China Law Blog recently posted on the basics of how to do business in China , and raised the issue of ‘guanxi’ relationships. It is a controversial point among the international community in China. Dan Harris and Steve Dickinson of CLB are not believers – warning that it doesn’t help all that much and may cause problems. On the other hand, every conversation I have with a Mainlander eventually focuses on the power and importance of their network of guanxi connections.

What’s really going on here?
Let’s start with a quick definition. ‘Guanxi’ literally translates as ‘connection’ though it is often used to mean ‘relationship’ and ‘network’. When Mainlanders use the phrase among themselves, they are referring to a fluid network of cordial business obligations and debts – sort of an institutionalized version of ‘you scratch my back, I’ll scratch yours’. A person with a wide range of well-placed relationships, all of whom acknowledge their indebtedness and willingness to reciprocate, is clearly in a very advantageous position. Conversely, a person who lacks connections and is not in a position to do favors for new counter-parties is in a relatively weak situation. The worst position of all is one who owes valuable favors to a wide range of highly placed connections.

When Chinese associates talk to Westerners about guanxi, it takes on a slightly different meaning. Here the emphasis is on the ability to influence members of his network – to ‘make things happen’ and expedite profitable transactions or bureaucratic approvals. A common Chinese business aphorism – “Everything is possible but nothing is simple” – underscores the importance of guanxi in the Mainland. For a long time, guanxi was synonymous with “local knowledge” – but carried a strong implication of corruption and under-the-table inducements.

When the China economy was first opening to the world (up until the mid 2000’s), commercial laws were still haphazard, contradictory and opaque. In such a chaotic environment, a local ‘fixer’ was often required to prod bureaucrats and state managers to make a decision – and a certain amount of persuasion helped to ensure that the decision was a favorable one. There was a time when no one – Westerner, Asian, Overseas Chinese or Mainlander – disputed the need for guanxi. The only issue was locating someone who really had the connections to facilitate basic business transactions. China’s central government, however, was busily constructing what it hoped would be a strong legal system and a (relatively) transparent regulatory framework – and objected to the close connection between guanxi and corruption, bribery & misuse of state assets.

That is why Westerners in China often find themselves caught between two opposing views on the guanxi issue. On the one hand, locals still maintain it is the only way to get things done in Mainland China – and that without it foreigners will never overcome their status as rich but clueless outsiders. However, a growing community of experienced, knowledgeable international experts maintains that guanxi is an ineffective, expensive and ultimately counter-productive throwback to the ‘bad old days’ of a lawless, chaotic China where personal influence trumped laws and regulations.

So which view represents the reality in China? Is guanxi a real force that all business-people in China need to have, or is it a shortcut to scammers, cheats and regulatory hot water?

The Truth About Guanxi
Guanxi is extremely useful and powerful – as an information network. A broad, active web of plugged-in connections can alert you to people who are willing and able to help – but who have no idea how to find you and no other way of being found by you. A good guanxi network is like a combination road map and address book – that will enable help you engage exactly the right resource or decision maker. As a research tool, a good guanxi network is extremely effective and powerful.

As a skeleton key that will magically unlock doors, it is problematic. Yes, guanxi can open doors, but there are three problems: 1 – it won’t necessarily open the door you need unlocked. 2- When all you have is a key, all problems look like locked doors. You may end up rewriting your business plan because your guanxi connection leads you to a single type of resource or decision maker. And 3 – that door may lock behind you. Westerners who encounter problems in China are rarely suffering losses at the hands of complete strangers. The people gutting you of your investment, assets and IP are the very same ones who lured you in with promises of powerful connections and influential friends.

In short, guanxi can play a role in your Chinese negotiating, but you will have to monitor and decide what that role will be. Guanxi networks are great as information and networking resources. However, if you plan on using connections to open doors – or knock down walls – then you are going to encounter some major difficulties down the line. When you use guanxi as a shortcut in China commerce, the destination is usually business failure.

Part II: Guanxi for Foreigners: 10 Caveats

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“I can’t be sure, but it doesn’t sound like you are being ripped off. In fact, it seems like things are going pretty smoothly”. When I told them that they were on track for another 6 months or so of similar successes before they could expect a solid agreement, they didn’t look happy.

New York has its own special style of deal-making during the best of times, but the economic situation is wearing people down and making them even more impatient and just a bit desperate. Not only do we hate wasting time, but we always want to know exactly where we stand. We respect decisive, straight-forward counter-parties who can give us a clear yes or no. If that means doing a few small test deals to work out the kinks and test the waters, then so be it.

This contrasts with the Chinese style of building life-long relationships that yield profitable transactions when the time is right. Like a winding mountain stream that eventually leads to the ocean, Chinese deals are rarely direct or efficient – and aren’t meant to be. If a potential partner has any character flaws or quirks it is best to find out before there is a fortune at stake. If it takes a long series of meetings over many months to get comfortable with one another, then so be it.

