Investing in China:

The Investment Decision, Operations and Performance of

Australian Multinational Enterprises

Dr Elizabeth Maitland

Dr Stephen Morgan

and

Professor Stephen Nicholas

Australian Centre for International Business
University of Melbourne

Abstract:
This paper analyses the foreign direct investment decision (modes of entry,
negotiations and technology transfer) operations and performance of Australian firms
in China. The theoretical framework rests on resource-based theories of the MNE,
with the explicit development of a transaction cost, internalisation and agent-principal
framework to explain why firms transfer firm-specific capabilities internally. The
model also addresses the question of pre contractual bargaining and post-contractual
operation of JVs and wholly-owned subsidiaries.
The data are drawn from a mail survey of Australian companies engaged in long term
contractual arrangements in China. Mann-Whitney and Kruskal-Wallis Tests are used
to statistically analyse the data.
The paper investigates the location factors and the motivation for transferring know-
how, selecting JV partners and operating JV and wholly-owned subsidiaries. Disputes
and dispute resolution are analysed for JVs, and the forms of control exercised by
Australian parents specified. The assessment of the risk environment and the role of
location factors are studied. The performance of Australian operations is examined
and suggestions for improving the choice of entry mode are provided.

Contact: s.morgan@ecomfac.unimelb.edu.au
tel: +61 3 9344 5340
fax: +61 3 9347 3770

1
Introduction

China in the 1990s became the major destination for foreign direct investment after
the United States. For the five years to end-1998 it was the second largest recipient of
foreign direct investment [FDI] after the United States [China Daily, 23 Jan. 1999; 28
Feb. 1999]. The rapid growth of foreign investment has inspired a proliferation of
studies on multinational enterprises [MNEs] in China. In the 1980s China was a
novelty, a socialist country embarking on an unsteady transition to a quasi-market
economy, which sought to attract foreign capital and technology. From the early-to-
mid 1990s, all but the rhetoric of socialism and party control was abandoned. MNEs
embraced the new, more open and friendly investment environment.

Australian firms were early entrants to the China market. During the years
immediately following Chinas opening up to foreign investment Australia was the
fourth largest investor in China, following Hong Kong, the USA and Japan. From the
mid 1980s its position slipped rapidly to rank 15 th largest investor in 1998 [SSB, 1986,
1998). Trade between Australia and China during the 1990s was typical of Australias
economic relations with other countries of Northeast Asia. Australia sells China
minerals and agricultural raw materials for its industries, while China exports to
Australia labour-intensive manufactures. China is Australias fifth most important
trading partner, while Australia is Chinas ninth most important trading partner
[DFAT, 1998, SSB, 1998]. China is a prominent investor in Australia, accounting for
the largest destination for Chinese outward capital after Hong Kong, mostly as part of
a resource security strategy (iron ore, aluminium smelting, cotton gins, meat export
processing, among others).i In 1998 there were more than 160 Chinese firms with a
FDI stock of US$1.26 billion in Australia [CCTV-4, News, 17 May 1999].

This paper analyses the modes of entry, negotiations, technology transfer and
operation of Australian firms in China based on a mail survey returned by 171
companies, of which 99 had transferred know-how to China through a non-export
arrangement. It is organised in the following way. The first section comprises a survey
of the literature on China and FDI theory. Next we described the parent sample
characteristics of the firms surveyed (annual sales, employees, ownership and prior
experience). The third section examines the motivations for entering China, the
process of entering China (staging of entry, negotiating experiences and location), the

2
types of know-how transferred and the contractual form governing that transfer
(including Joint Ventures, JVs and wholly-owned subsidiaries), and lastly the issues of
risk perception and performance.

Overview of FDI in China

China in late 1978 broke with the Maoist autarkic development strategy, and initiated
a program of opening to the outside world which boldly linked FDI with the
promotion of export-oriented manufactures. Foreigners were invited to establish
alliances with Chinese firms, transfer technology and know how, and produce goods
for sale to the world that would enable China to modernise its economy. Over the past
two decades this process of technology transfer and modernisation enabled China to
reintegrate into the world economy. By the late 1990s China had become the worlds
10th largest trading nation. Nearly half of its exports come from foreign-invested
enterprises [SSB, 1998]. China has also become the largest recipient of foreign direct
investment after the United States for the five consecutive years 1993-98. Between
1979 and 1997, 304,345 FDI projects worth US$520.14 billion were approved. At
year-end 1998, China had received US$265.72 billion in utilised FDI [SSB, 1998;
China Daily, 23 February 1999].

Chinese leaders and foreigner were mutually wary of investing in China during the
early 1980s, which has given way to a boom in MNE activity in China [Mathur and
Chen, 1987; Grub and Lin, 1991; Pearson, 1991; De Keijzer, 1992; Jia, 1994]. Five
major phases of FDI can be identified over the past 20 years, each corresponding to
specific legislative initiatives and institutional shifts. These have progressively made
the Chinese business environment more amenable to the foreign investor [Beamish,
1993]. Appendix I summarises the major features of these shifts and the resulting
utilisation of FDI.ii The early years of FDI in China, from 1979 to the mid-1980s,
were filled with great uncertainty for both foreign investors and the Chinese officials
responsible for implementing the new policy. Although China passed the Joint Venture
Law in 1979, the enabling provisions were not promulgated until 1983, the rules
governing wholly-owned foreign enterprises were not promulgated until 1986, and
nine years passed before the Contractual Joint Venture Law was promulgated.

3
Four main types of FDI were approved in 1979: equity joint ventures (EJV);
cooperative operation enterprises, also known as cooperative (contractual) joint
ventures (CJV); wholly-foreign owned enterprises (WFOE); and cooperative (joint)
development projects [Mathur and Chen, 1987; Pearson, 1991; Murray, 1994]. The
EJV is a limited liability company formed between a Chinese firm (usually a state-
owned firm) and one or more foreign firms, whose profit (loss) is shared based on the
equity held by the partners. It is an independent legal person. The foreign party must
hold 25 percent or more, though the China party has veto rights over expansion of the
EJVs capital.

