One of the more recent and high-profile cases highlighting the importance of pretransaction mutual understanding is the joint venture between France’s Danone and China’s Wahaha Group.
Wahaha began business in 1988 when one-time farmer Zong Qinghou started to sell milk products out of a school shop. By 1996 he had decided to move into bottled water and did a deal with Danone to help expand.
The partnership seemed a good fit at first. Danone brought the resources of an experienced multinational – including capital and product research – which combined well with Mr. Zong’s local knowledge.
The joint venture was formed in February 1996 by three parties in order to supply the fast-growing and lucrative Chinese soft drinks market. The Wahaha Group, which was owned exclusively by the Hangzhou Province government, held 49 percent of the joint venture Danone, the giant French fast-moving consumer goods manufacturer, and, Jinga, a Singapore company with whom Danone already had joint ventures, equally controlled the other 51 percent. Danone relinquished day-to-day and managerial control of the Chinese operations entirely to Wahaha who in turn was supposed to contribute the famous Wahaha brand and trademark to the entity. Danone’s oversight of the operation was provided by its inclusion of the board of directors.
The waters got muddied relatively quickly before the deal was completed. Firstly, the Chinese government ruled that the trademark was Chinese state property and couldn’t be given to the third party. Rather than renegotiate the deal, the parties agreed to modify the arrangement and opt for a licensing agreement to which the Chinese government had tentatively agreed; full disclosure of the extent of the entire transaction, however, was never made to the officials. Secondly, Wahaha was privatized and the responsibility to run the operations was given to Zong Qinghou who began running the joint venture as if he owned it, which in practical terms, he did. Danone ultimately agreed to this but the change in partners meant a misalignment of objectives of the various joint venture partners. Finally, Danone bought out their Singapore joint venture partner who was struggling financially thus creating the scenario where they held legal control of the joint venture. This latter action by Danone appeared to greatly upset Zong who allegedly felt as if he had been mislead by Danone and that they had intended to seize control all along. The stage was set for animosity and distrust between the joint venture parties.
Wahaha flourished in China, with sales growing to over $2 billion per year and a 15 percent market share making it the market segment leader. By this stage, Zong had become one of the wealthiest men in China. By 2006 it became clear that there were parallel companies supplying Wahaha products through the joint venture’s supply chain that were not joint venture assets. Danone accused Zong of cheating the joint venture out of millions of dollars and demanded to have these operations brought under the joint venture umbrella. Zong refused. Danone sued in several jurisdictions while the case went to arbitration in Sweden. Simultaneously, Danone lost both its initial case and its appeal in the Chinese court system that stated, among other things, that the use of the Wahaha trademark was illegal and it had never been properly granted to the joint venture in the first place. Danone was left with little choice other than to drop its legal charges and sell its half of the joint venture to Zong for a reputed $500 million.
There are several salient lessons to be learned from this case.
Firstly, when forming joint ventures in China, common, agreed, and transparent objectives between the partners are absolutely paramount in most cases, this involves an enormous amount of effort and time to ensure fit. In terms of legal control in China, there is no difference between a few percentage points of ownership – it really becomes theoretical. If a Chinese partner has a clear minority stake in the joint venture, say 30 percent, it is viewed as being a distinct significant minority holding. By contrast, even if the partnership is 45-55 percent, it is seen as a true partnership with both sides contributing equally to the venture’s success. This distinction was not seen by Danone.
Secondly, the role of trust on both sides in the Chinese market cannot be emphasized enough. Danone gave Zong operational control of the joint venture with very few control systems put in place. The duplication of operations went on for some time before Danone was even aware of it; as an incoming company, this is very dangerous. Furthermore, in China, employees in private enterprises often feel stronger loyalty to the boss than the organization itself.
Thirdly, foreign companies should understand and accept that the Chinese landscape shifts in terms of management and shareholder intentions, especially when dealing with state-owned enterprises further complicating the ability to ensure common goals and strategies.
Fourthly and related, while trust and mutual respect are critical, one cannot rely on the alone. When push comes to shove, the Chinese legal system is not going to save a foreign company when there is a significant conflict of interest with an indigenous firm, so foreigners do not have this fallback. They simply cannot hand outright control to a Chinese partner without active involvement in the running of the venture’s operations. To do otherwise is to invite disaster.