In the old days (2006) there was a safety valve built in to US-Chinese negotiations called “cultural barriers”. When China was a strange, undiscovered territory for US service providers – and Chinese SMEs (small & medium sized enterprise) wouldn’t dream of initiating deals in America – interaction between the two sides was regarded as exotic, specialized and just a little dangerous. People may not have known exactly what they were getting into – but they knew that they were getting into something that was at least a little over their head. Nowadays there is so much press about the difficulty of doing business in China that people think they are forewarned and forearmed about the dangers.

What perils lay in the distant gloom: Lions and tigers and bears — or the Bermuda triangle?
It’s not enough to be cautious and circumspect – you have to know what to be afraid of. New Yorker bravado has been an empty joke since Mayor Dinkins started cleaning up the streets in 1990 (yeah – you heard me. Dinkins) – and reading a few wise-ass articles in the Times about Shenzhen factory conditions does NOT count as cross-cultural training. Americans in general – but the hard-driving New Yorkers in particular – need to keep their eyes open during their first couple of China deals.

Rules for New Yorkers negotiating their first China deal:

1. Time and scheduling
It will take a very, very long time. Funny story – trying to rush the timetable will only delay things further as your local counter-parties get nervous and start adding people and extra meetings to try to appease you. Being a type A, table-banging, no-nonsense hard guy doesn’t impress your Chinese counter-parties and handlers. In fact, to them it looks like you are having a hissy-fit. Yup. You’re not “The Donald” — you’re the brat who has to turn off “Sponge Bob”. If you are buying you can move things along a bit, but if you are selling or partnering, I’d be concerned if your negotiation took LESS than 6 months.

2. Truth and Honesty
They think they are being polite by telling you what you want to hear. New Yorkers do the same, but instead of them saying, “What a cute baby” or “you look great in those jeans” they are saying, “we’ll wire the money within 60 days” or “it looks like we have a deal”. They are surprised you took them seriously. Not impressed – just surprised. If you want to avoid the worst of the overly polite double-talk, arrange for your own translators and spend an hour discussing background and procedures with them BEFORE your meetings. If you rely on the other side to provide translation services then you are putting yourself at their mercy. And no – not everyone in China speaks English. It’s pretty much a given that your key decision-maker doesn’t – at least not with you.

3. Dim lights, dusty city.
If the Chinese are calling you, it probably won’t be from Shanghai or Beijing. Those people have already got a supply chain and service providers they know. Most of the exciting stuff is happening out in 3rd tier cities deep in China’s interior. For New Yorkers, that would be like Syracuse NY or Allentown PA – except in China they have 7 million people and tons of government stimulus money. Expect to take a little plane from Beijing direct to the middle of nowhere, and then drive for 6 hours. Don’t panic – but yeah, you are off the map with no way of getting home and no one knows where you are and no one understands a word you say. Believe it or not, you’re completely safe.

4. Effort doesn’t count.
If you are in the countryside, don’t joke about how bad the roads are. In the cities, don’t complain about the traffic or crowds. Don’t whine about how hard it is to get there or the lack of 5 star accommodations. You know how that guy from Texas sounds like when he talks about the sky-scrapers blocking the sun in mid-town Manhattan? Well that’s you in China. This is their home. It’s not quaint or exotic. It’s where their parents grew up and where their children will probably grow old. They are not impressed that you are deigning them with your presence. If your negotiation goes well, you should plan on being there at least twice a year for the duration of your relationship. Make it clear to them that you understand that and are happy about it.

5. A little goes a little way.
It’s nice that you can say ‘ni-hao’ and use chopsticks. And yeah, in the sticks they will flatter you and tell you how good your Chinese is. Smile, laugh, and be friendly. But don’t think that you are done. Real compromise with a Chinese counter-party is a huge commitment. If you aren’t prepared to add manpower, put in the travel time and change your operating procedure to accommodate this new business, then you should think twice about starting the negotiation. A China operation isn’t like a fern that you water twice a week. It’s like a relationship that will sour and turn on you if you neglect it.

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Aren’t Chinese businesses supposed to be long term planners?

Yes, and that’s the problem. As many Western deal-makers are finding out, Chinese negotiators often see the foreign partnership as a short-term tactic on the way to the real long-term goal of independent global competitiveness.

Chinese firms are pragmatic. They acknowledge the need for Western technology and methodology, but that no longer means a permanent marriage. Since the financial crisis of 2007, Western firms have lost the brass ring that used to keep the Chinese side of the partnership in line – access to US and European markets. The cold hard fact is that Western firms are entering partnership negotiations with a hand that is not strong and growing weaker. The Chinese market is becoming the new El Dorado (though it may end up being just as mythical) and the technology gap is definitely growing narrower.