The CJV is a non-equity long-term contractual arrangement rather than a joint

venture. There is no separate legal entity formed, each of the parties to the contract is
autonomous, and the sharing of profit and loss as well as the contribution of each
party is specified in the contract. The CJV is a sub-contracting arrangement, which is
predominantly used by Hong Kong and Overseas Chinese firms [Pearson, 1991; Luo,
1999]. Its use has declined during the 1990s, which coincides with the relative decline
in the share of Hong Kong investment and the greater use of equity-based ventures.

The WFOE is a wholly-owned subsidiary for the foreign parent established in China
under the 1986 rules. WFOE have become the preferred mode of entry, and now
account for almost as much investment as JVs [Shaw and Meier, 1994; Luo and
OConnor, 1998; SSB, 1998]. The joint development consortium is the form used for
minerals and energy exploration. It was important during the early 1980s when China
was engaged in extensive search for offshore oil, but now accounts for less than one
percent of FDI. Other forms of foreign investment according to the Chinese definition
include compensation trade, international leasing and process assembly contracts,
which has been of little importance for most of the 1990s, accounting for only about
one percent.

Chinese officials during the early phase had a conservative view of technology
transfer, believing that joint ventures were necessary to compel foreigners to transfer
technology to China and retain control [Pearson, 1991]. They also sought to bottle up
foreign investment in south China in the special economic zones (SEZs) established in
Guangdong (Shenzhen, Zhuhai, and Shantou) and Fujian (Xiamen). Both attitudes
were a reflection of official concerns to preserve self-reliance and national

4
sovereignty, which required state control of FDI [Pearson 1991, Jia 1994]. The SEZ
provided foreign firms and their Chinese partners a variety of special tax and import
benefits. FDI to year-end 1983 comprised only 12.5 percent of total foreign capital
committed to China. The SEZs had poor infrastructure the most successful,
Shenzhen (which adjoins Hong Kong), was only a large market town of 30,000 people
in the late 1970s. Instead of becoming export platforms, the SEZs became a funnel
through which Chinese state-owned firms could cheaply import foreign goods for
selling to the rest of China. Only 20 percent of Shenzhens output were exported in
1984 [Pearson, 1991]. In response the Chinese government in 1984 extended the tax
and other privileges to foreign-invested firms that set up in the so-called 14 open
coastal cities of East China.iii The increasing openness and the greater ease for
finding suitable partners and skilled workers in the established centres led to a pick up
in FDI committed.

Early in the second phase (1986-90), a rapid growth in FDI reflected an increasing
level of comfort among Chinese officials, and a more sophisticated targeting of
investment. The Joint Venture Encouragement Provisions (also known as the 22
regulations) issued in 1986 loosened state control over foreign-invested enterprises,
provided additional benefits for technology imports, and liberalised the foreign
exchange constraints affecting FIEs. The major initiatives of this period was the
instruction that open cities should set up economic and technology development zones
(ETDZ), and the promulgation of the Law on Wholly-owned Foreign Enterprises. The
ETDZs had tax rates on par with the SEZs for firms that in established in these zones,
and the WFOE law made it easier to negotiate agreements to set up wholly-owned
subsidiaries [Tretiak and Holzmann, 1993]. Four times as many FDI agreements were
signed during the three years 1986-88 as the previous six years 1979-85, and
cumulative FDI for the period was nearly twice that for the first six years. Although
FDI slowed 1988-90, these were years that saw WFOE share of FDI increase from
one percent of realised FDI to six percent in 1988, 10 percent in 1989, and 18 percent
in 1990.iv

The third phase (1991-93) was marked by several major regulatory initiatives to bring
China more into line with the demands of international business. These include the
Equity Joint Venture Amendment Law, the Foreign Enterprise Tax Law, the Copyright

5
Law, the Software Protection Regulations, among others. The effect was striking: five
times the number of FDI agreements were signed during the three years 1991-93 than
had been concluded the previous 12 years. Chinas FDI boom began. Utilised FDI
jumped from US$3.5 billion in 1990 to US$27.5 billion in 1993. In 1992 FDI exceed
foreign loans as the major source of external capital for the first time.

Through the fourth phase (1994-97) FDI grew strongly. The growth reflected a
foreign perception that China had become an easier place in which to do business, its
regulatory framework more transparent, and its government agencies better able to
implement regulations, such as those protecting intellectual property. The major
legislative initiative was the promulgation in July 1994 of the Companies Law, which
sought to unify the regulatory environment for firms irrespective of ownership. There
were also signs of a greater willingness to reform the state-owned enterprise sector
through converting them to joint-stock companies as provided for in the 1994
companies law. This included the reorganisation and listing of Chinese firms at home
and abroad, and allowing foreigners to acquire equity in Chinese state firms without
joint venture arrangements. These developments opened opportunities for merger and
acquisition activity, though few foreign firms have yet used the law to establish joint-
stock subsidiaries with which they can takeover moribund state firms [Zaloom and
Liu, 1999]. These new developments saw significant increase in reported share capital
issued to foreigners, including private equity fund arrangements, which accounted for
the significant jump in the other classification for foreign investment in China. FDI
in new share-invested joint stock firms account for nearly one percent in 1997. Since
1998 China has been grappling with the impact of the Asian financial crisis. FDI
commitments slowed, growing less than one-percentage point over the previous year
[China Daily, 28 Feb 1999]. The big questions are those that the crisis raises for
continued reform of its own state enterprise sector and the financial system that props
it up [Lardy, 1998]. New initiatives include liberalising restraints on the private sector.

