its behavior, is closing, and approaching a time when behavior and reputation are essentially the same thing.

Beyond Goodwill

I tend to harp on reputation and goodwill first because these assets, always important, have become both more important and more fleeting when bad news travels at the speed of Twitter. But the problems with outsourcing and the loss of control over production goes beyond the risk to reputation posed by supplier misbehavior.

We in the west have forgotten that much of the value of our companies create happens in production. The stock market rewards companies for outsourcing their production because of a short-term focus on cost savings and on superficial measures like return on capital. But investors ignore – because they cannot see or measure – the implicit value of keeping production in house.

But, as The Economist pointed out in a superb editorial comparing the fortunes of bankrupt Kodak with those of prospering Fujifilm:

It is easy to think that companies can compete by outsourcing production and focus on developing and marketing. But many innovations bubble up from the factory floor. Even Apple, a master in outsourcing and orchestrating manufacturing, has in-house expertise and occasionally acquires certain technologies. Today, as debates rage in America over the degree to which returns on capital exceed those from actual business operations, and the relative merits of employment in manufacturing versus the services sector, the history of Kodak is more relevant than ever.

The point about innovations on the factory floor deserves some amplification. Apart from the product innovations that come from the factory floor, innovations in the production process itself can become a huge source of competitive advantage. Ford, Toyota, Hewlett-Packard, and Dell are just four companies that built their success to a great degree on innovations in the production processes.

Owning production is a hard sell to a lot of American business, not just because of Wall Street’s expectations, but because so few young Americans learn production or operations management anymore, preferring courses in finance and marketing in the hopes of getting a job in an office. That does not take away from The Economist’s point. You start outsourcing, and not only do you lose control, you mortgage your future for near-term returns.

There is no shortage of companies who, consciously or otherwise, defend their future by hanging onto their factories. Two examples off the top of my head are Boeing and Intel. Boeing got so good at manufacturing that it was able to cut an entire time-consuming step – full-size mockups – out of the development process, going straight from computer model to production on the 777 jetliner. When the company tried to go the “design and market” route with the new 787 dreamliner, they got hit with a three-year delay on their critical 787 program and, until they took back production from several contractors, they were on the verge of sacrificing expertise in a critical new skill area: manufacturing all-composite aircraft components.

Intel has always been a leader in manufacturing processes, being first in the industry to try new, expensive, and often risky technologies, working out the kinks, and sustaining leadership as a result of that expertise. Even today, Intel outsources little: the company continues to build, own, and operate manufacturing incredibly expensive manufacturing facilities – from chip fabricators to pack-and-test assembly lines – because the company understands that there is more to their business than design and marketing.

And the idea of outsourcing would be anathema to Mercedes-Benz, Fender Guitars, Microsoft, or most companies in the service industries. In all of those cases, keeping the production close is either an important part of the value delivered or the very source of  company’s differentiation.

The Vote of History

Outsourcing has saved its share of companies and returned its share of profits. But the persistent challenges encountered in its execution by one of the smartest and healthiest companies in the world is a warning: short-term expedients do not create long-term winners. Those of us who love Apple and the products it makes and who understand the nature of its relationship with its suppliers (and their own ambitions) make us worry that the company is forgetting a key source of its uniqueness.

The upshot of the above is simple: two years from now even Apple could find its reputation savaged by the perfect storm of one bad product, one down quarter, and a mishap caused by a factory it did not control; or fifteen years from now it could follow Bethlehem Steel, General Motors, and Kodak into the ignominy of Chapter 11. Either would be the ultimate result of depending on somebody else’s factory for the production of Apple devices.

What is true for Apple applies doubly for the rest of us. The factory floor matters. It’s time to take it back.

Deconstructing China’s Nationalists

To Screw Foreigners by Geremie R. Barmé

In an essay from 15 years ago that remains one of the best background pieces on Chinese nationalism that I have ever read, professor Jeremy Barmé of the Australian National University delves into the historical and philosophical underpinnings of this rising ethos.

