Power to the joint venture

Managing a joint venture in China can be a challenging experience. Here E&T explains how the formation of the Jinan Fuqiang Power Company proved to be successful, although not entirely in the way the partners had anticipated.

In early 1995, a UK Midlands-based engineering company engaged in the re-manufacture of automotive engines was invited to replace the US partner in an approved joint venture to re-manufacture engines in China. China National Heavy Duty Truck Company (CNHTC), located in Jinan, Shandong Province, had been chosen by the State Council, to which it reported at that time, to establish an equity joint venture (EJV) to introduce engine re-manufacturing techniques and skills to China by engaging with a foreign company. The US company that CNHTC had chosen, owned by Chinese expatriates, had failed to make its equity contribution after approval of the joint venture.

Faced with this embarrassing situation, CNHTC had sought the advice of the Centre for Trade and Development (CMTD), the market research consultancy arm of MOFTEC (now MOFCOM, the Ministry of Commerce), who had in turn enlisted my help. I identified and approached the UK engine re-manufacturer, which confirmed its interest and asked me to open negotiations on its behalf. It was quickly apparent that the UK engineering company did not have the financial resources to take over the position of the US company and provide further investment and a UK-managed offshore investment group was brought in as a second foreign partner. Preliminary negotiations proceeded rapidly and on a first one-day visit to Jinan we drafted a formal memorandum of agreement that was signed by all three parties in the days following. The basic elements for a pre-feasibility study were agreed at a distance and a proposal was submitted to the relevant authorities shortly thereafter.

Three months later, after receiving preliminary approval and confirmation of withdrawal from the US partner, the joint venture negotiations took place in Beijing with the assistance of CMTD on the basis of a draft joint venture contract and articles of association prepared by CNHTC. Over a period of two weeks that included a visit to Jinan, the detailed negotiations were concluded and the draft contract and articles of association signed for submission to MOFTEC and the other approval authorities. At the same time, a mission statement and a detailed business plan was also developed jointly and signed off. The basis of the JV was that CNHTC retained the 51 per cent equity interest that it had been allocated in the original JV, and the two foreign partners would share the remaining 49 per cent in agreed proportions. The contract provided for a registered capital of $2.05m.

One bonus from the two weeks together was that the chief negotiator on behalf of CNHTC, a young engineer from its technical centre, emerged as a clear candidate to be general manager. Although he did not speak English at that time, intelligence and maturity were evident and immaculate translation by the CMTD general manager enabled us to assess his quality. From that point onwards, there was no question who should be appointed general manager of the new joint venture, which was named Jinan Fuqiang Power Company. The approval and registration procedures were carried out over the four months following the Beijing meeting and the preparatory group started work from January 2006. In the interval, the financial condition of the British engineering company had deteriorated, mainly because of its declining business with the ailing MG Rover Group, and the investment group decided to step in and buy the UK company outright. This ensured that the joint venture could proceed without financial difficulty. CNHTC and the authorities agreed readily to the consolidation of the foreign shareholdings. During 1997, the preparatory group under the leadership of the now appointed general manager carried out the considerable job of taking over a largely derelict group of buildings on the site in central Jinan rented from CNHTC and adjacent to its technical centre, and transforming them into a modern facility with an office block rebuilt from workers' former accommodation and to a high standard of decoration. The building and installation works were carried out on time and, amazingly, within the budget approved by the board. Under the guidance of the UK technical director, the factory layout was prepared and equipment ordered. Standard high-quality machine tools were procured within China and the purpose-built machines and equipment were ordered through the UK partner from a range of European and US suppliers. Towards the end of 1997, while the equipment was on order, the Chinese training group headed by the general manager with the production and QA manager and a team of machine-setters came to the UK for training. They quickly showed that they were the equal of the UK factory employees on the production line, working on older equipment, in some cases of inferior design. The first full board meeting of Jinan Fuqiang had been held in the UK during the previous summer. So far everything had proceeded according to plan. While the training group were in the UK, the deputy general manager supervised the remaining preparation work for receipt of the equipment that began to arrive in Jinan as the group returned in time for the 1998 Chinese New Year. During the summer all the equipment was installed and commissioned.

Sales development

The chairperson, who was the vice-president sales of CNHTC, and the British deputy chairperson started to focus on sales development and toured the leading foreign-Chinese joint ventures in Beijing, Shanghai and Nanjing to explore the opportunities for taking on their engine warranty work, and, in the future, servicing their sales outlets with re-manufactured engines as a Chinese used-car and truck market developed. The results were disappointing, particularly with Shanghai Volkswagen where the German management expressed strong interest initially but were deflected by their Chinese partner and the labour union who insisted that their joint venture should set up its own engine re-manufacturing unit. This setback was mitigated by confirmation of demand for the re-manufactured engines of CNHTC heavy trucks from its customers, particularly owner-drivers engaged in construction projects such as the Three Gorges Dam. CNHTC was also ready to assign its engine warranty work to the joint venture.

By the autumn of 1998, the factory was in production and a management problem soon emerged. The equipment installed was of balanced capacity enabling a wide range of engines to be treated and for production to run on double shift as sales expanded. However, a flaw appeared in the form of a gap in the production planning function necessary to coordinate the efficient flow of work through the various manufacturing processes. The training programme had not addressed this issue fully and the computer that had been ordered for this function was inadequate. The problem was solved over the next six months with the installation of well-proven computer software and systems designed for this function. A related problem of finding a sufficient inventory of 'core' in China (old engine blocks no longer in service) was also solved by offering trade-in terms.

A change of emphasis

By the spring of 1999 the factory was operating well but at a lower level of activity than hoped. It had been written into the JV contract that the UK engineering company would send a proportion of its engine core and components to Jinan for re-manufacturing there and re-export to the UK although no pricing was specified. However, the UK factory was leaner by now and its operating costs were reduced so that the Jinan prices, after allowing for freight costs in both directions, made the export trade unprofitable. CNHTC understood this dilemma and the JV did not try to hold its UK partner to the commitment. Instead, the Chinese management set about generating machining work on the components of new engines from the nearest CNHTC engine plant to make up the balance. Over the next two years, although relations remained cordial, the interest of the investment group partner in building a business in China dwindled. Having explored the possibility of developing a component-sourcing business through a company that it could control under the umbrella of Jinan Fuqiang Power Company the investment group found that approvals from the authorities would be difficult and decided to re-focus its interest globally on South Africa. CNHTC had gained approval to offer its partner the opportunity to subscribe further in order to bring its share of the registered capital up to 50 per cent but the offer was not taken up. The investment group decided that it was content to leave the running of the joint venture in the capable hands of the Chinese management and to become a passive investor.

The JV continued to make steady progress and in 2003 registered RMB2m net income after writing off RMB2.85m of organisation expenses against sales of RMB11.3m. The general manager decided to cultivate a relationship with the technical arm of the People's Liberation Army (PLA), which needed to upgrade its own engine re-manufacturing capability. This relationship was fruitful and has enhanced Jinan Fuqiang's reputation throughout China for technical excellence. The company has been named as a model manufacturing operation by the China National Development and Reform Commission.

The joint venture has been relocated into a new, bigger factory close by the main CNHTC engine plant from which its machining and component manufacturing orders have multiplied. Its sales are reported to have topped RMB200m in 2006.

This article is an edited extract from Business Insights: China by Jonathan Reuvid, published by Kogan Page, www.koganpage.com [new window], hardback, 318 pages, £45

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