ISSUE 13: EXITING CHINA 2022: Why Can’t I open the Door?

Please note all content is personal opinion only. Unless I copied it from someone else. If I did then it would be their personal opinion.

In the last few years, we have had many foreign invested enterprises coming to us to discuss exiting China. However, only six liquidated at the end of the day.  Most kept a toe or even a foot in the China market (some had lost an arm or a leg) or they sold their China business to someone else – sometimes paying to do so. For most international companies China is very much a hotel California experience – it starts with:

"This could be Heaven or this could be Hell"

And then after a while it becomes:

“You can check out any time you like, but you can never leave".

To be fair over the years relatively few clients have wanted to fully exit China. Many decided to temper their ambitions or restructure how they did business (i.e. distribution model, OEM contracts etc.) rather than fully up sticks.  

General Musings

Retail is Prone to Death in China - The most likely to leave have been retailers – the saddest was one that spent 3 years (and many millions) to buy out the distribution rights to their brand for China and Hong Kong. Then a further 3 years to try and build out their brand in China. The more they built their network in China the more money they were losing. The local team kept on believing that growth would deliver success (a bit like Liz Truss ). Every store was leading to more losses. At some stage headquarters felt “we can’t afford any more of this success in China … it will bankrupt us”. Even in that case the retailer still kept a distributor, TMall Partner and an outlet store in China.  

There is Complexity … Almost Always – breaking up with China is not as easy as breaking up with your first boyfriend.  Another retail client had over 100 stores operating in multiple provinces across China with multiple WFOEs and branches – impossible to close simultaneously. Retailers also have lots of employees and lots of landlords. China may be an important part of the company’s wider global supply chain – they cannot burn their suppliers in China without burning down their global supply chain. Accordingly, for many stiffing the suppliers on the way out the door is not an option. 

Manufacturers tend to be simpler – rare is the manufacturer that fully leaves China.  One who did decide to make a clean break was Swiss equipment manufacturer with plant for assembly and painting of a relatively basic product.  Over the years China just wore the Swiss down. First the factory did not have the proper foundations so when the metal was stamped the product was a little uneven – perhaps for most companies this would have been an acceptable deviation – for the Swiss it was an affront. No sooner was foundation issue solved (by importing pre-stamped parts) then the fire department did not like that two buildings were connected by a roof. A few more years on and the local environmental authority said they could no longer operate the paint shop. The final straw was that the incinerator powering the oven to bake the product was deemed to be against environmental standards. The final straw may have been when a global account asked why they could not get the same after sales service that the Taiwanese GM had offered a tiny competitor. The owner (a very kind man) just called one day and said “life is too short”. I still think the main motivation was that he did not want his son to inherit the headaches of the China business! It still worked out for them as they purchased the factory in 2001 and then left in 2018 and sold the factory (or more accurately the land) for a massive profit.

Employees can have a Different Perspective – In the 2000s many multinational companies embarked on a flurry of building capacity in China – often over-estimating long-term demand and under-estimating local competition. As a result, many do not wish to exit China fully but to downsize or close some of the capacity (i.e. liquidate one of their three WFOEs). In most cases, HQ will consult with lawyers before discussing planned closures with local management. This allows me to appear psychic as I will tell HQ that when the local manager finds out about the closure plans their solution will be invariably to close down production in the USA and move everything to China.  

Downsizing or Liquidating JVs is difficult – Although liquidating a WFOE is much more difficult than many appreciate, the difficulties pale in comparison with a JV. The problem with a JV is that you cannot “wish” yourself out of the JV – you can terminate the JV contract, you can withdraw your directors (except if you appoint the legal rep), you can be very upset … but you will still be a shareholder, the JV will still bear your name and you will have difficulty in distancing yourself from the JV. “We have nothing to do with that JV in China … have no idea what is happening in that JV”. “The JV in which you hold 80%, have management control and your name appears first – that JV?” “yes that would be the one”. Everything with a JV needs to be consensual … and this can take a long time and involve quite some pain.