Chinese firms are increasingly viewing Western firms as a short-term partner, a medium-term customer or client and a long-term competitor. Operating a JV in China was tough enough before the crash in the US & Europe and China’s new ‘indigenous innovation’ policy came into force – but many international managers in China now see a bleak future.
Here are a few useful tactics for negotiating a long term relationship in China:

1. Plan first, negotiate after.
Don’t shy away from asking yourself hard questions about your basic plans for China. Do you really need a long term partner in China? Why? What’s the relative balance of power going to be through the life of your partnership? Are you looking for a perpetual subordinate – because your Chinese counter-party might not be interested in a permanent secondary role. As you and he both learn more about the business what’s the natural competitive environment going to evolve into? Not only do you have to plan for 2015 – you have to discuss those plans with the Chinese side. If you plan on calling the shots in China ad infinitum, then you would be wise to make that clear BEFORE you share your IP and trade secrets.

2. Structure is everything in China.
Forget about NDAs and contracts. The deal that makes sense is the deal you’ll end up with. If you plan on having a long term relationship, structure accordingly. If you are providing design and capital and he is providing market entry advice and distribution then you have to plan for a point 18 months from now when he has your designs and you have access to distribution channels. What are you basing JV 2.0 on? A Chinese partner who thinks he can do better without you is going to find a way out of the relationship, even if it means scuttling the business and starting over on his own after you have gone back home. If the only thing you have in your corner is a signed contract, then you are embarking on a lose-lose relationship.

3. Consider a sunset clause.
Your best relationship may be a short one with an option for some type of longer-term arrangement. Teenagers think that passion leads to happy-ever-after, but adults are supposed to know that compatibility is based on other things. Still – there’s nothing wrong with a quick hook-up if everyone knows that’s all there is. But don’t propose if all you want is dinner and a movie. No matter what your plan, always have a viable exit strategy.

4. Don’t pay today for what may or may not come tomorrow.
Cynical Chinese negotiators learned long ago that naïve Americans believe in the fantasy of ‘long-term guanxi’ and are more than happy to let you pay up-front for the relationship of your dreams. Their dream is being the sole patriarch of a family dynasty. You aren’t in their dream.

5. Use your words.
If you have thought it through and decided that a long-term relationship is what you want, then make that part of your negotiation from the beginning. Be explicit and open. This is exactly the kind of thing you should be talking about during those relationship-building activities & banquets. Don’t just stop with the easy platitudes about harmony and working together. Likewise, don’t hold your breath waiting for the Chinese side to come up with a comprehensive game plan. It’s up to you to come up with specifics that include benchmarks and a structure that keeps both sides satisfied.

Partnership hint: Long-term JVs in China are more threatened by success than failure. It’s relatively easy to pull together when disaster is at hand and everyone needs one another. It’s when the Chinese side comes to believe (rightly or wrongly) that you have outlived your usefulness that partnerships fall apart. Plan for the good times as well as the bad.
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Traditional competitive deals are referred to as Distributed because the two parties split (or distribute) a fixed pool of assets.   Integrative deals are often referred to as Win-Win or collaborative because the two sides cooperate to ‘enlarge the pie’ or increase the total value of assets beyond the initial scenario.

In China, however, where negotiations are often characterized by non-economic factors – often in the form of face, guanxi, or lately, nationalism – it is common to experience a third scenario: Lose-Lose negotiation.   To some Chinese negotiators, your gain is their loss and your loss is seen as a valuable asset.

In theory a negotiator should be neutral to the prospect of you earning 10 or 20 if his profit in each case if 15 – and he will certainly choose a gain over a loss, despite the counter-party’s outcome.  According to the orthodoxy of marginal economics, a rational actor will transact as long as his benefit is greater than zero.    But in China your counterparty will sometimes opt for a situation where he loses a little if you lose a lot over an outcome where you gain a lot and he gains a little.  This is particularly true in the case of risk-averse SOE representatives who don’t benefit directly from positive outcomes – but may be penalized for a negative outcome.   As trade tensions rise between China and the West, Win-Win deals will be regarded with increasing suspicion.  Chinese negotiators consider it increasingly advantageous to see you fail.

While we consider this spiteful, petty and quite frankly, NUTS, there is a rational explanation – at least some of the time.  American negotiators who count on Chinese counter-parties ‘ultimately coming to their senses and doing what’s best for everyone’ will be caught off guard if they don’t understand how the Chinese side understands the situation.

Different Valuations, Different Goals, Different Tolerances

Chinese dealmakers still see themselves as tougher and more willing to “Eat Bitterness” or endure pain than Westerners, so they are more willing to engage in ‘trench warfare’ negotiation – committing huge resources to a battle of inches over years.   Chinese negotiators are often working off a different time-frame and valuation model.  They are willing to wait a longer period of time to achieve a deal that gives them greater control and exposure to technology.  Because brand names matter less in China, they are also willing to engage in behavior that puts their reputation at risk.  Furthermore, many Chinese negotiators are working under policy constraints that American corporations simply can’t understand.  Finally, nationalism is playing an increasingly important role in Chinese negotiations – as real or perceived slights, insults and challenges impact on deal-making.