There is a growing consensus among Beijing-watchers that nationalism has replaced economic development as the primary driver of domestic Chinese politics on the eve of a generational leadership transition. For that reason, there is no better time than now to dive beneath the surface of this phenomenon and understand it from the roots.

I read Barme’s piece with great interest. While I didn’t come away with any profound conclusions, I see what is happening today with somewhat greater clarity. It also helps peer behind the Red Rhetoric of Bo Xilai’s campaigns to see something older and more elemental at work.

Not a short read, but a great one.

There is More to Tablets than Cheap vs. Dear


English: motorola xoom tablet
Image via Wikipedia

How Apple Can Keep Control of the Tablet Market – BusinessWeek.

GigaOM‘s Darrell Etherington believes that the way for Apple to sustain its dominance in the tablet market in response to challenges from the Kindle Fire is to offer a smaller, cheaper tablet. The case he makes – that a cheap tablet with a tightly integrated “content ecosystem” is the best response – is not a bad one, but it misses the wider point.

The issue with tablets going forward will not be large versus small or high-end versus low-end, but general versus specialized. The iPad, the Motorola XOOM, and the Samsung Galaxy Tab are examples of high-end, tablet format computing devices that are designed to perform an array of tasks. The Kindle Fire, despite the other things you can do with it, is designed to offer a quality book, music, and possibly movie experience. At doing other things, even browsing the web, it is somewhat weaker.

And this is not a bad thing. Not everybody wants a tablet to act like a laptop without a keyboard, and in fact the great untapped opportunity is in finding ways to target the format for specific experiences or vertical markets where the iPad or XOOM would be too much machine for the job.

Brands Add Value

Back in the Hutong
Finally, blogging again
1657 hrs.

As the debate over if, when, and how China will begin to produce global brands continues, someone quipped today that China will start building brands only after it starts creating products people want to buy. That’s a fair point, but I don’t think it goes far enough. As Thys De Beer wrote last year:

In the 1920’s WK Kellogg said: “The purpose of business is not to make a profit. What a dreary and demeaning description. The purpose of business is to add value to people’s lives. The consequence of doing that well is that you make a handsome profit.

Debate that if you will, but I think that Kellogg’s statement reflects

an idea that has yet to germinate among Chinese executives, and that therein lies the core reason why China has yet to produce global brands.

US Listed Chinese Companies: The Clock is Ticking

U.S. Regulators Push Chinese to Resume Auditor-Inspection Talks – Businessweek.

The U.S. is ratcheting up the rhetoric in the battle to improve the quality of auditing being done on Chinese firms listing or listed on U.S. stock exchanges.  The Securities and Exchange Commission and the Public Company Accounting Oversight Board (PCOAB) are trying to get the China Securities Regulatory Commission to require joint inspections of auditors from both the US and China for Chinese firms listed in the US.

The Chinese, claiming concerns over the revelation of “state secrets” are having none of it, seeing the US request as a violation of Chinese sovereignty.

PCOAB Chairman James Doty is apparently getting frustrated with his Chinese counterparts, who have abruptly cancelled bilateral discussions on the issue.

‘We can’t simply pretend that China is different,; he said. ‘You can’t come sell your securities here and ignore the fact that the law requires and people want to know that the auditor’s been inspected.’

Doty is not a paper-tiger bureaucrat that the Chinese can afford to just ignore:

The [PCOAB], which was created by the Sarbanes-Oxley Act of 2002 after accounting scandals contributed to the collapses of Enron Corp. and WorldCom Inc., has authority to de-register China-based auditors, which could start a chain reaction leading to companies being unable to list on U.S. exchanges.

Doty, SEC Chairman Mary Schapiro, and Senator Chuck Schumer all seem to believe that this tough talk will compel China to give in, believing that China is more afraid of losing access to the capital in US markets than they are of giving auditors a glimpse at the dirty laundry of Chinese state-owned enterprises, or even of China’s actual level of defense spending.

