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The perils of doing business in China without due diligence

Opinion

The potential profits from doing business in China are huge - but so are the losses, writes Luke Giles. Following The Social Creative's disastrous beer festival venture, he highlights where things can go spectacularly wrong.

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If you believe this article in The Economist, an Englishman in the 1850s famously said that if he “could add an inch of material to every Chinaman’s shirt-tail, the mills of Lancashire could be kept busy for a generation”. It is in that proposition, attempting to make money in China’s huge market, that many entrepreneurs have lost their minds (and fortunes).

Just last week we heard the news that Adelaide company The Social Creative, organiser of Fringe hub the Royal Croquet Club, lost more than $1 million on its ill-fated venture at China’s Qingdao International Beer Festival. Hindsight suggests it likely had poor advice and didn’t do its due diligence. It wouldn’t be alone.

The potential profits in the Chinese market, for everyone from small investors to multinational behemoths, are huge – but so are the losses.

Just look at Uber, which haemorrhaged almost $US1 billion per year before it finally gave up and sold its China operations to Didi Chuxing, the company that was its main rival in the country. In this case, it failed because its competitor was better, and buying market-share (through heavily discounted rides) turned out to be an unsustainable business model.

But plenty of others have failed through foolish mistakes. US home-improvement mega-franchise Home Depot, seeing no similar stores in China, thought the market was its to corner. What it inexplicably failed to take into account was that there was no DIY home-improvement culture in China: most Chinese live in apartments, work long hours and, due to low labour costs, simply hire a handyman when they need to make improvements.

But it isn’t just new market entrants that lose their way in China. Perhaps one of the best examples of getting into trouble was the Aussie company that made it big before it almost completely fell apart.

Bellamy’s, the Tasmanian family-run business turned billion-dollar company, had a meteoric rise based on surging Chinese demand for safe, reliable, foreign-produced infant formula. Much of this demand came from a “daigou” army – the Chinese shoppers who buy up big in Australian supermarkets and chemists, then post or carry back products to their friends and acquaintances at home.

Daigou is popular in China for the same reason that foreign-produced infant formula is: following a huge scare in 2008 in which a number of infants died after being fed with unsafe formula, Chinese parents lost trust in local brands and local distribution. Being able to purchase Bellamy’s organically produced milk formula from a trusted daigou seller quickly became a winner with Chinese parents.

Bellamy’s grew at 70 per cent annually from 2008-2013, went public in 2014, and saw its share price rise from a little over a dollar at listing to above $16 by late 2015. Soon after, it came seriously unstuck.

Where did it go wrong? It seems the company was over-ambitious and received bad advice. Rightly concerned that too much of its product was making it to China via daigou, a grey-market channel it didn’t control, it negotiated with a number of online platforms in China so that it could sell directly to Chinese customers. It marketed aggressively with these new online partners and sent large shipments to China.

This strategy backfired spectacularly, and in a manner it should have foreseen: Stock soon accumulated in the warehouses of Bellamy’s new partners, who responded by discounting, thereby undercutting the main daigou sales channel. Soon, daigou buyers started picking other more profitable brands; before you knew it the game was up, and $500 million was wiped off Bellamy’s share price. If it better understood the market, it would have avoided this mess.

Spectacular failures can be avoided more often than not through preparation, research and knowing your market

The Social Creative, which seems to have similarly misunderstood its market, budgeted for crowds of 7000 a day at its Qingdao International Beer Festival attraction the Royale Adelaide Club, yet only 700 materialised. If the entrepreneurs, or whoever was advising them, had been to the festival in 2016, they would have known the crowd estimates they were fed were heavily exaggerated.

We’ve also heard how The Social Creative was left holding the bag for power costs it was told would be waived. It sounded like a good deal – perhaps too good a deal. People often say that China is all about “guanxi”, the special relationships formed with friends and business partners over many years, and this trust ensures you don’t get ripped off. This is arguably true, but no relationship should prevent putting things in writing; contracts are just as important in China as anywhere else, as is knowing your business partners well.

Any business considering opening in a new market needs to do their due diligence, and this means double-checking information and assumptions.

Things go wrong in businesses all the time, but spectacular failures can be avoided more often than not through preparation, research and knowing your market. Here, China is no different than anywhere. You wouldn’t trust Joe Blow at the local pub on his word with a business proposition, so equally don’t trust Mr Li who you met at the airport.

For all the foreign failures in China, there have also been plenty of successes. The common thread among them is a good business plan, knowing the market, being prepared and having trustworthy partners.

China is a big market with plenty of opportunity for Australian businesses, but assuming Chinese demand will magically appear for any Aussie product we care to flog on their shore is undoubtedly a recipe for disaster.

Luke Giles is the business programs coordinator at the University of Adelaide’s Confucius Institute, and also sits on the committee of the China Business Network of South Australia. He is a fluent Mandarin speaker and spent a number of years in China running a live music bar.

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