There are 5 factors that Western negotiators must consider when approaching a Chinese counter-party to avoid damaging sub-zero sum game outcomes.

1. Learning curve
Some negotiations aren’t really negotiations – they are educational opportunities for the Chinese side, and you are the unwitting teacher.  Chinese have a huge appetite for technology and a great deal of confidence in their ability to reverse-engineer a product once they understand its function.  Many so-called ‘negotiations’ are really new-product development exercises.  The Cisco-Huawei negotiation is a classic example, though the more recent China Rail – Japan Shinkansen (bullet train) case looks like it will be the new textbook example of the Chinese tactic to act as the ‘good student’ in high-tech negotiation.
Remember that Chinese entities consider brand development, business planning and marketing strategy to be highly desirable technologies that Western partners can be persuaded to provide free of charge.

2. Competitive factors
In many cases, Chinese entities will enter into negotiation with Western companies that they view as potential competitors.  JVs and cooperative arrangements start out just fine when they focus on the production and product development side, but when it comes time to access the Chinese market the deal falls apart.  Many observers consider the DANONE – Wahaha negotiation to be a case in point.  The JV was quite effective when it was exporting to foreign markets, but things got rocky when it came to the Chinese market.

3. Timing
Sometimes the problem is about timing.  The Western side wants to move fast – the Chinese side doesn’t.  Many banking and finance negotiations in the 90’s & 00’s suffered this fate – the Chinese side wanted to move slowly due to regulation, technology and the limited experience of their staff.  Western firms grew frustrated and walked away, but not before training an entire generation of Chinese bankers in the finer points of international finance.

4. Differing valuations of the Chinese market
The Chinese side tends to value China access more highly than Westerners do, and this can ultimately scuttle the deal.  China, after all, has a long and unfortunate history of Westerners benefiting economically from Chinese resources.  Chinese policy-makers and managers have become very sensitive to losing control of the domestic market or resources.

5.  Risk profile
Chinese and Western negotiators view risk differently.  Too much uncertainty will raise the penalty for proceeding, even when there is a chance of gain. Westerners tend to see uncertainty and risk of loss as two sides of the same coin.  Chinese negotiators, however, have a much greater sensitivity to uncertainty – and tend to freeze up and stop deal progress if they can’t see what the risks are. http://www.chinesenegotiation.com/tag/risk-and-uncertainty/ http://www.chinesenegotiation.com/2009/09/risk-and-uncertainty-in-chinese-american-negotiation/

Last but not least, many Chinese entities see a real value in destroying your China business.  In some cases there are policy considerations – such as Youtube, Twitter and Facebook.  But sadly, there actors on both sides of the Pacific who consider it patriotic to scuttle deals that may yield profits to ‘foreigners’.  In the US this is generally a regulatory matter that takes place away from the deal table.  But in China where you may be sitting across the table from an SOE or policy-driven manager the issue of patriotic hostility is a negotiating matter.  Determine the likelihood of executing the deal (not just signing a contract) early in the process – before you reveal sensitive technologies or business practices.

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This time it’s commercial.

What’s different this time?  In the last round of trade tensions there were three sets of automatic dampers that kept the international drama out of your life.  First- most of the tough talk was drowned out by the noise of the financial sector going down the drain.  It was hard to worry too much about individual WTO rulings when the world as we knew it seemed about to crash and burn.   Second -  since most of us were trying to scale back and de-leverage, the notion of US-China hostilities actually shortened our ‘to do’ list by conveniently starving us of cash for expansion and new inventory.   Finally-  the previous round of tension centered on big-picture macro issues that didn’t really impact on us too much.  From here on in, the situation will be much more localized and granular.  The next trade war won’t be about the big-picture business environment – it will be about contract terms and bottom-line economics.   How should you handle negotiations with Chinese counter-parties during times of international trade tension?

5 best practices for negotiating in a less-friendly China.

1. Be patriotic
2. Counter-party selection is more crucial than ever.
3. Take a risk and show some trust.
4. Have a range of options
5. Now more than ever — be ready to walk away.

1.  Wave that flag – just don’t be a jerk about it.
The Chinese tend to be very patriotic and consider it to be standard operating procedure.  Don’t be misled by local Chinese who criticize bureaucrats, red tape or corrupt officials – they are often the most patriotic of all.  Westerners who try to pander or curry favor with Chinese partners by disrespecting their own country are considered weak and untrustworthy (even if you really feel that way).  Criticizing your own government about a specific policy or politician is ok, but beware of the slippery slope.  China is still a Confucian society, and if you don’t respect your own group how can you be trusted to respect the new relationship you are building?   It’s best to say nothing controversial or political – but if tested you are advised to come across as pro-American without being anti-Chinese.  If your counter-party asks you to explain something about US law or society, that’s ok.  If he tries to convince you about the superiority of the Chinese way of doing things then he’s sending a message that you shouldn’t ignore – but needn’t be a deal-killer.  Remember that some of the strongest relationships are built on a foundation of mutual respect between parties with honest differences.    If, however, he is overtly insulting, offensive or chauvinistic then you need to find a new counter-party at once.

