Proceed with caution in joint ventures in China

Last updated on July 2nd, 2019 at 09:08 pm

“What we’ve got here is (a) failure to communicate”

— A line from the script of the movie “Cool Hand Luke,” featuring the late Paul Newman.

D anone Group exited the Chinese drinks market in a bitter dispute with its joint venture (JV) partner the Hangzhou Wahaha Group Co. Ltd.

Hailed by Forbes magazine as a “showcase” joint venture in 1996, the partnership ended acrimoniously in 2009. At its height the JV was adding 100 million Euros to Danone Group’s top line and accounting for more than 5 percent of its worldwide net profit. In the end, Danone turned an initial $70 million initial investment into some sizeable profits and a $500 million U.S. dollar exit.

Hmmmm… Sounds pretty good, until you consider what could have been.

Today Wahaha is China’s largest beverage company with more than 160 subsidiaries doing everything from shopping centers to clothing. Its largest private shareholder, Zong Qinghou, turned his position as general manager of a state-owned enterprise, into a 29.4 percent private ownership position. That move vaulted him to the top of China’s richest list in 2010 and kept him there for three years. With a net worth in excess of $10 billion U.S., based on his 29.4 percent holdings in Wahaha and various associated subsidiaries, Danone Group’s 51 percent ownership of the JV would have theoretically added $15 billion to $20 billion U.S. to its current $43 billion in market cap.

So where did it all go wrong?

Danone Group’s website indicates its global strategy is to rely on well-placed and organized local partners who are responsible for developing the distribution. Danone Group contributes capital, technical and marketing expertise.

In 1996, Danone was intent on entering the Chinese market. Its chosen target was the Hangzhou Wahaha Group Co. Ltd., a state-owned asset company controlled by the Hangzhou Shangcheng District government, which had a number of hits and misses. To accomplish its goal, rather than investing directly in Wahaha, Danone and Peregrine Capital created a complicated joint venture structure, which saw them contribute just under $70 million U.S., in return for Wahaha transferring its brand to the JV. Due to Chinese government objections about, in essence, privatizing a state-owned asset, the transfer of the brand never occurred. To get around the government’s objection and get the JV moving, an abbreviated exclusive licensing agreement was registered which did not disclose the extent or terms of the full agreement.

The injected capital allowed Wahaha to quickly grow its manufacturing, distribution and market position.

The first hiccup was the demise of Peregrine Capital in 1998, which together with Danone held 51 percent of the JV. Peregrine’s exit ended in Danone taking 51 percent ownership and leaving it in control of the JV’s board.

In the West, this would have been game over as control of the board meant control of the company, but not In China. Unfortunately this was poorly understood by companies entering the Chinese market at the time, who tended to take as bedrock the legal and capital assumptions of their own markets. Based on the JV agreement, Zong Qinghou was the managing director and Wahaha had the right to appoint the general manager, which effectively gave Wahaha control of the company’s operations.

To effectively control a Chinese joint venture, you need to have a 70 percent control of the board, a situation which would never have been approved by the Chinese government at the time the JV was created.

From Zong Qinghu’s perspective, Peregrine’s demise and Danone’s ascension to a 51 percent ownership were viewed as a technical power grab. Rightly or wrongly, Zong viewed himself as the workhorse in the deal, which was lining the pockets of Danone. Zong’s response was to quickly set up a number of competing subsidiaries using parts of the Wahaha which were not acquired by the JV. Danone countered by trying to buy out Zong and Wahaha for $500 million. By 2007, the situation had become an international political and legal dispute, with both sides using attacking and counter-attacking, which led to the 2009 settlement.

Lessons learned:

Any company that cuts legal and regulatory corners in setting up their Chinese operations opens themselves up to unlimited risk within China. The notion that being clever will get you around restrictions does not play well with the Chinese government, and they will not step in to save companies or individuals who are playing fast and loose in their backyard. If a Chinese company goes to the United States or Europe and did the same they could expect a cold shoulder and no sympathy when the walls come crumbling down. This can be seen in the numerous “failure to disclose” cases brought against Chinese companies listed on U.S. and European bourses.

China is going through its robber baron period. The ego and appetites of its entrepreneurs, who are intent on moving quickly to seize any available opportunity, do not mix well with mature corporate entities, which tend to focus on core competencies and market domination. This is often put down to differences in culture, but this is a fallacious fabrication embraced by those who have failed to fully investigate and understand where China is on its development curve.

For SMEs entering China’s markets, the lesson is simple. Maintain control over your operations and only enter into agreements with companies and individuals you understand. China will continue to be in an entrepreneurial mode for years to come, which means the thinking of its businesses will be more akin to more nimble SME’s, than entrenched big caps. SMEs going to China need to have a clear idea of the markets, the opportunities and their competitive edge. Those going to China with the attitude that they wish to grow a business will do better than those who dream of dominating its markets.

Einar Tangen, formerly from Milwaukee, now lives and works in Beijing, China. He is an adviser to Heilongjiang Province, Hebei Province QEDTZ,, China International Publishing Group, Beijing Baotong and DGI DESIGN. He is also a weekly public affairs commentator for CCTV News’ Dialogue and the author of “The Kunshan Way,” an economic development history of China’s leading county level city. While in Milwaukee, he was a partner at Jackson, Morgan and Tangen, president of E-Tech and a senior vice president at Stifel Nicolaus. He chaired various boards in Milwaukee and was a member of the Federal Home Loan Bank of Chicago. Readers who would like to submit questions or suggest areas of interest can send an e-mail to

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