6
The Theory of International Involvement in China: Choosing Intra-
firm Transfer of Resources and the Market Entry Mode

Multinational firms make two simultaneous decisions: the form of international

involvement - exporting, intermediate contractual arrangements (such as licensing,
franchising and long-term supply contracts), and hierarchy - and the location of
economic activity. Multinational firms transfer resources (capabilities, inputs and
output) across national boundaries when spot markets and intermediate contracts
(including franchises, licenses and alliances) fail due to high costs of exchange.
[Buckley and Casson, 1976; Casson, 1979; Rugman, 1982; Hennart, 1982; Caves,
1982; Teece, 1986] Intrafirm transfer is particularly efficient when exchange involves
the firms tangible and intangible assets, including product and process technology,
network co-ordination, work and managerial expertise, advertising, marketing and
distribution skills and brand name and parent reputation advantages. [Johnson, 1970;
Teece, 1980; Hennart, 1982; Caves, 1982]

Spot and intermediate arrangements incur high transaction-agency costs when the
exchange of resources, inputs and output is subject to uncertainty and asymmetric
information. Moral hazard (better information) and adverse selection (different
information) allows potential opportunistic behaviour by agents who sell inputs to or
buy resources from the firm (principal). It is especially costly for the principal to write
spot market and intermediate contracts to monitor, bond and enforce resource
exchange with opportunistic agents when transactions are frequent and complex.
Principals are particularly vulnerable to post-contractual opportunistic hold-up by
agents, when the principal makes investments in physical and human capital assets,
necessary for exchange but with low or scrap value in second best uses. Given the
high costs of arms-length market and intermediate mode contracting, firms select
intrafirm transfer of resources through foreign direct investments.

Of course, the cost of transferring resources and inputs is not costless within the firm,
although MNEs provide superior mechanisms for managerial control, dispute
resolution and goal alignment compared to alternative arragnements, such as markets
and intermediate forms. [Williamson, 1975; Hennart, 1982]. Transaction cost
agency theory takes a comparative institutional perspective, since all contractual
forms have costs of writing, bonding, monitoring and enforcing incentive contracts for

7
the exchange of resources. Intrafirm transfers require complex incentive contracts
between the parent and its overseas managers and workers and monitoring by
sophisticated organisational structures, including internal accounting systems and
information reporting devices. [Chandler, 1962; Williamson, 1975; Carlos and
Nicholas, 1993] The analysis of Australian firms in China focuses on the ownership
advantages of China investors and the mechanisms for headquarter controlling,
monitoring and incentiving operations in China.

Transaction cost theory provides only a partial explanation for the choice between
markets, intermediate contracts and intrafirm transfer. Production and other real costs
favour hierarchy over licensing. Hierarchy might also be selected because ownership
allows better control and coordination of global MNE strategies, [Hill et al, 1990];
extends market power [Teece, 1981]; appropriates a larger share of investment returns
[Anderson and Gatignon, 1986]; allows follow-the-leader and oligopolistic exchange-
of-threat responses [Rose and Ito, 1995; Graham, 1974; 1978]; or reflects the
preferences of decision-makers. Using mail surveys, Erramilli and Rao [1993] found
that American service firms investing overseas preferred full ownership to other
arrangements, a result confirmed by Nicholas [et al, 1996] for Japanese MNEs
investing in Australia. Location factors, discussed below, also impact on the form of
overseas involvement. Host governments may exclude certain forms of involvement,
including wholly-owned subsidiaries in exempt sectors, such as mining,
communications and residential housing.

Once intrafirm transfer is determined, then entry mode choices include full equity
control through greenfield investment; full equity control through acquisition/merger;
and JVs, either greenfield investment or acquisition. JVs and acquisitions involve the
procurement of capabilities and inputs (raw material and component inputs) from
outside the firm. Markets for the procurement of capabilities and/or inputs fail,
otherwise the two firms would contract through the market or intermediate
arrangements. Similarly, JVs and acquisitions require the procurement of necessary
resources from outside the firm, otherwise firms make greenfield investments.
[Hennart, 1988; 1991; Kogut, 1988]

8
The nature of the firms capabilities and inputs determines whether the firm chooses
to go it alone (greenfield) or to cooperate through a JV or acquisition. When the
ownership advantages are nonseparable from the firm, especially when the
capabilities are tacit knowledge and embedded know-how, and the firm requires no
complementary assets or inputs, then greenfield is the selected mode. Inversely, JVs
and acquisitions occur when the investor requires know-how that is bundled in an
existing firm or when there are inputs not procurable through intermediate and market
contracting. Foreign market know-how typifies the high costs of contracting in
knowledge capabilities, which are subject to moral hazard and adverse selection
problems. It is costly to discover parties with market know-how, and to value the
know-how appropriately. JVs and acquisition requires the firm to use its incentive
structures, monitoring and enforcement regimes to efficiently utilise the know-how
embodied in the JV or acquired firm. Not surprisingly, JVs and acquisitions impose
high costs related to appropriately valuing the other firms resources and integrating
those resources (including management and workers) into the JV or new acquired
firm. [Williamson, 1975, 1985; Teece, 1985, 1986; Hennart, 1988, 1991]

JVs have a number of advantages over acquisitions, including being able to

terminated more inexpensively, which is an effective enforcement device for non-
opportunistic behaviour by JV partners. When complementary assets are hard to
disentangle, acquisition involves the purchase of all the acquired firms assets, even if
only subsets of assets are required. JVs allow the partner firm to contribute only those
assets required by the MNE. [Hennart and Reddy, 1993] JVs also embody an efficient
incentive structure for attenuating opportunism. Both parties are rewarded for their
resources according to their share of the ventures residual, rather than payment for
inputs, reducing opportunistic rent dissipation. [Hennart and Reddy, 1993] In the
presence of transaction specific assets, both parties have an incentive to continue the
JV relationship, when the second-best use for specialised assets is low or scrap value.
The internal governance costs of JVs might be lower than those for acquisitions, given
the factors outlined in the preceding paragraph.