2.  Counter-party selection is more crucial now than ever.
You know enough not to work off a nationalistic agenda – now you need to find a Chinese partner that has the same good sense.  The best counter-parties are the ones who genuinely couldn’t care less about anything but transacting.  There are plenty around (at least in Shanghai, though in Beijing the pickings may be a little slimmer).  As tensions grow, beware of SOEs who consider ruining your business prospects to be an act of patriotism.Be realistic and sensitive about how your counter-party is affected by the international trade environment.  Ideally, both he and you agree that politics is left to the politicians and business to the business people.   It is natural, however, for your counter-party to raise the nationalist bar a bit – but it should still be possible to do business.  If you have to pay a bit more, don’t sweat it too much — everyone is.  If quality or compliance is suffering, then you have a problem.    But beware of subtle and overt signs that your counter-party is working off a purely nationalistic, non-economic agenda.  Walk away quickly, quietly and amicably.  Let him have the last word.  The important thing is to get the hell out of there.  This is a disaster in the making.  If you guy has a nationalistic agenda, then you are weakening your position with every word you utter.  Starting a new relationship with a bureaucrat or SOE manager is particularly daunting right now.

3. Take a calculated risk – be the first to show trust.
Even in the best of times, Chinese dealmakers tend to feel that they are constantly being pressured to over compromise.  When tensions are high China can feel like one big mine-field.  The guy you are looking for is just like you – he is as nervous about you screwing him over as you are about him.  You may have to expose yourself to a little more risk at first.  Tread carefully, but if you have reason to believe that this counter-party is strategic for you then you might be wise to take a chance.  True guanxi isn’t developed at banquets or KTVs – it’s built through trust, reliability and flexibility.  He is in the same boat as you.

4.  Have a range of options and alternatives in place BEFORE any particular round of negotiations gets too advanced.
Now is the time to get creative.  Even by Chinese standards, the situation is particularly fluid and unpredictable right now.  If there is any way for you to diversify your risk or develop new options then you should explore the possibility.  The time may be right to try an arms-length transaction or to consider working through another expat firm that may charge a bit more but can be relied on to give you a straight answer.  If your business depends on government or regulatory approval then you may want to consider partnering with a local firm (or established expat) that already has the requisite relationships in place.  Avoid ‘all or nothing’ deals and ‘least worst’ decision-making.  Before you make decisions based on the notion that “the devil you know is better than the devil you don’t” double check to make sure you know what you think you do.

5.       Know when to cut bait.
This is a great time to review your bottom line and decide when to walk away.  This is a good idea in even the best of times – and these are not the best of times.  Ironically, this will require some tough negotiation with your own people back home.  If the heaviest pressure to sign a China contract is coming from your CFO and VP of Marketing in Edison NJ then you are in for a very rough ride.  It’s best to have a wide range of options – and putting your China deal on hold for a few months may be one of them.   When tensions are high and the ground is shifting, you don’t want to flying by the seat of your pants.  Chinese negotiators smell desperation a mile off.

Next:

Part III The Sub-zero sum game negotiator

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1. Western commentators are once again connecting unnumbered Chinese dots to form the picture that they want to see.  The PBOC statement on Yuan flexibility says nothing about timing, direction –  or anything of substance having to do with the new RMB currency regime.  It may be the harbinger of a new Grand International Coalition, or it may be Orwellian doublespeak justifying anything Beijing wants to do.
2. The west is expected to take forex off the table forevermore in exchange for a vague non-promise of flexibility.  How does this change the situation on the ground?  Western financial leaders have once again been pressed into service against their own Main Streets.  If the rmb appreciates by less than 10% over the next year, Geithner & Co are going to look a lot like Jack trading the cow for magic beans.
3. The Chinese side is controlling not only the substance of the argument, but also the timing and the scope. This is classic Chinese negotiation tactics.

Still, the chundits (China pundits) and globalists are thanking Beijing and congratulating themselves for averting a crisis.  Well, it’s certainly nice to think so.  But as we prep for the Toronto G20, how does this announcement change the negotiating environment?

First, China gets to maintain the status quo until it sees fit to change.   Even more significantly, the global recovery debate has been shifted away from artificial exchange rates and structural trade imbalances to western debt levels (which are still very much on the G20 table).  China once again trades smoke and mirrors for concrete western concessions.

