dolution

When to pull the plug?

Ralph Henderson could not sleep. He was rehearsing over and over the justifications he would put to his new Managing Director, who tomorrow was due to visit the Shanghai plant of East China Conditioning Systems (ECAS). ECAS is a joint venture between Shanghai Engineering Corporation, a state-owned enterprise employing 1200 staff, and Koolair Australia. Three months ago, Koolair had been bought out by a British multinational, Colonial Air Conditioning, and since then the new managing director had made clear his intentions of boosting profits by cutting unproductive functions. He intended to start by inspecting all offshore activities.
Ralph arrived in Shanghai to live with his family in November 1994 after being involved in more than two years of informal negotiations and relationship building during six visits to China. His wife had managed to obtain a satisfying job as a teacher of English at a local school while his two children, aged 12 and 9 years, were enrolled at the expensive international school in Shanghai. Fortunately, the Australian parent company had agreed to a comfortable remuneration package for him that covered an annual salary of A$98,000, full subsidy for rental of a luxury two-bedroom apartment, contribution to telephone, fully serviced motor vehicle, full cost of children’s education, and annual return airfares to Sydney for all members of his family or contribution of an equivalent sum to holiday travel to any other location. Although his appointment as General Manager of the Shanghai joint venture cost the company over $450,000 annually, Ralph in no way felt guilty about receiving these benefits, taking into consideration the difficulties of crowds and traffic when compared to life in Sydney and the constant challenges involved in doing business in this foreign environment.
Koolair Australia designed, manufactured, and installed air conditioning systems, specialising in high-rise commercial buildings. With 120 staff, the firm had concentrated its activities on Sydney and Melbourne. With a slowdown in building activities in the late 1980s, Koolair was forced to look abroad for continuing growth. China, especially Shanghai, was a logical choice-a rapidly developing city of 18 million people, hosting 18% of the world’s tallest cranes for current high rise construction projects.
A joint venture in Shanghai presented several advantages.

First, a joint venture would give a leading edge to a rapidly growing market in South East China: Strong funding support were promised by local banks; tax holidays were offered for materials imported by the joint venture company. A more flexible and efficient recruitment process than other local state-owned enterprises; Given the extremely expensive cost of labour in Australia, there will be huge savings on labour cost recruiting local skilled employees while complying strictly with the relevant local entitlement standards. And the Chinese parent company enjoyed a dominating and competitive market position in respect of local air conditioning in Shanghai.
Acting upon advice from Australian government trade officials and mangers of other Australian firms operating in China, Ralph took great care regarding the basis of the joint venture agreement. With some justification, he considered this among his more significant contributions to his firm. His fundamental achievements were to:

• Ensure Koolair was indispensable to the new joint venture. (Koolair had 40% equity and contributed managerial and technical expertise and technology, while Shanghai Engineering Corporation had 60% equity and contributed finance, guaranteed by the State).

• Establish ECAS as a stand-alone financial entity. (This was standard protection against other parties in an agreement attempting to ‘milk’ funds out of the system).

• Establish a two-tiered management accounting system. (One supplies information as required to local Chinese authorities. The second system provides information to Koolair senior management)

• Structure policy decision making at board level of ECAS so that all policy matters are resolved by consensus and that nothing of any substance happens unless both parties agree.

Despite these sound structural arrangements, and Ralph’s 18 years’ experience in the industry in Australia, the early years in Shanghai had presented major difficulties. First was the cultural clash, Chinese culture was quite different from the West. Building a relationship with Chinese companies and local contacts not only require business skill, but also respect and understanding of the Chinese culture, as well as their ways of life. Ralph realised that foreign businesspeople must respect this difference while doing business in China, even though they might not understand or agree with everything. Chinese place high value on “Guanxi”, it is a long-term connection developed by the traditional Chinese culture and upon which parties are able build a connection beyond just one business transaction, but more at a level of “friendship”.

By the time the out-of-town production plant for ECAS had become fully operational at the end of 1995, Ralph had encountered some further unexpected problems.

First, the Australian staff training system was not properly implemented and therefore the local workers production was lower than expected. The instructors were not trained with local knowledge and could not communicate effectively with the local moderators and the trainees. Second, there are also cost that was not expected from Ralph’s experience in Australia, such as employees in China may be entitled to days of paid leave when donating blood voluntarily and the social welfare system requires payment of five insurances and one housing provident fund to all employees. Organisations may be fined heavily by the government if found not complying with this legislation. In Australia, employees usually only have one superannuation payment which contains some insurance to cover accidental death or disability. It is also a tradition for Chinese companies to supply all employees with welfare “gifts” (rice, cooking oil, wine etc) in celebrating some of the traditional Chinese holidays. This is to show respect to employees and the traditions. Ralph was not aware of some of these holidays and was feeling sometimes unprepared, leaving the employees unhappy (even though it was not his intention to do so). Ralph also failed to budget these costs into the ongoing operating expenditure, which has caused his spending exceeding the budget in some areas.

The most frustrating environmental challenge was the longer account settlement period which slowed the payment coming from various parties. Ralph constantly struggled with cash flow issues.

When commencing the Shanghai joint venture, Koolair recognised that return on investment in places such as China may take 7-10 years to commence from the time of initial outlays. Hence senior management was pleasantly surprised by early predictions from the Shanghai Engineering Corporation that modest profits from the joint venture could be expected from 1997. Unfortunately, these predictions proved to be too optimistic, and Ralph had to report to Koolair, just prior to its takeover by Colonial, that profits were unlikely before 2000.

Responding to international pressure from organisations such as IMF and the Asian Development Bank, the Chinese Government in Beijing in late 1997 announced a program of reforms to improve the efficiency of state-owned corporations. In November 1997, Shanghai Engineering Corporation wrote to ECAS indicating that in response to these reforms:

• A German multinational firm would be permitted during 1998 to establish a plant in Shanghai to design and manufacture locally, air conditioning systems for commercial buildings.

• The Shanghai Engineering Corporation would require 70% equity in ECAS from the yea 2000, with 80% holding by the year 2005.

• Local finds promised to allow expansion of plant capacity by 30% would be delayed 12 months until 1999.

Ralph had immediately dispatched these requirements to his new managing director of Colonial in Sydney. Thus, he awaited tomorrows visit with a sense of anxiety.

Students must answer the following Two Questions

Question 1

What detailed arguments would you prepare for tomorrow’s visit if you were Ralph? What would be your recommendation for the future of the joint venture?

[10 marks]

Your answers:

AND

Question 2

Ralphs contract for appointment to the Shanghai position is due for renewal in 12 months. If you were in his situation, would you extend the contract by another four years, or return to Sydney as a manager with Colonial on an assured A$70,000 package, with no additional ‘perks’?