They may be right. But many Chinese policymakers, offered the choice of putting state secrets at risk or funding Chinese firms outside of U.S. equity markets, will be motivated to take the latter course. As I noted in an earlier post, the growing complexity of listing Chinese companies in the US and the maturation of China’s own equity markets make the repatriation of offshore listings an increasingly tempting option both for regulators and companies.

Don’t get me wrong: I think that whatever else might be motivating them, Doty, Schapiro, and Schumer are right to be trying to protect the interests of investors. At the same time, though, they have to recognize two hard truths.

First, it is still unclear whether U.S.-based auditing firms operating in China are passing PCOAB inspections. Not only should the PCOAB attend to that task first, it should make the results of those inspections public. Failing to do so makes US regulators look hypocritical.

Second, the long-term outcome of this effort is less likely going to be a major improvement in corporate transparency in China than to hasten the shift of Chinese equities out of the U.S. and into Chinese exchanges. While US bourses boast far greater liquidity than China, the Shanghai and Shenzhen exchanges have access to a large, relatively undemanding pool of capital hungry for hot new listings. PRC exchanges could easily absorb a steady, modest stream of Chinese companies de-listing in the US and listing (or conducting new offerings) in China.

Doty et al are to be commended for their efforts. Sadly, corporate transparency in China will only improve when the Chinese government demands it in order to protect Chinese investors and/or the global position of Chinese markets.

Chinese TV: App to the Future

In the Hutong
Back from CASBAA
1307 hrs. 

China: The New Mobile App Dragon,” by Peter Farago, Flurry Analytics

If one conclusion stands out after all of the panels at the Cable and Satellite Broadcasters’ Association of Asia (CASBAA) conference this week, it is that all of the broadcasters in the region see the challenge posed by New Media (even China Central Television [CCTV]), and none of them are quite sure what to do about it. As one CCTV executive told me, “we all acknowledge now that new media, the Internet, and mobile are the future, and that we want to be a part of that. But the question is ‘how’?

Steve Garton of Synovate suggested in a well-attended breakfast meeting that part of the answer lies with apps. In his presentation, Steve made the case to the region’s broadcasters that they needed to get better at using mobile apps to distribute their content on smartphones and tablets. Specifically, Steve noted that his company’s research around the world had proven that the best way to get in front of users would be for a broadcaster to have its app pre-installed on phones when sold.

It is not hard to foresee an edict from the Central Government requiring all carriers selling smart phones to include a CCTV app on those devices, and the numbers suggest that the Party needs to start looking at mobile as a means to ensure that it is still reaching China’s post-90s generations. According to Flurry Analytics, China began 2011 ranked 10th in the world in the number of global app “sessions” on smartphones and tablets. Growing 870% in the first 10 months of this year, China has passed every country but the US and now ranks second worldwide in app use. And one of the top 10 must used apps? Youku, which, by the way, comes pre-installed on many of China’s handsets and tablets.

I’d wager CCTV and the other broadcasters will not long permit Youku exclusive rights to that space, but all of the terrestrial and cable broadcasters face the same problem: how to attract the user to their apps when those users do not watch the stations? And if they collaborate with Youku and Tudou to distribute their content, what value do the broadcasters add? And what happens to their brands?

We cannot yet rule out the possibility that the broadcasters will move to create a Hulu-type service and pull their content off of the other sites. But that still leaves them with a large back of programming all in one place, and the brutal challenge of getting people to actually use the service. And for all of their production and engineering prowess, Chinese broadcasters are not the bastions of marketing that their U.S. counterparts have been.

For these reasons, the question of how broadcasters will deal with apps and mobile seems to point toward the same eventual solution as do the tricky politics and economics of the broader online video sector: eventual mergers between the broadcasters and the major online video sites.

China’s Choice

As Number One, China To Face Hour Of Choice, by Richard Bush, YaleGlobal Online, June 30, 2011

Richard Bush, who is the director of the Center for Northeast Asian Policy Studies and a senior fellow at the Brookings Institution, offers alarmists in the West some perspective about China and its seemingly inevitable rise to economic leadership in this well-worded article in YaleGlobal.

