How US companies utilize Guanxi in China

Table of Content


If language is at the center of the Chinese culture, then social relationships are at the core of Chinese society. Nearly all the social interactions in Chinese societies can be understood in terms of guanxi. Most of the studies of guanxi or Chinese business networks have either explicitly or implicitly established that such connections are extremely important in business affairs. It is seen that if there is guanxi between two businessmen, each seems willing to grant more favorable terms to the other in business affairs so that deals are more easily struck between them. Guanxi requires deep commitment and a long-term investment of time and energy, and like all social relationships has the potential to reap considerable returns. Nearly every aspect of Chinese business interactions is affected by guanxi. The concept is alien to US companies, who go mostly by legal right and wrongs and contractual obligations, and do not really go overboard to cultivate personal relationships. This paper studies the importance of guanxi and offers ways in which US companies can utilize guanxi in China.

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1                    Introduction

Interpersonal relationship or Guanxi is one of the major dynamics of Chinese society. In fact the principle of Guanxi has been a pervasive part of the Chinese business world for the last few centuries. The concept binds literally millions of Chinese firms into a social and business web. Guanxi is hence recognized as a key business determinant of firm performance, and the lifeblood of both the macro-economy and micro-business conduct. Any business in the Chinese society inevitably faces guanxi dynamics. It is not an exaggeration to say that no company can go far unless it has extensive guanxi networks in this setting (Luo, 2007, p. 1).

“The Chinese world guanxi or关系, literally refers to the concept of drawing on connections in order to secure favors in personal relationships” (Luo, 2007, p. 2). That is to say guanxi means “interpersonal linkages with the implication of continued exchange of favors” (Luo, 2007, p. 2). It forms an intricate, pervasive relational network which the Chinese cultivate energetically, subtly, and imaginatively. It contains implicit mutual obligations, assurances, and understanding and governs Chinese attitudes towards long-terms social and business relationships. Guanxi is more than a friendship or simple interpersonal relationship, since it includes reciprocal obligations to respond to requests for assistance. Unlike inter-firm networking in the West, however, this reciprocity is implicit, without time specifications, not necessarily equivalent, and only socially binding. The basis for guanxi establishment can be defined as a “commonality of shared identification amongst two or more people”, and can be achieved through shared experience or is ascriptive i.e. based on kinship of some kind. However, the basis for guanxi does not imply that such an alliance with develop. The existence of a base only paves the way for an opportunity to establish guanxi. Guanxi is also dynamic and certain social bases for guanxi can be transferred. Many foreign companies use this tactic to initiate guanxi in China (Luo, 2001, p. 53-56).

Researches have found that guanxi is one of the critical factors for success in Chinese business environment and that there is a direct correlation between a corporation’s level of guanxi connections and its domestic sales growth in China. Since, guanxi is widely practiced, there is no doubt that any US firm, whether an operating business firm or an auditing forms, will directly under the exposure of guanxi. However, it has been found that guanxi is a factor that often puzzles foreign investors, particularly from the West. Hence, it is important to come up with frameworks for the strategic management of guanxi in Chinese context, covering the formulation and implementation of guanxi-based strategies and their evaluation. Guanxi is considered so important that some researchers maintain that one cannot get any success chiefly in the long terms without it. Virtually every major success story involving foreign companies in China involve the building on guanxiwang i.e. networks of relationships. Companies like IBM China and Shanghai Volkswagen devoted literally years to this process (Vinten, 2005, p. 230). This paper focuses on how US companies utilize Guanxi in China.

2                    Purpose of Study

.The purpose of the study is to evaluate how US companies utilize Guanxi in China. Since foreign companies do not have a local base, and are also extremely distant culture-wise, development and maintenance of social relationships is not often easy because of many barriers. These issues will remain the same for any firm in US deciding to enter the Chinese economy regardless of its operations. This paper evaluate how various companies use this concept to come up with a framework that could be used as a realistic reference guide for foreign firms deciding to operate their business in China.

