Guanxi – Business Implications

By

Keerthi Purushothaman DM15267

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TABLE OF CONTENTS

GUANXI – THE KEY TO SUCCESS IN CHINA? 2

ETHICAL DILEMMA 3

WHY DOES GUANXI EXIST– UNDERSTANDING THE ROOTS 4

GUANXI IN BUSINESS 4

GUANXI AND THE GOVERNMENT 5

THE NEGATIVE EFFECTS OF GUANXI AND REMEDIES 5

CONCLUSION 6

REFERENCE: 8

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GUANXI – THE KEY TO SUCCESS IN CHINA?

In business anywhere, it’s a lot more about whom you know than what you know. In China this is almost the only way to do business. It is here that the practice of Guanxi becomes an important concept to understand. By definition, it implies special treatment given to partners in an exchange by way of easy access to scarce resources, access to controlled information, easy access to credit grants, and protection from external competition. Guanxi is mistaken as a means of networking, i.e. a means of social capital that may be converted into political, economic or social assets. But to the Chinese, the guanxi is more than mere networking; it is a governed by the value of reciprocity. Thus the guanxi is a system of favours that generates obligations and indebtedness and has no time limit for repayment.

Every businessman anywhere in the world uses his connections and relationships in doing business yet in China, many businessmen rely almost entirely on these relationships in doing business. They protect these networks with a level of devotion that is rarely seen anywhere else. This brings us to question why guanxi is so important in China.

In China, it is said that your “Guanxi” network is like a bank where “Mianzi” is the money and “Li Shang Wang Lai” is the way in which you conduct your deposits and withdrawals. Mianzi is the concept of ‘face’; it represents a person’s reputation and feelings of prestige within the workplace, society and family unit. Li Shang Wang Lai on the other hand is how you give gifts. Understanding these values that are embedded in Chinese culture become crucial to doing business in the country. A simple example can be given to substantiate its importance:

In the pharmaceutical industry, for example, a Chinese sales representative may be selling drugs from local companies that are competitors to his foreign employer who is often in the dark about it. This is because his guanxi is regarded as personal and the employer needn’t be aware of it. Selling competitors’ products to local hospital buyers is a way by which he can pay back favors, build guanxi, and make extra money, all at the employer’s expense.

Guanxi Mianzi Li Shang Wang Lai

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Clearly, guanxi is not always favorable to foreign companies. This is why despite the many opportunities presented by the Chinese market, many foreign entrants have commented that operating in China is more complex and time-consuming than necessary. This gives rise to the issue that will be discussed in following sections, is guanxi ethical? Does it give rise to corruption? What are its implications for business? How can foreign businesses adapt to this practice?

ETHICAL DILEMMA

It is easy to understand why the question of ethicality arises with respect to guanxi. Our textbooks on microeconomics have taught us that perfect competition is the ideal market form. It calls for equal access to suppliers, equal access to factors of production and perfect information. In contrast, the merit of guanxi is that it reduces transaction and information costs, eliminates operational uncertainty and competitive threats, enhances institutional support and increases economic return and business effectiveness. The problem here is that, someone who doesn’t understand guanxi as a concept, for that matter any non-Chinese person will find this as an unethical means to conduct business.

Subsequently, guanxi is viewed as the cause for corruption, or rather as the means for it. Lai Changxing is one of the biggest success stories of Xiamen. It was entirely through guanxi that this poor peasant was able to transform his life and become a billionaire. Although this example shows that guanxi can indeed transform your life and that building guanxi is merely personal effort and does not require the backing of a powerful family, what it really shows is that guanxi can be used to achieve success by wrong means too. Lai’s fortunes were earned through smuggling that was made possible by his powerful connections or guanxi.

But, guanxi is not always used for corruption of that kind. In many instances, guanxi can be very useful to get things done in a country where rule of law is not always upheld. In fact, it is the uniqueness of China’s social and political environment that makes guanxi absolutely necessary for doing business in he country. In the case of Schindler, the Swiss-based transportation systems company, for example, the General Manager’s good relation with the local party commissioner was useful in protecting their patent. A local competitor had copied their product, got it patented and later sued Schindler for patent violation! If it wasn’t for the local party commissioner’s influence on the judge, the case would not have been annulled and Schindler would have faced a lawsuit.

Thus, instead of avoiding guanxi, companies must learn how to use it to their advantage. And instead of trying to reduce guanxi, which might be impossible in a country that has had it ingrained in its culture for years, measures must be taken to keep a check on its wrongful use in corruption. Once a strong guanxi network is established it is up to the owners of the network to ensure that it is used for rightful purposes that create a greater good for the society.

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WHY DOES GUANXI EXIST– UNDERSTANDING THE ROOTS

To understand why guanxi prevails in China, we must go back to their Confucian culture. It is this long tradition of Confucianism and the importance of social order that is imbibed in their culture that makes guanxi important.

The main principles of Confucian teaching are: - Social stability through unequal relationships among people (Husband to wife, Parent to Child, Ruler to people, Older to Younger, Friend to a Friend) - Family is considered the prototype of all social organisations - Virtuous behavior - Virtue with regard to tasks in life

Understanding these principles will help better understand business relationships in China. In ancient China, people faced many hardships that often resulted in loss of wealth, home or a family member. Farmers faced droughts, locusts and storms. Because of all this, the Chinese developed a survival mentality that led to entrepreneurs in China adopting values such as these:

• Only family can be trusted • The advice of an incompetent relative is more reliable than that of competent

stranger

Thus, the Chinese rely on their closed networks for business and this gave rise to guanxi. To build this guanxi network, giving gifts is an integral part due to the personal nature of guanxi. It is this practice that has been misused so as to mean ‘sealing the deal’ with a gift. Next we try to understand how guanxi works in business and with the government.