One fascinating point Bush makes is that China faces a choice with its economic might: either build for domestic prosperity and harmony, letting the US “bear the burden of international leadership,” or it may use its treasure to expand its global influence and power. It is a fascinating point, but I would wager most Chinese would reject the choice. The US has (until recently) enjoyed global power and domestic prosperity, as have Britain, France, Spain, and the Netherlands before it. Why, the thinking will go, must China choose? Can it not have both?

The greatest challenge the world faces with China’s rise is the sense of national entitlement that seems to suffuse popular sentiment, in particular among the young. Being the world’s largest economy should come with the trimmings, they think.

Some Chinese believe that passing this milestone will have automatic consequences for international politics, giving China more international influence. In their view, other countries should then confer more deference on China and accommodate to it on issues that China regards as important, rather than China continuing to accommodate them. At some point, Beijing will likely insist that the head of the International Monetary Fund or World Bank be a Chinese.

Whether practical or not, the people of China will want both prosperity and power, and unless the government begins a campaign to manage those expectations rather soon, the Party will find that it has made a mighty rod for its own back. The government will be expected to deliver on both global power and local prosperity.

That challenge will form the primary driving force behind China’s international relations, whether in defense, diplomacy, economic relations, or commerce and trade. A China so pressured from behind will not sit politely in its seat at the table of global power and learn which fork to use. It will have to insist that the rules created to manage a world led by an Atlantic civilization be changed to address a shift to a world dominated by Pacific powers, including the US.

Rather than panic, which Bush suggests is uncalled-for, the time has come for us to determine which aspects of our global systems of security, diplomacy, economy, and commerce are – for us – non-negotiable, and why. We should try to guide China’s hand at the global table much as Britain guided ours, but we should hold true to our principles and our non-negotiables.

China’s choice has been made for it. The real choice belongs to the West.

Eight Questions the WSJ Could Have Asked KPMG China

Managing in Asia: KPMG Audit Chief Benny Liu Faces China Risks –

As a public relations professional myself, I want to congratulate the KPMG PR team on their coup in today’s Wall Street Journal. In an interview with the Journal‘s Duncan Mavin, Benny Liu, the head of the Audit practice at KPMG China is given an singular opportunity to deliver his messages in what was clearly a very friendly discussion.

This interview could have been much more challenging for Liu. At a time when Chinese companies that are listed offshore are facing uncomfortable questions about the accuracy of their accounting, you would expect a newspaper that is ostensibly an advocate for investors to come down on a senior China auditor with some very hard questions. Alas, those question were not forthcoming. Not today, anyway.

But the recent wave of scandals around U.S.-listed Big Four-audited Chinese companies suggests that the time will come when harder questions will be asked. Mr. Liu and his PR team would do well to prepare for such questions as:

1. What measures does your firm have in place in your China practice to ensure that auditors and their reports are not influenced by the pressure to retain and please the client?

2. Has your firm ever altered its audit reports on a Chinese company under pressure either from the client or from a senior KPMG executive?

3. Has your firm ever reprimanded, transferred, or terminated an employee in China because of a refusal to alter an audit report to reflect more favorably on a client?

4. What does your “risk management” department do, exactly? In layman’s terms?

5. Have you personally ever intentionally overlooked or failed to report client accounting practices that do not conform to GAAP? Have you ever done so for a company that was listed or was about to be listed in the U.S.?

6. What do you feel should be done to auditors and firms who overlook, ignore, or fail to report illegal, unethical, or ineffective accounting procedures practiced by their clients?

7. Is there a need for a independent professional accreditation body for auditors in China? Why/why not?

8. What would you change about the auditing profession to ensure that investors and the public are better protected?

This is not to pick on KPMG China: any big-four auditing firm with operations in the PRC would do well to keep this list of questions close, build on it, and be ready with something more than a holding statement when – not if – these questions come up.

VIEs: The Long Resolution

In the Hutong
Prepping the Pack Meeting
0917 hrs.