Nontransaction cost factors also contribute to the choice of mode. For example,
acquisition may be a source of market power, governments may require JVs, late
entrants may seek speedy entry through acquisition, and economies of scale may

9
make greenfield unprofitable in a small or saturated market. The study analyses the
choice of a JV partners and the incentivising, monitoring and controlling of China JV
operations by Australian parents.

Simultaneous with the choice of MNE as the form for transferring firm-specific
advantages internationally, multinational firms also decide on the location for direct
investment in service and production facilities. Foreign direct investment means it is
more profitable to combine the firms ownership advantages with factor inputs in a
selected location than with factor inputs in some other location. Locational factors
include production costs (wage rates/labour costs; energy costs; input and component
availability and price; tax rates), transfer costs (tariffs and non-tariff restrictions;
transport costs), financial assistance from central and local governments, market size
and growth potential and political stability.

The study focuses on two decisions. First, the decision to establish hierarchical forms
of involvement, especially the choice between JVs and wholly-owned subsidiaries,
including the costs of monitoring, controlling and assessing the operations and
performance of Chinese subsidiaries by Australian headquarters. Secondly, the
location decision is examined, assessing the reasons that Australian firms selected
China as an investment destination.

The Survey, Data and Sample Characteristics

The Survey

The data are drawn from a mail survey of Australian companies engaged in long term
contractual arrangements in China. As no comprehensive list of Australian companies
with offshore activities was publicly available, a mail list was constructed with the
cooperation of the Australia China Business Council. The survey was conducted
through the Australian Centre for International Business at the University of
Melbourne, with endorsement from the National President and Victorian State
President of the Australia China Business Council. A reminder letter was posted to all
non-responding firms 4 weeks after the first mail-out, and telephone calls made in
week 7. The return rate was 43 percent, or 171 firms from the total sample of 403
firms. Of the 171 companies responding, 99 had transferred know-how to China

10
through a non-export arrangement, which yielded information on 133 intermediate
contracts and foreign direct investments by Australian firms.

The parent firms were analysed according to size, industry sector (manufacturing and
non-manufacturing) and international experience. Two statistical tests were used to
analyse the data, besides descriptive statistics. A Kruskal-Wallis one-way analysis of
variance by ranks was used to determine whether the means from different samples
are from the same population. [Siegel and Castellan, 1988] Secondly, the Mann-
Whitney U test was employed as a non-parametric version of an independent sample t
test. [Bryman and Craner, 1997; Siegel and Castellan, 1988]

Data and Sample Characteristics

The 99 parent companies who made an FDI were a diverse cross-section of the wider
Australian business community. As shown in Table 1, the sample of firms
encompassed very small business entities, employing fewer than ten workers and
annual sales revenue less than AUS$1 million, through to diversified, multinational
corporations with workforces in excess of 30,000 employees and annual sales greater
than AUS$1 billion.

Table 1 Parent Size

Employees Respondents Annual Sales Respondents
<50 25 25.3% <$5m 18 18.2%
50-999 30 30.3% $5m$49m 22 22.2%
1,0009,999 17 17.2% $50m$499m 20 20.2%
>10,000 8 8.1% >$500m 21 21.2%
Missing observations 19 19.2% Missing observations 18 18.2%
TOTAL 99 100% 99 100%

The core activities of the parent companies encompassed a wide spectrum of

industries, from primary extraction sectors to the provision of financial products and
services, as detailed in Table 2. Business service and property firms were significantly
smaller in turnover, assets and employees than manufacturing firms, who were
significantly smaller than the residual category, which included all other industries in
Table 2. JV were significantly larger in terms of employees than wholly-owned
subsidiaries, which were significantly larger than other types of contractual
involvement in China. Roughly two-thirds of the companies were majority Australian
owned, with wholly Australian owned parent firms representing the largest group (42

11
percent), far exceeding the 9 percent of companies with wholly foreign owned
shareholdings (Table 3).
Table 2 Main Income Source of Parent
1
Industry Respondents
Mining1 5
Manufacturing1 35
Machinery & equipment2 (13)
Utilities1 4
Logistics & Distribution4 12
Finance & Insurance1 4
Property & Business Services1 28
Scientific research3 (5)
Technical services3 (7)
Legal & accounting services3 (7)
Other (inc. education, construction)1 5
Missing observations 6
Total 99
1
Australian and New Zealand Standard Industrial Classification (ANZSIC) Division Title Subdivision
Title (two digit code)
3
ANZSIC Group Title
2
ANZSIC (three digit code)
4
Amalgamation of ANZSIC Divisions D (Electricity, Gas and Water Supply) and J (Communication
Services)

Table 3 Foreign Holdings in Parent Company

Shareholding Respondents
Wholly Australian Owned 42 42.4%
Majority Australian Owned 22 22.2%
Minority Australian Owned 13 13.1%
Wholly Foreign Owned 13 13.1%
Missing observations 9 9.1%
Total 99 100%

Just over half the sample firms were experienced multinational enterprises, as defined
by their engagement in more than five investment projects worldwide. As Table 4
shows, this experience was gained in a diversity of economic and cultural settings,
such that few firms controlled regionally concentrated subsidiary networks, favouring
dispersed holdings. Firms with international experience outside the local Asian region
had a significantly larger number of forms of involvement in China than firms with
only China or Asian experience.

12
Table 4 Multinational Experience
Number of Number of Companies with Investments:
Investment Worldwid Asia North Europe Other China
5 39 71 84 84 86 72
>5 54 22 9 9 7 21
Missing 6 6 6 6 6 6

The Foreign Direct Investment Decision: Location and Form of

Involvement

Location Decision

The majority of Australian firms were located along the eastern seaboard. Most were
located in Beijing-Tianjin, Shanghai-Jiangsu, and Guangdong areas. Only 12 percent
of Australian firms reported activity in the central and western Chinese provinces,
such as Hubei, Hunan, Sichuan, Gansu, and Xinjiang. This geographical distribution
is typical of foreign investors who have clustered in the areas with suitable sources of
more highly skilled employees and wealthier consumers.