This time, however, Beijing may be outsmarting itself.  This is the second doublespeak manifesto to come out in 2 weeks – following close on the heels of the Internet White Paper  released on June 8.  Beijing is displaying a new tendency to spell out in black and white just how gray and subjective its standards are.  Chinese tacticians have always exalted ‘formlessness’ and misdirection, but after a while it becomes possible to benchmark deception.  A pattern is emerging – Beijing enacts a policy (the currency peg or the Great Firewall), calmly waits for international debate to die down, and then finally releases an official definition of terms.  These pronouncements are fait accompli that protect China’s complete range of motion – but are couched in legalistic terms that sound objective.

In the bad old days when capitalism was the enemy and secrecy the rule, China-watchers used to count  coal cars on trains heading into Beijing to gauge the level of economic activity.  With this new set of documents — the Internet Manifesto and the Yuan de-peg paper — we have a new metric by which we can understand Beijing’s true intent.  This time, however, we will be judging the hardness of the NO by the conviction with which we’re told MAYBE SOMEDAY.

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Old tensions were brushed under the rug
It’s been about 14 months since March 2009 when Wen Jiabao signaled the start of the ‘new relationship’ between China and the US by very publicly fretting about the future of the dollar and Treasuries.   The winter of 2010 saw relations between China and the West sink to their lowest level in decades.   During the few weeks between the Second China-US Strategic and Economic Dialogue (SED) and start of the Shanghai Expo there was a noticeable improvement in top-level relations.   Even the People’s Daily gushed that the world was amazed over sharp turnaround in China-U.S. relations:

The China-U.S. relations entered into a warm spring from a cold winter in less than a year, and previously, it also took almost the same amount of time to drive the ties from summer to winter.

New troubles on the way.
Ironically, it was China’s success at managing the last round of international tension that is feeding into a new, more serious round of conflict.  Leaders like Timothy Geithner who were so expertly ‘handled’ by the Chinese side in Round 1 are now looking like empty-handed suckers whose kowtowing to Beijing yielded nothing.  China’s argument that it could help the world most by keeping its own economy strong is wearing thin as the global economy sputters along while China overheats.  Globalists from Washington to Geneva have very little to show for their patience and diplomacy, and the international trade environment is becoming more hawkish than ever.

Old tensions are spawning new conflicts.  The WTO regulations that helped China pry open foreign markets are now being used by Europeans and Americans to press for increased access to Chinese consumers.  Labor unrest in the factories seems to be focused solely on overseas firms.  China’s whitepaper on the internet has  enshrined censorship and blockages as official policy. Domestic content rules and new trade restrictions are destroying hopes for a level playing field for domestic and international firms.

The economic recovery in the West is moving in fits and starts with persistent unemployment and uneven economic growth.  Main Streets in the US and Europe have grown tired of empty promises.   Chinese managers are facing troubles of their own, as inflation, labor strife and fear of bursting housing bubbles eat up what was left of their margins and threaten the only business models they know.  The Chinese operating environment is becoming expensive, less profitable and far less predictable than at any time in the last decade.   There are fears that a double-dip recession may strike in Europe, the US and China.

Why is this time different?
Where the pre-SED (crash – May 2010) round of tension was primarily a clash of world leaders over macro issues, the new troubles will be much more bottom-up.  If you were negotiating with a Chinese counter-party in the last year you may have noticed that the atmosphere was less cordial than in the times gone by, but your deal-points and goals probably weren’t affected.  Emerging tensions, however, will center on more bottom-line issues.   We all know that Chinese negotiators tend to put more emphasis on relationships.  During times of international harmony, this represents a significant but not necessarily unpleasant challenge for American negotiators. What about during times of rising tension?  How should Americans handle their relationship building?   In a word, ‘cautiously’.  Unlike the first round of trade conflict, this will not be a war of words between elites, but more of a bare-fisted brawl between street fighters.

The game is changing, and it’s up to you to decide whether or not the next phase will benefit you.

Next:  Best Practices for Bad Times.

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We’ve looked at the causes of the BOPS and how it affects Chinese negotiating tactics. Now we are ready to look at how American negotiators in China can prepare and protect themselves from the fallout of BOPS.

Forewarned is forearmed.
Watch for shifts in behavior, communication style and attitudes.  Remember that even with good Chinese partnerships, your gain is often perceived as his loss – and vice versa.  One of the few constants in Chinese negotiation is that you have to be proactive about managing the relationship.  Well, it’s time for Westerners to raise their game a bit.  The days of qualifying as a cross-culture pro by learning to say ‘ni hao’ and passing business cards with two hands is over.   Building a relationship in China is a delicate process that will be influenced by external events.  Anything that impacts on the balance of power of your business will affect the relationship.   Don’t be blindsided by your counter-party’s negative reaction to your success or progress.