In the course of some debates about China, all you learn is how strong peoples opinions are. Yet in a few cases, the debate itself is a socratic-style graduate seminar not only on the topic but on China. The back-and-forth online around the status and eventual fate of Chinese companies who have listed abroad via a structure called a Variable Interest Entity (VIE) has been just such a debate. The most prominent participants have been:

  • Digicha, the blog by Bill Bishop, Beijing-based investor, former China online game company executive,  co-founder of CBS MarketWatch, and MVP of the China Twitterverse.
  • China Hearsay, by Beijing-based Stan Abrams, a technology and intellectual property attorney and law professor; and
  • China Law Blog, Dan Harris’ award-winning forum that chronicles the intersection of Chinese law and global business, among other things.
  • In particular, take a look at this post on China Law Blog, “China VIEs: The End of a Flawed Strategy – an Update/Rebuttal,” along with all of the comments, which alone are a seminar on a very hot topic.

Rule of Policy

I had started to see this issue as a matter wherein the rule of law clashes with the political expediency of accommodating elites. But the aforementioned post on China Law Blog convinced me that this is not the case. As with most Chinese legal codes, the statutes are vague, there is huge room for political and administrative interpretation, and there are overlaps and conflicts among the laws that leave in question which agency has the authority to make or enforce a ruling against any or all of the companies involved.

The matter will be decided not on the basis of law, therefore, but on the basis of policy, and probably at the State Council level. Bishop, correctly, notes that no bureaucrat has the political cojones to take on the wall of entrenched interests that protect the VIE-based companies, and suggests that the easiest way to handle the situation would be to issue clarifying regulations about the legality of VIEs and to grandfather all current VIEs.

I agree, and I suspect that is what will happen, but I also suspect that this will not be the end of the matter. Even though no policy maker would be willing to risk his or her career by slamming the door on VIEs, if such structures are considered politically undesirable by China’s leaders, then we still have a problem.

Bringing the Capital Home

As someone quite wise once said to me, “the Chinese government likes to boil its frogs slowly, not all at once.” What this sage meant was that when dealing with any issue that affects a wide range of powerful interests, Chinese policy makers tend to eschew immediate and radical solutions in favor of a gradualist approach. In a system that depends increasingly on tenuous consensus, this is perhaps the only possible approach. Each step taken moves the matter closer toward resolution without causing severe disruptions for any of the interests involved. All that is necessary to understand whether a solution can be considered temporary or permanent is to look for the larger national goal that is driving the change in the first place.

An idea of what might be driving the government’s efforts around VIEs can be found in an article in New Century magazine last week that sums up the current state of play with the VIE issue. The article quotes a situation report provided to attorneys and the industry three weeks ago as saying that in the early days of the development of the internet in China, the local A-share market was inadequate to the capital needs of the industry, thus it was decided that overseas listings of these companies offered more good than harm. The report goes on, however, to suggest that it would be in China’s interest to arrange the earliest possible return of the shares of such “leading enterprises” to China’s own local exchanges in Shanghai and Shenzhen.

If repatriation of share ownership is (or becomes) the goal of the government, that is a more reasonable target than abruptly pulling the plug on VIEs, but it does point to a long-term dissolution of those arrangements by substituting offshore capital with capital from China’s own markets, either via domestic listing, private placements with domestic enterprises or sovereign funds, or all of the above. To give a simple example, were Jack Ma to recover the 40% of Alibaba that Yahoo! currently owns, he could replace the cash thus expended by a domestic share issue in China. Using similar mechanisms, the VIEs could be dissolved in a manner that would harm none of the powerful interests involved, yet would satisfy the government’s policy goals.

None of this would take place quickly, nor should it, and I do not think that regulators have come to an agreement yet on how to proceed, and things may roll out quite differently. The point is that a short-term accommodation with the VIE structure in the name of political expediency neither institutionalizes the structure as a long-term funding option, nor signals a change in the fundamental drivers of policy. It should, rather, be seen as the high-water mark in China’s effort to tap offshore capital to fund the growth of the nation’s leading online enterprises, and perhaps the beginning of the next phase in the maturation of China’s own domestic capital markets.