GUANXI IN BUSINESS

Unlike in other countries, business in china is not governed by the enforcement of contracts. It is done on the basis of relationship and trust. In the absence of legal contracts, guanxi serves as a logical substitute. People will honour a transaction when the relationship itself is more important the transaction and there are long-term benefits for everyone. Due to the collectivistic culture in China, business decisions are often not made by a single person but are taken by the network as a whole.

Guanxi hu refers to the inter-organisational guanxi, which consists of managers at other firms. This can be beneficial to businesses because a good relationship with suppliers can ensure better quality, service, delivery and reduced purchasing costs. Having good guanxi with customers ensures their long-term loyalty and thereby helps reduce marketing costs in the long run. An important kind of network is guanxi with competitors. Guanxi with managers in competing companies encourages inter-firm collaboration and helps reduce informational asymmetry and thereby reduces transaction costs. Guanxi is very important for the success of non-SOE’s, service firms, small firms and low growth industries.

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GUANXI AND THE GOVERNMENT

Guanxi is not merely a network of personal connections within business circles. The guanxi network also includes political heads and government officers. Political guanxi networks that consist of local government officials, party cadres and other political representatives give private firms access to government agencies. These firms are then able to influence policy-making, get information on policy changes, access bank credit and in this manner they create a more certain business environment. Firms thus, use these networks to further their success.

Nestle is an example of how good guanxi with the government through a process of give and take has been beneficial for them. The company complied with the tough conditions put forth by the government regarding the location for setting up, this commitment helped build a good relationship with the government. Apart from this, Nestle provides education and a stable source of income to farmers and it brings the best technology in food processing to China. In return, the government ensures that the administration delivers fast for the company helps with the speedy resolution of any problem that arises. Thus, guanxi enables openness and efficiency in matters relating to the government. This is especially important for international companies.

THE NEGATIVE EFFECTS OF GUANXI AND REMEDIES

Guanxi can often be misused and sometimes guanxi can also be bad for business. The principle of reciprocity implies that the most important aspect is that the debt must be settled. This can be detrimental for companies because the employee will return a favour even if it is not in the best interest of the company. This may involve seeking favourable credit terms for clients even if his creditworthiness is not high or even buying from a more expensive vendor because of guanxi. Because guanxi networks can turn into liabilities, measures must be taken to create transparency in existing relationships, prevent any conflicts of interest from arising and also to align employees’ interests with that of the company. Taking this into consideration, the following steps may be taken:

• Create competition: To avoid conflict of interest in choosing suppliers, a competitive bidding process may be instituted. This will reduce personal connections being used but will also not discourage employees from cultivating guanxi.

• Periodic rotation: To avoid powerful guanxi connections from disrupting business, the sales or procurement staff’s client assignments.

• Team-based selling: This will help increase the number of points of contact and reduce the guanxi’s pull on an individual employee.

• Build loyalty: Family relationships are the strongest in China. Companies must thus focus on building close family-like ties between employees and top management. This can be done by engaging in activities with employees outside work and also by regularly letting them bring their families to visit the company.

Because of how widely practiced the system of guanxi is, foreigners especially are prone to getting mixed up in deals that could get the caught up in corruption cases. It is important to always keep in my mind that if you aren’t Chinese, then you can’t be

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Chinese. Your guanxi network can never be as strong as the ones among Chinese people. So it is in the best interest of the company and yourself that you keep the following points in mind:

• Think from the perspective of how a particular transaction would look like in court. How would a judge perceive it? Can it be justified? If the answer is no, then gift giving could very well be considered bribing.

• Consider the best practices that are followed in your home country. • Think of the deal in perspective of the future. Ten years down the line does it

still look like a good business deal?

These are simple yet important questions that could help avoid being caught in a corruption scandal. Many foreign companies like Coca Cola and GlaxoSmithkline face corruption charges in China because their employees were accused of accepting bribe.

Another instance of guanxi and corruption is when officials for their personal gains, blackmail firms into maintaining guanxi relationships. For example, a manager in a private company was forced to spend tens of thousands of RMB every year in maintaining his guanxi with local officials. If he didn’t do so he would not be given an export license, a bank loan or even access to electricity and water supply to run the factory.

CONCLUSION

From the above discussion, it becomes clear that guanxi is an integral part of doing business in China. As long as the legal system in China remains inadequate and lacks enforceability, the rule by man will ensure guanxi sustains. But in the future, when the legal system is developed, for which the government has been taking various steps, it is expected that the relevance of guanxi will reduce.

Thus, the need for guanxi very much exists especially for foreign multinational companies looking to set up operations in China. It is especially so when the project requires authorizations and approvals from the government.

In business, guanxi certainly helps in obtaining otherwise rare resources like:

• Import /export license • Land, shares, human resources, key supplies, cheap credit or foreign exchange • Confidential information • Secure a market/distribution channel • Official endorsement for a poor product

For these reasons, building a good guanxi network in China is definitely a key to success. Although it is possible to try to avoid doing so, it is more beneficial to follow the practice. IKEA, a Swedish company, decided to stick to the western management style and avoid guanxi, which it viewed as unethical. As a result, IKEA is the only company that voluntarily pays royalties to the government for the music it plays in its stores. The government viewed the company as being “strange”. Soon IKEA realized it could not sustain in this manner. A Chinese manager was employed to take care of the guanxi

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relationships. But due to lack of involvement of the top management in cultivating this guanxi network, IKEA does not enjoy the benefits of having good guanxi with the government. This only further re-iterates the importance of Guanxi in doing business in China.

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