Table 5 - Location Factors in the Investment Decision

Mean Standard
Deviation
Strong market growth prospects 4.5 0.94
Establish long term presence 4.3 0.84
Size of market 4.1 0.14
Low wage costs 2.5 0.17
Establish export base 2.5 0.18
Service foreign company in China 2.2 0.17
Service Australian company in China 2.2 0.19
Tax incentives 2.1 0.13
Access raw materials 2.1 0.18
Forestall entry by competitor 1.8 0.3
Source components for Australian 1.8 0.15
operations
Bypass government trade barriers 1.7 0.14
Lack of local licensee/franchisee 1.7 0.14
Government financial assistance 1.6 0.12
Follow competitor 1.5 0.11

The major reasons that Australian firms selected China as an investment location was
size and the growth potential of the China market and the commitment to a market
presence, as shown in Table 5. Low wage costs and the establishment of an export
base were rated only of low-medium importance, while all other factors in Table 5

13
 were ranked lower. Australian firms were not seeking low wages or an export
platform in China. All firms irrespective of multinational experience, industry
classification and parent size ranked the first three categories as the most important
location factors. Low wage costs were more important to small than large firms, and
more experienced firms in China were attracted by a low wage cost environment
compared to inexperienced investors. While recognising these differences for size and
experience, neither wage factors nor an export platformed were major factors in the
location decision.

Negotiations

Ninety-five percent of the firms invested in China as part of a long-term business

strategy, with more than half the firms engaged in multiple business activities 33
percent operated three or more project. Entry forms were diverse, although equity-
based investments were prominent, as shown in Figure 1. Between the 1980s and
1990s, Australian firms in China increased their use of wholly owned subsidiaries and
JVs, a general trend observed for firms of all nationalities.

Figure 1 - Entry Forms

1980s 1990s
MC/TEC Export
BOT MC/TEC Export BOT
17% 12%
2% 16% 18% 3% WOS
Lic/Fran WOS Lic/Fran 8%
10% 5% 9%

RO/RA JV RO/RA JV
25% 24% 22% 29%

BOT - Buildoperatetransfer contract MC/TEC Management Contract/ technical expertise contract

WOS - Wholly-owned subsidiary JV Joint venture
RO/RA Representative Officer/ Agent Lic/Fran Licence/Franchise

Existing commercial networks were crucial for Australian firms seeking to enter the
China market. Half the Australian firms learned about their China business
opportunity, or were introduced to the China market, through informal but established

14
 overseas business links. Nearly a third of the firms discovered China through
Australian links.

Australian firms achieved relatively rapid entry into China in contrast with American
and European experience as shown in Figure 2, 30. Thirty percent of Australian firms
had no or low difficulties communicating and negotiating in China, while 50 percent
experienced moderate levels of difficulty. Few firms (20 percent) were subject to high
levels of difficulty. Australian firms found the responsiveness of Chinese government
agencies slow, fairly difficult, and less open than desired, though not hostile. Three-
quarters of Australian firms did not make facilitation payments to secure their
contracts. For the remainder, such payments were extended to a variety of government
bodies, as shown in Figure 3.

Figure 2 - Communicating and Negotiating in China

Figure 3 Facilitation Payments

Central, Provincial
& Local Central
High 11% Authorities
3%

Moderate Provincial &

Local
4%
Other
Low
14%
Local Authorities
7%
No

Unidentified
0% 10% 20% 30% 40% 50% 60% 1%
No Payments
74%
Communication NegotiationTechniques

Correspondently, contract negotiations were fairly quick for most firms, with 50
percent successfully finalising within 12 months and two thirds within 18 months.
CEOs were heavily involved in negotiations and more than half the firms had their
own in-house market entry specialists in the negotiating teams. CEOs of large firms
made significantly fewer trips (3.7) than the CEOs of medium-small firms (7.8). The
average negotiation period for Australian firms first entry was roughly equivalent to
that for the second or third American FDI in China. Industry sector was a significant
variable: business services and property firms ranked problems of communication,
linguistic and cultural differences and negotiations with provincial and local
authorities as less difficult than did manufacturing firms. Further, large firms (83

15
percent) and medium size firms (100 percent) were significantly more likely to write
contracts that were binding outside China than were small size firms, who were less
likely to seek dispute resolution options.

Competitive Advantages and Technology Transfer

The theory of international involvement requires the MNE to have ownership

advantages, which allow the international firm to compete in foreign environments.
Australian MNEs in China drew on two distinct sources of competitive advantage,
knowledge of efficiently operating an enterprise and the ability to build a consumer
base. Non-process intangible technologies embodied in human capital were the pre-
eminent sources of competitive advantage. Managerial skill, skilled personnel and
process technology, encompassing intangible knowledge of co-ordinating and
controlling product and service delivery represented distinct organisational
capabilities for Australian firms in China, as displayed in Figure 4. Complementing
this operational expertise, Australian firms drew on strengths in product technology,
brandnames and trademarks, and marketing and distribution expertise to define and
establish customer loyalty in China. Patents (3.2) and copyrights and design (3.3)
were of less strategic importance in the pursuit of market share. All respondents
ranked the resources and capabilities in Figure 4 the same, although small and large
firms were significantly more likely to transfer marketing and distribution know-how
than medium-size enterprises.

