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IDENTIFYING, MEASURING, AND TAKING ACTION ON THE RISKS OF CHINA 

An Interview

Thursday, September 2, 2010 6:09

Risk. Everyone in China is exposed to it. Some recognize it, and act on it, better than others

This was the topic of several conversations between Richard Brubaker and Neal Beatty 

(Regional Director, Global Client Services for Control Risks). In some ways it was a followup to

the interview I did of Dane Chamorro, his colleague, but this time it was over lunch and

encompassed a much larger set of issues…. and given the importance nature of risk, I asked

Neal if he would do All Roads readers the favor of answering a few questions about risk in

China, if risks here are different than in other regions, and how good firms are at planning for

and managing risk.

Below is part 1 of the interview, and with its focus on identifying the risks, and how firms work

with “China” risk, there are lessons for everyone. 

1. Are the risks of doing business in China any different than say in the US or EU?

Every operating environment has its own risks. What makes overseas operations more complex

for multinationals is that many of the operational issues in China (kickbacks, conflict of interest,

corruption, etc) are exacerbated by the very fact that they are so far from the comforts of 

home, and from familiar regulatory and legal environments.

When the company sets up in China, either through acquisition of a local firm, or through

establishing a JV or their own facility, the operating environment is often alien. Everyone’s read

the books on “doing business in China” and that’s a great start for people n ew to the country.

But that’s just scratching the surface, and often seems to lead managers to over-emphasize or

over-simplify a few features of operating environment, so for example you often hear “China is

all about “guanxi”; we don’t worry about risk X because our local guys have great connections”.

There’s also a tendency even these days to get carried away with the “China is different”

concept, and lose sight of commercial and risk-management principles and processes the

company applies elsewhere. China is different in many ways and understanding the differencesis vital, but that doesn’t mean there’s some mysterious formula here that only a few people

understand  – like everywhere else, you need a well-informed, comprehensive and rigorously

planned out approach to managing risk, not silver bullets. Few companies sit down from the

very start, and map out what the risks to the business in China could really be. They will no

doubt have looked into the financial and commercial risks in some detail, but what about the

operational or general business risks, not to mention the reputational risks? There is even a

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potential downside to hiring someone with fantastic local connections to run the business or

engage as a joint venture partner, and this needs serious consideration, too.

In China, what you see is not always what you get. This can be especially true of understanding

who you’re dealing with in business, whether it’s your key hires, an M&A target, or new partner

or supplier. People and entities can have so many hidden interests, connections and potential

conflicts that you simply can’t be sure who you’re getting into bed with unless you’ve really

done your homework the right way – specialist due diligence is essential.

2. What are the real risks of doing business in China? What can business lose if they

misjudge their environment? 

Some common risk issues include:

  Compliance & integrity issues: internal fraud (kickbacks and conflicts of interest are

most common)

  Corruption & Graft: recognized by the government in Beijing as a serious issue in

China. And now an increasingly serious issue in the US and UK with the growing impact

of anti-corruption laws.

  IP issues - counterfeiting, internal theft of critical information, and the protection of 

your trade secrets are major issues

  Business partners: Who really is your prospective JV partner? How did they accumulate

their wealth? Does your partner or key staff have undeclared family or businessconnections to a competitor or supplier?

  Political and regulatory risks  – this is largely more of a strategic, ‘big picture’ issue, but

companies who lose touch with the prevailing political pressures affecting their industry

can find themselves exposed to problems or shifts that they weren’t expecting. 

  Supply Chain risks – lack of transparency and controls along the chain

  Natural Disasters – typhoon, flood, earthquake

  Business disputes  – the concept of “illegal detention” by business partners as a means

to settle a dispute over payments due; threats by disgruntled former employees.

  Restructuring & labour disputes  – closing a factory, or dealing with the disgruntled

employee who seeks revenge on a manager

  HR risks – associated with the new HR law and the complexity of hiring & firing staff.

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Obviously the extent to which a particular company is exposed to these risks will depend on

their specific circumstances, for example the size of the company, the location, the industry and

the effectiveness of its own internal risk mitigation controls. But if you show a group of 

managers the list of risks above, many will admit that they have experienced several of these

issues in China.

Most issues will have been dealt with and the business will have survived intact, but once in a

while, something happens that has a catastrophic impact on the business, that no-one could

have foreseen.