In China honesty tends NOT to be the best policy, but it has its uses.
Yes, Chinese people tend to be less direct than Americans, but this doesn’t mean that you are expected to speak in riddles and vague allusions.  If your counter-party seems dissatisfied, distant or hostile then you should find a non-confrontational way to start a dialogue.  Different regions of China have varying attitudes towards direct confrontation.  You may find that northerners and even many Beijingers have few reservations about sharing very frank opinions – particularly if there is booze involved.  Even if you don’t work through every personal or commercial issue, you will certainly learn a great deal from a serious discussion.  If the main thing you learn is that your counter-party isn’t being honest or forthcoming, then that’s a great bit of information to have.

Always be ready to go it alone.
Many Western counter-parties in China are more prepared for failure than for success.  Ask yourself a simple question at the start of your negotiation with a Chinese business person – ‘what if this is a big win?’  Sure, you may build a rock-solid joint venture that your grandchildren end up running together in amiable cooperation – but there are other, more likely, possibilities.  The fact is that you and your Chinese counter-party are each on a separate learning curve and have your agendas.  If you don’t already have a Plan B that involves you going your separate ways, then you are putting yourself in a very weak position for no reason.  Your Chinese counter-party certainly has a wide range of alternatives – and that is one source of his negotiating power.

Structure strategic deals with a rising pay-out.
Chinese and Americans view risk and opportunity differently.  For many Westerners, the China operation is an extension or expansion of a larger business.  We tend to be accretive – building up and accumulating pieces of the puzzle in an effort to assemble a large, stable operation.  Modern Chinese, on the other hand, have grown accustomed to an endless stream of potential counter-parties coming ‘round the bend and seeking them out.  When you tell a Chinese counter-party that he can expect a level payout from a stable business, he may very well take this as a sign that this deal has lost its potential and it’s time for him to find a more promising project.    Many Westerners sourcing goods in China are shocked and dismayed that instead of building guanxi and receiving better terms from long-term suppliers, they suffer from unpredictable quality problems and cut-throat price pressure.
Chinese negotiators tend to be more sensitive to opportunity cost than sunk cost and are always looking for a higher return.  It’s precisely this willingness to book gains and move on that gives Chinese so much leverage in negotiations with Westerners.

Don’t rely too much on your Chinese counter-party’s self-interest to preserve your partnership.
Clever Westerners used to gloat that they had guaranteed cooperation and compliance from Chinese partners by structuring a deal that only involved small up-front good faith payments—with the bulk of the payment coming after the Chinese side had performed satisfactorily.    This plan usually failed for one of three reasons.
First, this kind of behavior, while considered prudent in the West, tended to undermine guanxi and led to a vicious cycle of distrust and suspicion in China.  A second problem stemmed from the fact that cash was not the only asset involved.  While the Westerner was very withholding and cautious with his dollars, he tended to be much more generous with his IP – such as designs, brands, and processes.  Many Chinese counter-parties considered the up-front money a scholarship to Your Business University – and these guys take their education VERY seriously.  And finally, even a small up-front payment was worth having if the Western side was offering.  We don’t see this as often as we used to from established players in Beijing or Shanghai, but if you are dealing with entrepreneurs or venturing out to the sticks, a small sum can go a long way.

Shifts in the power balance have to be seen through the filter of your counter-party’s culture and experience. You might think that moving money or assets into China means that you have more power in the relationship with your local partner – but to him this may signal the beginning of the end – his last chance to get paid before the finale. You see your new venture as something stable and growing – he may see it as one component of a larger, more fluid set of opportunities. He’s learned a new product or process from you, and profited a bit in the process. Staying put with you would be lazy and slothful – what he should be doing is putting this new expertise to work by developing his own operation. He’s already got the network and the channels – all he needed with process training.

Chinese tactics
After a balance of power shift, the tactics employed by your Chinese counter-party will become more aggressive and goal-oriented. In the pre-BOPS negotiation your counter-party was learning and waiting for you to put the pieces together. But now that your business is starting operations there is little more to be learned. It’s about cash now – and there are a few different approaches Chinese negotiators can employ after the BOPS occurs..

A BOPS in your favor.
Scenarios: You have developed expertise, contacts or resources of your own in China.
Key variables: Exclusivity, Territory, Pay-out
Tactics: Putting down roots and digging in for the long haul.
If you are becoming more successful and independent, your local counter-parties may see this as an increase in your power and influence in the relationship. From here on in, they will be looking to maximize money, power and influence within their own network (usually involving you buying, hiring or spending with their friends). The good news is that they aren’t going anywhere. The bad news is that it is going to become more expensive to maintain the relationship.

A BOPS in their favor.
Scenario A: You have brought in money, registered, set up the business and started operations. Now he wants out.
Variables: IP, trademark, designs, customer lists, quality, promotional material, etc
Tactics: Cut-throat quick-kills and fast exits.
You’ll be wondering why they are giving up a deal that is doubling in value for them – it’s because your share is going up even faster. They think they can do the same business elsewhere without having to give you the lions’ share of the profits. Their power and influence is at its highest point the moment you successfully start operations. They may feel that their best chances of capitalizing on your achievements don’t include you.