But it is Bigger than All of This 

If you think this is an issue of parochial interest to lawyers and China geeks only, think again. The reason the VIE issue is important goes beyond the effect the recent uncertainty has had on nearly 100 Chinese companies that have listed abroad (and their shareholders.) It is more important to anyone doing business in or with China because of the implications that the issue and its eventual resolution will have on foreign investors and business in the PRC in the coming decade.

A recurring theme of this blog of late has been the apparent shift in attitudes in China toward foreign enterprises and capital. Since the beginning of reforming and opening, foreign participation and foreign investment in the Chinese economy has always been seen as an expedient means to hasten development. What has changed is not the attitude, but China’s perception of itself and the extent to which it still needs the necessary evils of foreign capital and expertise. China still needs both more than either the Party or the people are willing to admit publicly: alongside other considerations, what will slow movement toward a resolution of the VIE issue is disagreement within China’s leadership over how much the door to such structures needs to remain open, and how much local capital is actually available to local high-growth businesses.

But the long-term goal should not be in doubt, and it is that desire for financial self-sufficiency, followed by global financial leadership, that guides the evolution of policy (and law) toward VIEs and all offshore listings.

Update: In what may be the first step in that share repatriation, Shanda Interactive’s founder Chen Tianqiao, his wife Luo Qianqian, and his brother Chen Danian have formed a group to buy the publicly-owned shares of Shanda (NASDAQ: SNDA) that they do not already own. J.P. Morgan is issuing the debt to finance the transaction.

Stop Shunning Beijing’s Foreign Correspondents

Me Reading the Financial Times
Image via Wikipedia

In the Hutong
Good grief, Thursday already?
1317 hrs.

In a recent profile of Michael Lewis, arguably the leading long-form journalist of our age, New York magazine’s Jessica Pressler quotes her subject on the gulf between journalists and the people and organizations they cover:

It is amazing how much contempt there is for the professional media that surrounds any given enterprise,” he says. “I find it all the time. Silicon Valley entrepreneurs think the tech journalists are all stupid. The sports people think that about the sports journalists. They don’t say that to the sports journalists, because they want the sports journalists to be nice to them. But the level of contempt is very high.

As someone who is called upon to bridge the gap between companies and the media who cover them, I can attest that this contempt, mixed with more than a little fear, is a problem here in China as well. In defense of the companies, part of that contempt is self-inflicted: any journalist who cheapens himself and his trade by taking payment or expensive gifts from a company he covers earns his full measure of scorn and contempt, and splatters his fellow journalists in the process.

But it is not always justified, in particular in the case of the global media. There are hacks in every crowd, to be sure, but China has been blessed with a crop of some of the most astute, erudite, and talented people ever to face a daily deadline. I challenge anyone to impugn the intelligence or abilities of people like Andrew Browne at The Wall Street Journal; Tania Branigan of The Guardian, Louisa Lim of NPR, James Kynge (formerly of the Financial Times), Charles Hutzler of the Associated Press, Barbara Demick of The Los Angeles Times, or anyone working behind the veil of anonymity at The Economist, including their most recent addition, Gady Epstein. And for every one I mention, I am skipping a half dozen of equal or greater talent, as well as those who have been here and left, like the brilliant James Fallows.

Granted, engaging with foreign correspondents can be painful at first: there is much to explain about one’s business and industry, because most of these reporters are by necessity generalists. One executive complained to me that it was a lot of trouble to explain the basics of their business to someone who had not bothered to do the research ahead of time. My response to him was that as bright as these folks are, they are also under the constant gun of a deadline and cannot always afford to do the research ahead. But a stupid question is a golden opportunity: when a foreign correspondent asks you to explain your business in your terms, it doesn’t get any better than that. And nowhere do those opportunities crop up more often than here in China, especially Beijing.