… JVs with State Owned Partners are Most Difficult – the most frustrating project is seeking to liquidate or downsize a JV with a powerful SOE as a Partner. For all their faults you can normally guess what the private JV partner wants – agrees to liquidate, wants to sell you his share for a high price or buy you out for a low price. There is an economic rationale. With a large SOE not so much. SOEs do not quickly respond to economic arguments – they tend to prefer the status quo – the reasons are complex but typically trace back to no single person wishing to take responsibility for a problem. Compounding this problem is that SOEs have opaque decision-making processes making it extremely challenging to anticipate time lines or outcomes.

Lessons Learned

Bankruptcies are Rare – we have many companies approach us with the goal of letting their Chinese entity just go into bankruptcy. However, to date only two went into bankruptcy as the clients were not willing to cede all loss of control. In both cases the main reason was that the overseas investor was also essentially bankrupt. The bankruptcy requires the court to accept a bankruptcy petition which can often be difficult. Also once in bankruptcy control will pass to a court appointed administrator and the foreign investor will have zero input. For these reasons most clients that wish to close down their China operations have to actually inject further funds into the entity to pay off severance to the employees and pay suppliers.

Liquidation is Normally the Worst Solution – Closing down your business is unlikely to be a joyous occasion - there are no good options – only less bad ones. The best option is to rename the company, take back the IP and sell it off. For manufacturing companies buyers may be the JV partner, the local management (hmmm) or (surprisingly often) a real estate play. In the last 3o years the value of real estate in China has skyrocketed so that real estate can sometimes be a solution. The advantage of selling it off is clear – no longer your problem, you are distanced much more quickly from the process.

Downsizing is normally Preferable – Most closures are just to damn complicated to do in one foul swoop. If you have multiple facilities across China then it will be likely impossible to successfully one big bang liquidation. If you are heavily dependent on the China supply chain or you are the showcase foreign investment project in a remote area then it may be better to slowly ghost the Chinese suppliers and authorities by way of a step by step downsizing. By the time one client had reduced its business it was no longer a big deal to finally pull the plug.

Liquidation will take much, much longer than expected – even if you have a relatively simple WFOE in a prosperous part of China the liquidation will likely require 9 to 12 months. There will be a flurry of activity at the start – dealing with employees, suppliers, landlords and then a long period of relative low impact process. The main issue will be dealing with the tax de-registration as this is the last opportunity the local authorities have to extract their pound of flesh. Tax de-registration has been described as being similar to a colonoscopy but more intrusive and less fun.  Beware of consultants or lawyers that speak of expedited timetables. We missed out on a major part of a liquidation project because one of the Big 4 guaranteed that they could complete the process within 6 months. This was fully 4 years ago. Discretion means I do not want to disclose who they are … but it was not Deloitte, EY or KPMG.

Employees can be Naughty – it is understandable that employees react badly to hearing that the company is closing down. We have had cases of violence, sabotage, mass theft. My favorite was a retailer with over 700 employees, most of whom were female … and most of whom would become pregnant during the time in which the downsizing was announced and the liquidation occurring. There were three theories: 1) the employees were getting pregnant en-masse in order to benefit from PRC labor law protections and then be able to negotiate a higher settlement payment; 2) the regular travel by Brad from headquarters – part hero, part leader, all man resulted in 100s of pregnancies; and 3) my theory that they had all used the same ultrasound scan – an ultrasound scam!

Next Issue: China 2023 – My Company is Staying – What Questions should HQ grapple with?

Most international companies will not leave. The world may have become more complicated but unscrambling the omlette is more complicated still. Also, China is for many MNCs too big to walk away from … but they know China is changing and they need to change and also guard against new risks and grasp new opportunities.

Munich Visit               

I will be visiting with colleagues in Munich – 13 to 15 September – we are having drinks on us on the 14th – or if you want a more sober experience, I do have some slots available (especially on 15th as I extended due to unprecedented demand and then demand seemed to taper off – oh well) so send me an email.

Till next week,