1 – Figure out what you are really looking for in a partner — being as specific and detailed as possible.
2 – Create a win-win deal structure that can be executed and put into action reasonably quickly and effectively.
3 – Avoid building an operational structure that allows (or requires) your partner to screw you over the moment it becomes possible.

Today we focus on Part 3 – building a self-reinforcing deal structure that gets stronger (in a positive way) as it succeeds.

Common Mistake: The Swinging Balance of Power
Too many China deals follow this patter: the Western part agrees to inject capital, IP and know-how into the partnership and the Chinese side agrees to provide administrative support, local expertise and distribution. The western side – seeking to protect its investment – crafts a contract that includes conditions, penalties, punishments and contingent liabilities. China side receives assets, capital and IP from western counter-party – and promptly stops picking up the phone.

What just happened? The deal was structured in such a way that the Balance of Power shifted 180 degrees in favor of the Chinese side the moment the assets were transferred. Suddenly the western side found itself with a worthless partnership, poor control of its own property and a contract that probably can’t be enforced.

How can western deal-makers structure their relationship to avoid this turn of events? By creating a deal that both sides can reasonably expect to be more valuable tomorrow than it is right now.

Structuring a self-reinforcing deal:

There are 3 ways to build such a deal structure:

1) Triggered incentives.
You agree in advance about what the incentives will be and what will trigger them. These are default-mode rewards – barring any unusual or unforeseen event, the reward is granted once a specific requirement is met. This could be number of units sold, amount of profit accrued, length of time spent in the partnership or any other condition. This kind of incentive usually repeats and can be predicted as a normal course of business. The most common examples are sales commissions, profit shares, vesting accounts or scheduled bonuses.

2) Conditional incentives
Changes to the basic structure of the agreement can be made after certain conditions are met. One common example is a discount for cash payments or a bonus for meeting a deadline. Another application would be exclusivity for a certain region if certain sales targets are met. These incentives are often unique or 1-off deals.

3) Penalties and punishments
Some negotiators and lawyers still try to enforce compliance through use of penalty or punishment clauses in the contract document. Withholding payment or commissions to collect on ‘fines’ imposed for non-compliance sounds good in theory – but is mess to put into practice. Chinese courts rarely award damages, so once your conflict reaches the court-room you are almost guaranteed of losing – even if you win the case.

In China, options 1 and 2 sometimes work. Option 3 is ineffective, and often leads to far bigger problems than the one you were trying to solve in the first place.

The key to developing effective incentives is to figure out specifically what kind of behaviors and outcomes you wish to reward, and then developing a simple, straight-forward means of measuring it. Incentives only work when all parties expect tomorrow’s payoff to be bigger than yesterday’s. The problem here is that counter-parties often pick the wrong goals to compensate – leading to ineffective or counter-productive deal structures.

The Sales Commission Approach
A common example is the basic ‘commission on sales’ incentive scheme. Fewer deals are more straight-forward and effective, yet there is still plenty of room for misunderstanding and problems.

The first issue is that if you pay someone to sell, then that’s what he is going to do. Sell. He’s not going to manage, train, collect, design or plan. That’s fine, if all you want him to do is sell – but if you’re plan (whether written or ‘in your head’) is to have this person provide a range of services in addition to selling, you have a problem on your hands. He may have little interest in performing such ‘unpaid’ work while there are sales to be made.

The second issue is the SIZE of the commissions being paid out. Developing new markets is hard, time-consuming and risky. That’s why some clever partners try to incentivize sales reps by paying them a higher commission rate at the beginning, and a lower rate as their sales rise. This seems much fairer to the boss than to the salesmen – who perceives it has a real DROP in his pay. Partners who propose a sales arrangement had better stop and consider what they’ll do in the even of success. Every owner and sales manager SAYS he isn’t bothered by writing big commission checks – but the truth can be different. Many partners feel that big, regular commission payments can destabilize a partnership over time and encourage the non-selling partner to seek cheaper options.

Third – be careful what you wish for. If all you want is sales, then your local partner will provide you with sales. But be very clear on the return and collection policy at the beginning. A smart salesman can manufacture bogus sales that will look real enough for a few months, but will ultimately burden the company with non-collectible receivables or a warehouse full of returns.
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The problem used to be figuring out the identity of the true decision-maker.  Now it’s about figuring out which team decision-makers is winning the corporate power struggle within your prospect’s company.

In general terms, there are three groups of players that you have to understand:

 Overseas office / global HQ.  
 Local top-level decision makers (MDs, owner, department heads)
 Local bureaucracy (HR/Purchasing)

The problem is that these groups tend to compete with one another and base their purchasing decisions on widely varying criteria that don’t necessarily have anything to with the actual needs of their organization.  On the bright side, internal communications is often so poor that you can tell different people completely different things and no one will ever find out.  Maybe.  The downside?  You’re selling to groups with widely different perceptions of value.
 

Who are these people or groups?

• Global HQ or centralized decision makers.
  These people are not in China.  They tend to not know – or even care – about market realities over here.  For many China-based SMEs or departments, it is very hard to make this sale since they have global operations and only seem to deal with international giants.  The good news?  While it’s hard to make the sale, it is much easier to get the deal.  Stop selling direct and look to partner with companies that are strong near the HQs– but weak or building in your own backyard.  There are plenty of smaller “global” companies that are just starting to get their China ops off the ground – or trying to rebuild after initial difficulties.  Don’t be intimidated by international giant consulting comapnies.  China standards are rising quickly, and many respected names are quietly reaching out to high-quality subcontractors on the ground in China’s business centers.  Hint – fast growing third & fourth tier cities are good bets.
   
•  Local Top-Level Decision Makers.
  The good news – this is your house.  These are people just like you – ex-pats, returnees, and overseas Chinese who speak your language.  They ‘get’ the local business environment, know that international SMEs and entrepreneurs deliver the right quality at the right price, and honestly believe that you are the answer to some of their biggest problems.  They understand your situation – and your value.  The bad news – there are relatively few of them and they are constantly under fire from Global HQ and local-locals who want their power (and their jobs).  Keys here:  Sell the end result (solutions to their worst problems) – and the control (make them comfortable that you are ‘their guy’ and won’t go around them to Global HQ). 
   
• Local Bureaucrats – HR & Purchasing departments.
  Dynastic eunuchs with better haircuts.  Very tough – and they are on the rise.  Bad news – there are more of them then ever, they fit in with Global HQ’s cost-cutting strategy – and they tend to be fussy and resentful of westerners, overseas Chinese, returnees, other local Chinese, and just about everyone else.  They are still getting informally compensated by their friends who try to compete with you.  But the worst part is that stamping the contract is the only real power they get to exercise.  Good news?   They are getting more and more sensitive to quality and scheduling.  In many cases their own network has let them down in the past, and they are very wary of looking foolish again.  They often fill the role of “influencer” or “implementer” – and not the “decider” or “initiator” that they say they are.  With these folks, you want to sell to their ego first.  Play to their sense of middle-class respectability and their position within the international community.   These are the people you network with at the AmCham functions.

General China B2B sales advice: 

Spend the early part of your negotiating cycle determining how decision gets made.  Focus your energy on the ones you have a shot at.  Understand who really makes the decision.  

Don’t sell to two groups at once.  Sell twice within the same organization.  Global HQ overseers care about total cost of ownership (TCO), warranties and guartantees.  Mid-level managers and country heads will focus on quarterly (or monthly) bottom line profits.  Local locals focus on price and terms.  Don’t try to convince locals that TCO is what they should care about.  Don’t complain to COOs and CFOs in New York about how difficult it is to deal with their China-based reps.  You’ll be right, but poor.