A New Challenge for Multinationals in China: Mao-era Politics

September 30, 2013, 1:53 p.m. ET

A New Challenge for Multinationals in China: Mao-era Politics

The ambitions of some of the world’s largest consumer brands in China are colliding with an unexpected new reality: hardball Mao-era politics.

ANDREW BROWNE

The ambitions of some of the world’s largest consumer brands in China are colliding with an unexpected new reality: hardball Mao-era politics. Increasingly, say China-based Western business executives, lawyers and consultants, a drive against alleged corporate price-fixing and corruption that has ensnared some of the biggest names in the global dairy and pharmaceutical industries has taken on a harsh political—and antiforeign—edge.In August, six dairy companies were fined more than $100 million combined for price-fixing. The companies paid up and cut prices for their products, including infant formula. None of the dairy firms have contested the administrative fines, even though they have the right of legal appeal.

Regulators are also probing the pharmaceutical sector: GlaxoSmithKlineGSK.LN -0.70% is under investigation for alleged corruption. Glaxo has acknowledged that some of its senior China executives may have violated the law.

There’s more to come. Western auto makers and medical-device companies are bracing for a round of scrutiny, according to people in those industries.

So, has China declared war on multinationals? Such a judgment would be too sweeping. Few emerging economies are as open to foreign investment as China, and surveys of American businesses show it’s still an attractive—and profitable—destination for business, even though many investors chafe at ownership restrictions and forced technology transfers.

Yet the way price-fixing investigations have been conducted suggests that the business climate in China is becoming more hazardous across the board.

What concerns many Western business executives is not just that price-fixing investigations have concentrated on foreign companies—often accompanied by shrill denunciations of their corporate targets in state media. Individuals within companies and their networks are also being singled out. And, say lawyers and others, there are disturbing Mao-era echoes in the tactics employed.

One Western lawyer describes what he calls “inquisitions” of several of his multinational dairy and pharmaceutical clients by regulators.

“The typical gambit,” he says, is to summon the country heads to a meeting where they are handed allegedly incriminating internal company documents and told: “If you confess, we can show leniency.” The executives are then urged to “acknowledge your wrongdoing” by agreeing to price cuts, the lawyer says. To encourage compliance, the executives are told that their competitors have already confessed and agreed to lower prices.

Several dairy firms were spared punishment because they “carried out active self-rectification,” Xu Kunlin, an official at the powerful National Development and Reform Commission, told state television in August.

Such tactics are part of the playbook of political campaigns that date back to the Communist Party’s early years. And, in fact, that’s the inspiration for a new political style adopted by new President Xi Jinping as part of his effort to root out corruption. Last month, party highflier Bo Xilai became the most prominent domestic target of the anticorruption campaign when he was sentenced to life in prison.

In a country where many rules are often murky—deliberately so—and only intermittently enforced, foreign business executives say they are turning ultracautious on legal and compliance issues.

President Xi is pushing a populist agenda as he tries to shore up support for the Communist Party. Few issues stir the Chinese public as much as corruption and the high price of essential consumer goods and services, including medicine. Forcing down prices is an easy win. And regulators have a strong incentive to be seen as acting tough.

Besides, it’s a tradition in China to make an example of foreign companies to induce better behavior among Chinese firms. Unlike domestic companies, they have no bureaucratic protection networks, and allegations of impropriety—corruption, environmental neglect or labor abuse—elicit a quick response.

“You just attack the easiest targets,” says Scott Kennedy, director of the Research Center for Chinese Politics & Business at Indiana University.

But as the economy has slowed, the risk of domestic protectionism has grown. China is shifting its export and investment-led growth model toward consumption, a process that will produce both winners and losers. Foreign consumer companies with strong brands and a reputation for quality ought to be the winners. But expect state-supported “national champions” to push back aggressively, enlisting the support of their allies in the bureaucracy.

Western executives who have sat through a grilling by regulators “are terrified,” says the Western lawyer. The NDRC didn’t immediately respond to a detailed faxed request to comment.

In one episode in August, China Central Television paraded a detained British private investigator, Peter Humphrey, and his American-Chinese wife, whose company did some work for Glaxo. Dressed in a red prison smock, Mr. Humphrey confessed to using “illegal methods” in his business. “I want to apologize to the Chinese government,” he said in a monotone.

His crime, according to a Shanghai police officer interviewed by the network, was to invade the privacy of Chinese citizens by going after information such as property and travel records—the type of intelligence routinely solicited by Western corporations, law firms and hedge funds. Neither Mr. Humphrey’s family nor his lawyers have commented on the program.

To be sure, foreign companies in China aren’t blameless. Sarah Butler, who leads the China practice of international consultancy Booz & Co., notes that foreign generic drugs in China “are priced higher than you’d expect.”

Yet attacking foreign drug makers won’t fix the more fundamental problem of systemwide corruption within the medical industry. Chinese hospitals are forced by the government to charge below-market prices for basic services, leaving them with little money to pay doctors. The result: It’s now routine for doctors to take kickbacks from pharmaceutical companies to pad their salaries.

Indeed, without this kind of corruption, says Ms. Butler, “you wouldn’t have a health-care system. How would you pay the doctors?”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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