A generation ago, the “best and the brightest” young stars of international journalism made their careers covering the Vietnam War. Today, many are making or sustaining their careers by covering the rise of China. If your company is not taking advantage of that opportunity, (and plenty of both Chinese and foreign companies are blowing that one terribly,) what excuse do you have?

Jack Ma’s American Journey

Jack Ma, Founder of Alibaba Group
Image via Wikipedia

In the Hutong
And…We’re Back!
1151 hrs.

Amidst all of the recent speculation about Alibaba, Jack Ma, and his intentions toward Yahoo!, the real story keeps slipping below the fold: Jack Ma’s pledge to spend a year living in the United States. It is hard to discern whether that was a genuine promise or a trial balloon, but let’s assume that Jack intends to carry through on it.

Mr. Ma deserves praise for what cannot be an easy move. He appears to understand that if you are going to do business in one of the most complex and competitive markets in the world, you had better know that market in your guts, and not designate some subordinate to do that understanding for you. It is long past time for American and European CEOs to start doing the same in China. We are waiting for the first one to do so, and that little problem is a factor in the challenges that foreign companies face here.

Yet if Mr. Ma believes that his expressed desire to live in America will soften the discomfort of the American public and the Committee on Foreign Investment in the United States will feel toward the purchase of Yahoo! by a Chinese company, he is too late. Assuring both Washington DC and Main Street USA that Alibaba is not the long arm of the Party and is trustworthy enough to be the custodian of a massive storehouse of information on American citizens will demand a lengthy campaign, not well-meaning gestures. A year under American law building visibility, accessibility, and trust is a good start, but no more, and any bid for Yahoo is likely to happen sooner than that.

Finally, before venturing into the North American wilds, both Alibaba and Mr. Ma would do well to consider an adjustment in their approach to the global media. I spend a lot of time with journalists who represent the world’s leading media outlets in China, and whenever the subject of Alibaba comes up, the response is always a shaking of the head. The word is that not only does Mr. Ma appear increasingly inaccessible to the global media, his international PR staff is allegedly not above haranguing journalists whose coverage of Alibaba is deemed less than supportive. If true, this is an approach that will make neither Ma nor Alibaba many friends in the United States. The primary coverage of the company is still going to come from China, and alienating foreign correspondents ill-serves the purposes of a company with audiences outside of the PRC. The global media can be allies or enemies in Alibaba’s leap abroad, an effort that will demand the help of all the friends the company can get. At the moment, that list of friends – inside the Beltway, across America, and in the fourth estate – seems a bit short for Alibaba’s ambitions.

Time to change that.

Hutong Weekend: Top Ten Signs that it is Time to Leave Foursquare

In the Hutong
Mid-Autumn Festivus
1515 hrs.

After much angst and contemplation recently, I gave up on Foursquare.

I wasn’t stalked, and it has nothing to do with something the company did to offend me. I just woke up one day and realized that I was probably putting a lot more into the service than I was getting out of it, and that of all of my social media outlets, it was giving me the lowest return on my investment.

I do not think I’m alone in this predicament, but as a public service in order to help you assess whether you should give up on the service or stick with it, I have prepared the following list of signs and symptoms indicating that you no longer need Foursquare in your life.

10. You have not earned a new badge in six months, despite regular use.

9. You have not only created a spot for your home, you have checked in there at least 50 times.

8. You realize that do not care where the latest B-grade actor or actress had dinner last night.

7. The highlight of a night out at a new restaurant with your significant other becomes checking in at a new location

6. You keep swapping mayorships at the same half dozen places with the same half dozen people

5. You start asking your spouse to drive so you can do more “drive-by” check-ins.

4. You start doing “drive-by” check-ins – while flying in an aircraft.

3. You stop reading the “specials” because you know you cannot qualify for them.

2. You start wondering when Foursquare is actually going to evolve the experience

And the number one sign that it is time for you to leave Foursquare:

1. You realize that, since you are not Lady Gaga or POTUS, nobody cares where you are at every minute of the day.