Figure 4 - Sources of Competitive Advantage

Managerial skill 4.3

Skilled personnel 4.2

Process technology 4.1

Brand names 3.9

Marketing & distribution 3.9

Product technology 3.9

Copyrights & designs 3.3

Patents 3.1

0.0 1.0 2.0 3.0 4.0 5.0

16
The characteristics of the technology transferred to China were consistent with
Australian MNEs competitive advantages. Half the firms transferred core technology
to China, but most of the technology was not patented in Australia (33 percent), nor
state of the art (39 percent). However, as the theory suggests, large and experienced
firms who entered through wholly-owned subsidiaries exhibited a greater tendency to
transfer state-of-the-art technology than smaller and inexperienced firms who
preferred JV entry modes.

Joint Ventures

Australian firms entered into JVs with PRC firms to access complementary
capabilities as predicted by the theory of entry mode choice. PRC state-owned
partners accounted for 68 percent of JV partners. PRC partners possessed strengths in
interpreting the surrounding environment and providing downstream distribution
connections, which complemented the operating and consumer product technologies
transferred by Australian firms to China. As shown in Figure 5, Australian firms
identified local market knowledge, government and commercial contacts, cultural and
social knowledge and contact and access to marketing and distribution networks as
the most important capabilities supplied by PRC partners. Notably, Australian firms
that entered China using JVs had significantly less experience in Asia, with an
average of 1.8 projects, compared with Australian firms that established wholly-
owned subsidiaries, with 6.5 projects.

Figure 5 - Motivations for Seeking PRC Partner

Government contacts 4.0

Local market knowledge 4.0

Cultural knowledge 3.9

Access to distribution network 3.5

Commercial contracts 3.5

Existing contract/relationship 3.5

Available long term facility 3.1

Chinese government requirement 3.0

Access to supply network 3.0

Spread risk of project 2.7

Access to finance 2.6

Access to technology 1.9

0.0 1.0 2.0 3.0 4.0 5.0

17
When consortiums were formed by Australian firms to pursue business opportunities
in China, third country partners were sought predominantly from Hong Kong and
overseas Chinese business communities. Australian firms bought cultural expertise
to facilitate communication and interaction with PRC partners and to help manage
day-to-day operations. As suggested by theoretical models of learning and
international JVs, host and third country partners were sought for complementary
know-how required to maximise potential rents on firm-specific assets. Prior
multinational experience, particularly in those Asian economies which underwent
rapid economic transformation, lessened the need for the experienced firms to form
JVs and seek consortiums to successfully operate in China.

Given the nature of their transferred competitive advantages, Australian firms had no
need to access production know-how. Correspondingly, PRC partners were sought
from outside the core activities of the Australian firm to inhibit spill-over of know-
how to Chinese partners. Further, most PRC partners had no experience of operating
outside China which also represented an attempt to minimise technological spill-over.
International inexperience proxied the PRC partners lack of experience in operating
alliances and hence a lack of a developed capacity to learn from a partner through
demonstration effects.

Although all headquarters faced problems controlling subsidiaries, MNE theory

identifies control and decision-making as a special challenge to JV operators. In the
JV, PRC partners exercised on-site and day-to-day operational control. Such
management tasks reflected the skills of PRC partners in communicating with local
suppliers, logistics providers and the local workforce. To counter immediate
operational control by their PRC partners, Australian firms implemented a range of
mechanisms to control, monitor and supervise the JV, while minimising the diversion
of managerial effort into dispute resolution. Australian partners appointed 65 percent
of JV general managers, while PRC partners appointed 67 percent of the deputy
general managers. Australians had equal or dominant control of the JV board and
most Board meetings (63 percent) were held in China, providing Australian parent
managers with the ability to directly monitor the activities of their JVs..

18
Figure 6 - Source of Disputes with PRC Partner(s)

Cultural/language
3.2
differences

Different short term

3.1
expectations

General
3.1
misunderstandings

Attempts to befit at
2.7
other's expense

Disputes 2.5

0.0 1.0 2.0 3.0 4.0 5.0

The leading sources of JV disharmony in Figure 6 were cultural and linguistic

differences, different short-term expectations and general misunderstandings. Such
difficulties are common to all international JVs. Encouragingly, Australian managers
saw beyond the myopia of the current dispute, solving problems with their Chinese
partners through negotiation. The dominant factor in negotiated JV conflict resolution
was the desire to maintain an on-going partnership. Recourse to legal action was rated
as of low importance in dealing with disputes with Chinese partners. The absence of
threats of legal retribution mirrors the experience of Australian MNEs engaged in
non-equity arrangements. Serious JV problems, related to benefiting at the expense of
the other party, were ranked low-medium and, again, resolved primarily by
negotiations.

Operating JVs and Wholly-Owned Subsidiaries

Monitoring, controlling and assessing operations in China posed significant

challenges for Australian executives, as outlined in the Theory section. Australian
headquarters tightly monitored their JVs and wholly-owned operations in China
with senior parent executives receiving formal monthly reports and informal reporting
on a daily or weekly basis, as shown in Table 6. Supplementing the numerous written
and verbal communiqus, these executives frequently visited their China operations.
Large firms, with more than 1000 employees, monitored more intensively than small
and medium size enterprises. There were no differences in the intensity of monitoring

19
across industries (manufacturing, business services and mining firms) or with respect
to the level of Asian region experience.

Table 6 - Frequency of China Head Reports

2-3 3-4
1 per Half
Report Daily Weekly per per Other
Month Year
Month Year
Formally --- 18% 17% 48% 5% 13% ---
Informally 15% 60% 12% 7% 2% 3% 2%

The intensive monitoring was coupled with the employment of experienced

international managers as heads of the China operations by 48 percent of the firms in
the survey. Large firms were more likely to have appointed experienced overseas
general managers (61 percent) than small (37 percent) and medium (44 percent) firms.

Approval from Australian headquarters or JV board was required for all decisions
affecting financial and growth strategies for the venture. The Australian parent or JV
Board exercised control over appointments of senior managers and decisions affecting
the retention of capital in China or its repatriation for expansion elsewhere in the
parents network. Figure 7 shows that budgets, capital budgeting and dividend
payments were heavily controlled. In-country managers retained discretion over
decisions involving sensitivity to local conditions, such as work organisation and
product price, range and design.