One of the most serious potential risks to any business in China is the tacit acceptance of the

“This is China” approach to business ethics and compliance issues. “We can’t do business

without paying the occasional bribe to win contracts” or “it’s OK to allow employees to take a

few kickbacks from suppliers – that’s how business is done here”. I’ve heard similar sentiments

from managers in China and I worry that they are leaving themselves exposed to more seriousissues further down the line. By condoning “low level” corruption within the organization, there

is a serious risk of it getting out of control and in the worst case putting the entire operation in

 jeopardy. A zero tolerance approach is certainly not easy, and requires time, effort and budget,

but I would say it is the best way to operate in China, just as in other parts of the world. And it

is essential that senior management lay down the law and set out the company culture towards

such issues from the very start. The Chinese idiom 上梁不正下梁歪 (if the top beam is not

straight the whole structure is crooked) is very true.

3. How much of the risk is political vs. cultural vs. commercial? 

It is all three. The risks listed above could happen in any country in the world, but what makes

China unique is the combination of engrained local business culture and business practices, and

very patchy, often lax, legal and regulatory enforcement. This can result in people thinking

there are no personal consequences to their actions.

I don’t believe Chinese people are any different in terms of morals or bad behavior than

someone from Northern Ireland. But in China, there are cultural norms that sometimes conflict

with the corporate expectations. For example, the concept of a conflict of interest is not

understood in the same way as in the EU /US. To many Chinese people it seems perfectly

reasonable to consider engaging a supplier owned by a family member or old school classmate.

After all, I trust these people far more than some random supplier that approaches me at a

trade fair. And if laws are unevenly enforced, then employees may never expect that their

unethical, and often illegal, behavior might land them in jail.

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And a kickback is often seen as nothing more that natural reward for the sales effort, something

owed to the salesman, who probably doesn’t make much money anyway: no-one gets hurt, so

what is the problem?

Where these three areas (political v cultural v commercial) often overlap is when doing

business away from the big Tier One cities. Generally speaking, the influence of local politics on

local business is more unrestrained away from the biggest cities. This can pose its own set of 

unique risks that can only be mitigated by a very thorough due diligence process prior to

forming a business relationship in that location.

4. What are the biggest risks that you feel firms overlook when entering China? 

I feel the biggest risk is not taking the time to sit back and look really seriously at “what if this

doesn’t go according to plan?” or “what if this should happen?” The opportunities in China are

huge, as all the business books tell you, but although most people are aware to some degree

that there are very considerable risks out there, not so many are keen to think too long about

the downside and address that head on when they don’t see any immediate, severe problem. 

If you are new to China, whether sourcing, selling or manufacturing, the first step needs to be

to ask for advice. But who to ask? Lawyers are a necessity, but as I have seen from my own

experience, they do not always give you the full picture of the risks your operation may face.

So the biggest risk is actually not actively assessing and properly planning for the risks! Many

firms still don’t really do this until something goes wrong.

5. Are there firms that are in denial on obvious risks? 

I would have to say yes.

I once spoke to the head of a multinational R&D facility in Pudong who had first-hand

experience of unaccompanied visitors strolling around their facility, with access to any number

of laptops left sitting on desks. When asked whether he was concerned about competitors

entering the facility to steal trade secrets, the executive replied “but why would anyone want

to steal trade secrets from this facility? We have dozens of such facilities in the US, why would

they come all the way over here?” The conversation on business risks didn’t go much further. 

And then you have an attitude of some foreign managers who, after having worked in China for

many years, f eel there is no alternative to “low level” kickbacks and bribes. Leaving behind the

ethical arguments for a moment, and focusing on the bottom line  –it simply is not cheaper in

the long run to pay bribes if you had to pay hundreds of millions of dollars in fines in the US and

Europe, and you factor in the potential reputational impact.

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And then there is the argument ”well, all my Chinese competitors pay bribes to win contracts,

so I have to”… 

6. How does the average firm’s risk profile change over the course of its china

life? can a firm run risk free? 

I don’t think any company can run “risk free”, no matter what sector or what size of operation.

From the largest MNC with multiple manufacturing and distribution facilities around China, to

the “one-man-band” sourcing operation, everyone will face risks.

Moreover, you can never reduce risk to zero. No matter how good your risk management

program, there will always be someone who does something without considering the possible

outcomes and impacts thoroughly, or simply faces a problem that couldn’t be anticipated or

couldn’t be prevented. And thus you need to be able to react appropriately and have

contingencies in place. But a good awareness of the risks from the very beginning, along with

regular (twice a year) reviews of your level of risk exposure, will go a long way to mitigating

many of your operational risks.

Richard Brubaker, Founder and Managing Director of  China Strategic Development Partners. 

Neal Beatty (Regional Director, Global Client Services for Control Risks).