Scenario B: You have set up the business – and now he wants more:
Variables: Money, hiring & buying (from their network), quality.
Tactics: Spend your money to prop up their local network.
In this situation, they see you as the deep-pocketed Daddy Warbucks type who always has cash to throw around. They become resentful that you are exploitative and manipulative, and start upping fees and charges. The size of your operation – and staff – begins to increase rapidly. You are spending more – and facing increasingly aggressive counter-parties – but not seeing an improvement in terms of quality or service.

Next: Part III: BOPS and counter-tactics

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Introducing, the Balance of Power Shift, or BOPS.

Part I: What’s the Balance of Power Shift?
Part II: BOPS and tactics.
Part III: BOPS and counter-tactics

In every Chinese deal a little power must shift. There will come a time when the prospective supplier who was kissing your assets yesterday starts acting surly and aloof. Or that busy, cell phone guy suddenly has all the time in the world for you. What’s going on – Balance of Power Shift. BOPS.

Chinese deals can have a lot of them, but they almost always have at least one. This is when the Westerner suddenly outlives his usefulness – or the Chinese realizes that the Lai Wai can do this just fine on his own from now on. One way or another your partner feels that the relative power of the relationship has changed, and now it’s your problem. The first rule is that you can’t ‘opt-out’ of the pettier and dumber aspects of the culture just because you think they are petty and dumb. Your Chinese counter-party has a propensity to get fussy about power games and deep strategy. And because it is part of their world, now it is part of your world. Got that?

Post-BOPS behavior patterns:
Behaviors change rapidly, and experienced negotiators know what the new signals mean. You should too.

After the Western side wires the funds, one of three things will happen.

•One is that everything stays 100% on track as both sides worry about execution and expansion in a balanced, systematic and logical manner. It usually doesn’t.
• Sometimes the Chinese will feel that they have been dealt a losing hand. Either it looks like they will make less money or that you will make more than optimistic estimates led them to believe. This is where the quality problems, the unfinished projects and the unanswered phone calls are born.
• The third option is that the Chinese side feels it has the advantage. That’s when you have outlived your usefulness. This is the signal for the start of some potentially aggressive behavior, like the kind of IP theft where they start running a competing business with your plan, product & designs.

China Deal BOP: Which way is it moving?

What triggers a power shift?
The BOPS – the Balance of Power Shift. It can be caused by something external to the negotiation or something internal – but suddenly your Chinese counterpart feels either stronger or weaker than he did yesterday – relative to YOU.

• Maybe you moved money into the partnership – in which case you are weaker. Maybe you signed a deal with a different Chinese firm – in which case you are stronger. If you are making more – or he is making less – it may be causing resentment which can force a BOPS earlier.
• You are supposed to be the brawn, they are the brains. Even though your brawn was cash, technology, designs and know-how – they were the brains of China. Each day the balance is shifting. As you transfer more money, know-how, training and IP to the circle, their power grows. As you learn more about China & the industry and build up your network, your power grows.
• In China, your success can suddenly trigger a BOPS against you – as your Chinese counter-parties decide that you are exploiting them and that they should A) charge more and B) find other deals that don’t include you.

Why does it occur?
They either think you were screwing them (your fault or not) or think they can do better by screwing you. Either way, it’s a decision – not a rule – and it’s governed by the Chinese notion that there is always another opportunity just around the corner. Another factor is that Chinese negotiators consider education about your operation and industry to be an intangible but valuable asset. The knowledge they’ve gained is part of their payout. It usually declines steeply. By the time they have the upfront money, they are done.

In other words, your cooperative structure may be eroding at the base even as it looks the most successful. While you are building and struggling, your Chinese counter-party remains loyal because he is still putting the pieces together. But once you have succeeded with your first order or preliminary operation, then your usefulness as a teacher is exhausted. They have learned it all, and can probably do better on their own in China than in helping YOU prop up your fat margins.

There are a lot of factors contributing to the BOPS, but it seems to be closely connected to how low-maintenance the relationship is, and what the earnings potential looks like. If the payout is level or falling, look for the Chinese side to decide that the grass is greener and the BATNA higher on the other side. At that point, you need them a lot more than they need you – hence the BOPS.

Time & Risk
Westerners believe that the safest course of action is to secure a stable base of operations and grow from there. The Chinese feel that the smart businessman acts quickly when an opportunity appears – and is always ready to move on to the next one. Both sides, pursuing a risk-reduction strategy, will undermine the partnership. It is important to put aside your own preconceptions about what constitutes long term benefit, best practices and common sense.

Next: BOPS II – How it affects tactics

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