Figure 7 - Decisions Requiring Parent Approval

Budgets 98%

Capital budgeting decisions 95%

Appointments of senior managers 91%

Dividend payout 80%

Production technolgy 43%

R&D 42%

Product price 42%

Product range 38%

Product design 36%

Work organisation 32%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

20
Risk Assessment

Australian managers did not view China as a particularly risky investment location.
Overall risk was ranked as only of moderate concern (2.9), and no risk factor was
ranked higher than 3.4 on a Likert scale of one (low) to five (high) in Figure 8.
Bureaucratic obstructionism was seen as the greatest source of concern, with foreign
exchange/currency risk seen as the next highest factor. These benign assessments of
risk were consistent irrespective of the level of equity exposure to China.

Figure 8 - Risk Assessment

Bureaucratic obstructionism 3.4

Foreign exchange/currency risk 3.3
Inadequate infrastructure 3.2
Intellectual property protection 3.1

Restrictions on profit/remittances 3.0

Political uncertainty 3.0

Gov. favourtism to Chinese party 2.9

Lack of state neutrality 2.8
Embryonic reform process 2.8
Low labour productivity 2.8
Rising labour costs 2.7
Labour laws 2.5
Social and communal unrest 2.3

Labour disputes 1.9

0.0 1.0 2.0 3.0 4.0 5.0

Divergent risk assessment emerged when the sample was assessed according to the
Australian parents international experience. Firms with little overseas experience
ranked inadequate infrastructure and restrictions on profit remittances as greater
sources of apprehension than experienced multinationals. MNEs experienced in
operating in Asia recognised the risk emanating from Government favouritism, while
firms with little prior China experience saw bureaucratic obstructionism and foreign
exchange/currency risk as major problems. Larger firms were particularly dissatisfied
with the pace of reform in China.

The perceptions of only moderate risk levels was consistent with the transfer of state-
of-the-art know-how and the selection of contractual forms. Australian firms were not

21
ignorant or dismissive of the difficulties of operating in China. Rather, they matched
the choice of JV form to the nature of their distinctive resources and capabilities, and
the characteristic of the host commercial, political and legal structures. Sixty percent
of Australian firms sought equity JV involvement in China, which offers greater
control and security than licenses, management contracts and other non-equity
involvement. As discussed earlier, Australian firms also closely monitored and
incentivised their operations and JV partners in China.

Outcomes

The performance of Australian operations in China was measured according to short-

term financial ratios and subjective assessments by managers. Australian MNEs
performed well in China, with 71 percent breaking even or posted a profit. Eighty-two
percent of the firms were satisfied with the performance of their China ventures16
percent describing them as very successful. The high levels of performance and
satisfaction were consistent across firm size: the operations of large firms were no
more profitable than small.

However, there were two significant differences across the sample of firms. The China
operations of inexperienced MNEs performed less well than firms with extensive
experience of operating outside Australia. Managerial skill as a competitive advantage
was enhanced where that skill included knowledge of operating offshore and dealing
with different commercial, political and legal systems. Second, JVs were more likely
to post a loss than wholly-owned operations. Such findings are consistent with
numerous studies of multinational experience and international JV formation.

Disputes with partners did not exert a negative effect on the performance of JVs
compared to wholly-owned operations. This finding re-enforces the conclusion that
partner conflict between Australian and PRC firms stemmed primarily from cross-
cultural business styles, rather than fundamental differences in goal objectives.
Overall, parent CEOs were happy with their business activities in China. Few
Australian firms expressed a desire to seek a new PRC partner and only 10 percent
would have sought a contract with tighter wording. With hindsight, few firms, less
than 7 percent, would not have invested in China.

22
One of the most important outcomes was the new operational capabilities Australian
headquarters derived from their business activities in China. Nearly 70 percent of the
firms drew lessons from their experiences from negotiating entry and establishing a
presence in China, which were then applied to the establishment of new foreign
investments. Parent headquarters captured the new or enhanced multinational skills
learnt in China. The experiences of China staff were primarily seen as offering the
greatest value to the local operations, with little movement of staff to other parent
investments.
i
Chinas outward investment is poorly studied and more poorly reported. Chinese state firms are not
required to publish details of their overseas investments. Much outward investment is illegal asset
shuffling from China to Hong Kong and onward to tax havens, which then come back into China
dressed up as foreign capital. The major indicator of this leakage is the errors and omissions on the
capital account. Illegal capital movements some years have been several tens of billions of US dollars.
ii
China reports foreign direct investment as a subgroup of foreign capital comprising foreign loans
(government-to-government, international agencies, etc), foreign direct investment (joint ventures,
wholly-owned subsidiaries, etc), and other foreign investment (compensation trade, leasing, process
assembly, etc). These data are reported as the pledged contracted project amounts and secondly, as the
amount actually used or the utilisation amount. The latter reflects the amount committed. Often there is
a delay of two-three years between the contract and the commitment of funds, and a proportion of the
contracted amounts are never realised in actual projects.
iii
These 14 cities were cities which had in the past been treaty ports, and were for the most part quite
highly developed, with established industries and infrastructure.
iv.
The Tiananmen Incident of 4 June 1989 did not produce a decline in utilised FDI, though total foreign
capital utilised decline slightly due to suspension of loans by government and multilateral agencies.

23
Appendix I

Phases and cumulative trends in foreign direct investment in China, 1979-1998

Phases Institutional and legal developments Cumulative

FDI (US mil)

1st: 1979-85 The initial phase saw the approval for Special Economic
Zones (SEZs) in South China, and the 1979 Joint Venture
Law, and its belated September 1983 implementing
regulations. FDI was slow, reflecting uncertainty among
investors primarily due to the vagueness of the law. In 1984 4,721
the SEZ-style investment concessions were extended to 14
coastal cities.

