Corruption: China’s New Great Wall

For international companies, fears of corruption are creating a potentially formidable Great Wall to succeeding in China.

Luxury shoppers in China.

For international companies, fears of corruption are creating a potentially formidable Great Wall to succeeding in China.

This story first appeared in the July 18, 2012 issue of WWD.  Subscribe Today.

The alleged bribery cases currently ensnaring Avon Products Inc. — and potentially Wal-Mart Stores Inc. as it widened its probe in recent weeks beyond Mexico — paint China as an ongoing, challenging landscape for multinational companies.

A prevailing Wild East-style attitude within the Chinese business culture, coupled with anticorruption legislation and uneven enforcement, has turned the world’s second-largest economy into a minefield for foreign companies.

Only last week, the Chinese government unveiled new rules barring government agencies from purchasing luxury items, goods or commodities “above certain standards” in an effort to curb ostentatious spending by government officials. This latest crackdown appears to be motivated more by a growing national dissatisfaction over widening income disparity rather than an aggressive crackdown on corruption and bribery. But whatever the motivation, the new restrictions are likely to focus more attention on the rules of propriety and established patterns of corruption.

A recent survey released by the American Chamber of Commerce in Shanghai — AmCham Shanghai’s 2012 China Business Climate Survey — has two-thirds of respondents reporting that corruption hinders their business in China.

“Although some high-profile steps have been taken toward addressing this problem, corruption continues to be a top challenge for U.S. companies operating in China,” said Brenda Foster, AmCham Shanghai president.

“Corruption is baked into the cookies here. There is no way to really avoid it,” said longtime Shanghai resident Tom Doctoroff, head of J. Walter Thompson’s Greater China division and author of the new book “What Chinese Want.” “There is no rule of law when it comes to enforcement. Courts are biased in favor of local defendants, and something you have been doing for years without a problem can suddenly turn into trouble.”

American companies, in particular, come under intense scrutiny in regards to their dealings within China, as they try to navigate unreliable local laws and, in the U.S., the Foreign Corrupt Practices Act, which is designed to prevent American firms from conducting corrupt activities overseas.

An added complication for foreign firms operating in China is that state-owned companies still largely dominate the market. This means the FCPA considers many people in China government officials who would not be considered government officials elsewhere — for instance, doctors at state-run hospitals and employees of state-owned enterprises.

Another problem particular to China is the many levels of bureaucracy facing any company wishing to operate a business in the country. Meg Utterback, a partner at King & Wood Mallesons in Shanghai, explained that establishing a subsidiary in China requires several steps, including filing with the Administration of Industry and Commerce, the tax authorities and the labor bureau. It is also necessary to obtain a stamp of approval from the Public Security Bureau and, depending on the industry, other government entities.

“In some Western markets, the exercise is as simple as going to one government office and making a filing, with no requisite approvals,” said Utterback. “With more government intervention in the process, you increase the risk of someone seeking an improper payment or other consideration for an approval.”

As a general rule, Beijing-based lawyer Ronan Diot, who works with the firm Norton Rose, said that foreign companies should not engage in any commercial behavior that would be unacceptable in the West, even if they see other companies getting away with it.

“The difficulty is that some people within companies tend to see corruption as inevitable, and that when they are in Rome, they should do as the Romans,” said Diot. “Too many foreign companies run afoul of the local rules because they think, ‘most companies are doing it,’ or ‘there is no other way.’”

If American companies operating in other countries are hoping to escape the scrutiny of the authorities back home, they are unlikely to succeed. The U.S. Securities and Exchange Commission and U.S. Department of Justice, which investigates FCPA violations, have been working overtime in the wake of recent allegations against Wal-Mart Stores.

The world’s biggest retailer is alleged to have engaged in widespread bribery in Mexico, a practice that many claim is rife in China.

Recently, WWD reported that lawyers for Wal-Mart recommended that the retailer expand its internal review of its antibribery policies and operations beyond Mexico to include China, India, Brazil and South Africa, where the risk of bribery is the “greatest,” according to two lawmakers probing bribery allegations at Wal-Mart, namely Reps. Elijah Cummings (D., Md.) and Henry Waxman (D., Calif).

One reason people are concerned that a Wal-Mart-type scenario is possible in China is that it has happened to other large U.S. companies. Perhaps the highest-profile corruption case to hit China involving a foreign enterprise has been the ongoing investigation into cosmetics company Avon Products Inc., which in 2006 was the first foreign company to win a direct-selling license in China.

In 2008, Avon revealed results of an internal inquiry into potential FCPA violations. In the aftermath of these revelations, the company’s China operations shed much of its top management and a new generation has since taken the reins. The SEC is still investigating the case.

According to a source with knowledge of the Avon-China affair, the case should not be taken as a textbook example of how business in China is conducted, with the performance of the Chinese management team and the New York head office both proving far from typical.

“Those guys in top management were operating a fiefdom,” said the source. “The fear of the management in New York confronting the people in charge of the China operations was unbelievable. It’s not normal for there to be such a disconnect between international management and the local China operations.”

Avon was contacted for comment but declined to be interviewed for this story.

A more normal state of affairs in China, said Doctoroff, is for bribery to come into play in a sales-related business, because of the actions of renegade individuals operating within large and decentralized setups.

“China is such a big country. There is so little direct control, and each pair of hands along the operational food chain presents an opportunity for the people buying the product to receive a kickback,” he said.

The best method for foreign companies to avoid this problem, and the solution commonly sought by large foreign enterprises setting up Chinese operations these days, is to centralize their budgetary operations in order to maintain as much control as possible, he said. “It’s not just a question of culture but a question of operational scale. A geographically large area of administration equals corruption. Networks are corrupt almost by definition.”

Opinion is divided as to the climate for small-business owners. After almost two decades of operating his own businesses in China, Robert Young, a New Zealand-born entrepreneur, said he has not once witnessed bribery or corruption.

Although he admits the practice is likely to be more widespread in certain industries — construction, energy and health care have been cited by experts as the most vulnerable areas in the Chinese system — and also more common among Chinese rather than foreigners, Young said that from his perspective as an operator of small foreign enterprises, corruption in China “simply doesn’t exist.”

That being said, relationships (or guanxi in Mandarin) are an incredibly important tool in any business operating in China, and maintaining these relationships, Young explained, is often the only way to negotiate gray areas of legislation with officials, who have enormous scope for interpreting local laws in one’s favor, or not.

“I was caught not issuing customers with official invoices. The Commercial and Industrial Bureau official had the discretion to impose a fine of anywhere between 5,000 yuan and 40,000 yuan,” or from $785 to $6,277 at current exchange, said Young. But his friendly rapport with the official resulted in the lower fine of 5,000 yuan.

“There may not be black-and-white definitions, but in my view, bribery is the exchange of cash for a specific favor. Guanxi is a more general ongoing ‘relationship,’” he said.

Foster of AmCham Shanghai disagreed, stating that businesses of any size are at risk of corruption in China. The major difference may be that small and medium-size enterprises are less able to combat the ensuing legal problems than their larger brethren.

“Whether you’re a [small or medium-size enterprise] entrepreneur or multinational company, corruption is a significant challenge to doing business in China,” said Foster. “They are often at a greater disadvantage because they have fewer resources to deal with the problem. They typically don’t have in-house legal teams, expert government relations staff and may have a limited ability to conduct in-depth due diligence into their supply chain.”

Utterback emphasized the need to “do your homework,” no matter the size of one’s business. She said, “Know your business partners, anticipate the problems, define your limitations and accept the possible economic downsides of enforcing those limits.”