2nd: 1986-90 In mid-1986 the Encouragement Provisions (also known as

the 22 regulations) were issued. These liberalised foreign
exchange, provided incentives for technology imports, and
allowed economic-technology development zones in
established industrial centres. The 1986 Wholly Foreign-
Owned Enterprises (WFOE) Law promulgated. The years
1986-88 saw four times as many Joint Ventures established 14,261
as in the first six years 1979-85.

3rd: 1991-93 A raft of new and amended legislation presaged the 1990s
FDI boom. These included: JV Amendment Law, Foreign
Enterprise Tax Law, Copyright Law, Software Protection
Regulations, etc. China becomes the main destination after
the USA for world FDI in 1992. Shenzhen and Shanghai
stock exchanges open. Rules issued for joint stock and
share-equity firms, and corporatised SOEs list abroad, 42,888
notably in Hongkong (H shares) and New York (N shares).

4th: 1994-97 The Company Law came into effect in June 1994, covering
all firms whatever their ownership. Special exemptions for
foreign and overseas firms were gradually wound back as
China attempted to comply with standards required for its
admission to the WTO. Greater efforts made to improve
implementation of regulations and increase the
transparency of Chinese commercial legislation. 158,271

5th: 1998- Increased recognition of the private sector, and the need to
introduce modern firm forms to the state sector. Private
equity investment funds and M&A activity based on the
1994 Company Law appear. The Asian financial crisis
undermines plans to create 'pillar' SOE firms modelled on 45,580
Korean chaebols.

Sources: Mofert 1984-98, Grub and Lin 1991, Roehrig 1994, Jia Wei 1994, SSB 1998, China
Daily x/x/1999. Tretiak and Holzmann 1993.

Note: Cumulative FDI is the sum of foreign direct investment actually used during the years of
the particular phase. Excluded are other types of foreign capital such as loans, leasing,
assembly and compensation trade. Sum each of phases for cumulative FDI for 1979 to 1998.

24
Appendix II
Total Amount of Foreign Capital to be Utilised Through the Signed Agreements and
Contracts (US$ million)
Total Foreign loans Direct Foreign Other
Investment
number value number value number value
1979-1983 1,471 23,978 79 15,062 1,392 7,742 1,174
1984 1,894 4,791 38 1,916 1,856 2,651 224
1985 3,145 9,867 72 3,534 3,073 5,932 401
1986 1,551 11,737 53 8,407 1,498 2,834 496
1987 2,289 12,136 56 7,817 2,233 3,709 610
1988 6,063 16,004 118 9,813 5,945 5,297 894
1989 5,909 11,479 130 5,185 5,779 5,600 694
1990 7,371 12,086 98 5,099 7,273 6,596 391
1991 13,086 19,583 108 7,161 12,978 11,977 445
1992 48,858 69,439 94 10,703 48,764 58,124 612
1993 83,595 123,273 158 11,306 83,437 111,436 531
1994 47,646 93,756 97 10,668 47,549 82,680 408
1995 37,184 103,205 173 11,288 37,011 91,282 635
1996 24,673 81,609 117 7,962 24,556 73,276 371
1997 21,138 61,058 137 5,872 21,001 51,004 4,182
cumulative 305,873 654,001 1,528 121,793 304,345 520,140 12,068

Total Amount of Foreign Capital Actually Used (US$ million)

Total Foreign loans Direct Foreign Other
Investment
1979-1983 14,438 11,755 1,802 881
1984 2,705 1,286 1,258 161
1985 4,647 2,688 1,661 298
1986 7,258 5,014 1,874 370
1987 8,452 5,805 2,314 333
1988 10,226 6,487 3,194 545
1989 10,059 6,286 3,392 381
1990 10,289 6,534 3,487 268
1991 11,554 6,888 4,366 300
1992 19,202 7,911 11,007 284
1993 38,960 11,189 27,515 256
1994 43,213 9,267 33,767 179
1995 48,133 10,327 37,521 285
1996 54,804 12,669 41,726 409
1997 64,408 12,021 45,257 7,130
1998 58,900 11,000 45,580 2,320
cumulative 407,248 127,127 265,721 14,400

Sources:
Moftec, 1984-98, Duiwai jingmao
SSB 1998, Zhongguo tongji nianjian, Table 17-13 p. 637;
"Foreign investment continues momentum", China Daily, 23 Jan 1999

25
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29
30
i
Chinas outward investment is poorly studied and more poorly reported. Chinese state firms are not required to publish
details of their overseas investments. Much outward investment is illegal asset shuffling from China to Hong Kong and
onward to tax havens, which then come back into China dressed up as foreign capital. The major indicator of this
leakage is the errors and omissions on the capital account. Illegal capital movements some years have been several tens
of billions of US dollars. For a discussion of aspects of these flows see Lardy 1995, 1999, xxx, Sung xxx.
ii
China reports foreign direct investment as a subgroup of foreign capital comprising foreign loans (government-to-
government, international agencies, etc), foreign direct investment (joint ventures, wholly-owned subsidiaries, etc), and
other foreign investment (compensation trade, leasing, process assembly, etc). These data are reported as the pledged
contracted project amounts and secondly, as the amount actually used or the utilisation amount. The latter reflects the
amount committed. Often there is a delay of two-three years between the contract and the commitment of funds, and a
proportion of the contracted amounts are never realised in actual projects.
iii
These 14 cities were cities which had in the past been treaty ports, and were for the most part quite highly developed,
with established industries and infrastructure. They were: Shanghai, Tianjin, Nanjing, Lianyungang, Nantong, Qingdao,
Dalian, Qinhuangdao, xnxnxnx.
iv
The Tiananmen Incident of 4 June 1989 did not produce a decline in utilised FDI, though total foreign capital utilised
decline slightly due to suspension of loans by government and multilateral agencies.