3                    Literature Review

When US based firms enter China they encounter a world where personal relationships determine much of what is goes on, and where every individual has his or her own web of acquaintances and connections, and where each individual’s web is one among thousands of intertwining nets of relationships of varying degrees of intensity, many of which are invisible to the outside observer. Basic guanxi relationships are shown in Figure – 1 in APPENDIX.. Guanxi can be viewed from two perspectives as is shown in the Figure – 2 in APPENDIX. From one point of view, one stands outside the interlocking rings and must establish several connections to reach the center. Form another vantage point, one is already at the centre of one’s own guanxi network, and the interlocking rings surround him. Guanxi is not about gaining access to a network, but about cultivating and expanding and nourishing one’s own network (Chen¸ 2003, p. 50).

The concept of guanxi has been researched by several researchers. One of the major studies on guanxi was conducted by Mayfair Yang who used extensive interviews conducted over a decade to conclude that guanxi and guanxi practice are key to understanding all manner of social relations, including economic relations in China. She made the distinction between guanxi and guanxi practice – the former being social relationships that people develop through normal interactions, while the latter being the deliberate and strategic cultivation of social relations. The concept became extremely popular after the reform period, where people with commercial intents deliberately and strategically cultivated social ties for economic gains for the purpose of circumventing laws, policies, and regulations which did not suit them. The existence of an extremely strong and interfering government and bureaucracy has prompted most of the foreign companies to follow the suit, though the reason for cultivating guanxi is not so much to bypass laws as to make the process simpler and faster (Gold, Guthrie, Wank, 2002, p. 79, 80).

In 1988, Bruhnner and Koh studied a sample of American and Chinese negotiations. They noted the impact of guanxi in China after the implementation of the Chinese open-door policy in the year 1979. The underlying concept of guanxi found was the traditional Confucian concept of the group taking precedence over individual, and the term subtly defines the moral code. Brunner further found that the development of a guanxi web depends up on whether some attributes of a guanxi base exist among individuals, and extent of guanxi cultivation depends up on an individual’s position within a framework based on some social unit classification – may be family, work units and social network. Brunner et al. in a further research conducted in 1989 indicated that a major factor motivating the efforts to form guanxi as the prevalent shortages of everyday necessities, housing, and goods, so that the Chinese obtained guanxi ties to obtain them. Another reason was the primitive communication system and the infamous bureaucratic maze, which made guanxi literally as a currency to complete ordinary transactions. In addition to this guanxi has also been analyzed in several western marketing literatures as linking within a network. The network approach has four major perspectives: networks as relationships, structures, position, and process (Wong, Leung, 2001, p. 5-6).

In 1996 Yeung and Tung researched the critical factors that contribute to business success in China by asking managers of 19 diverse international companies to rank 11 key factors. They found that guanxi was the only item consistently chosen as a key success factors. Yeung and Tung’s research pointed towards the weight carried by guanxi on the long-term business success as compared with any other business variable. A further research in 1997 by Luo found that there was a direct correlation between a corporation’s level of guanxi connection and its domestic sales growth in China. Hwang and Baker in 2000 proposed that guanxi results in better cost efficiency in doing business as well as lower credit costs (Vinten, 2005, p. 230).

Based on an empirical analysis of the survey data collected between 1966 and 1997 containing 127 firms, Peng and Luo were able to deduce several results. The first result was that it proved that guanxi with other managers and government officials are both significantly correlated with sales growth. Overall, guanxi networks with government authorities have a stronger linkage with performance than ties with other businesses. The second result was that, while guanxi is positively related with sales growth, it is not the case with profit growth. The linkage with sales growth was evident even after a regression analysis of the data was carried out by controlling for ownership type, firm size, and industry effect. However, in case the firms had a guanxi with the government officials, the profits too were significantly affected, which was not the case with the guanxi with other managers in different firms. An important result that came out after the study was after performing the multivariate effect on the overall performance. The managers viewed product quality as being the most important factor followed by guanxi, terms of payment, delivery, pricing and at last advertising. All these six business determinants have significant impacts on the firm performance, which suggests that guanxi is important but not a sufficient condition for overall performance enhancement (Vinten, 2005, p. 231-234).

Luo’s study in 1997 conformed that different foreign businesses in China with different investment traits have different relationships between guanxi and performance. A reason for this is probably due to the difference in the way a firm utilizes guanxi. A firm enhances its performance by benefiting from the guanxi network it has established. In essence, this network constitutes a firm’s core competency and distinctive competitive advantage that can lead to high performance for the firm. The ultimate realization of guanxi potential depends up on the application and operation of several business variables in which guanxi is embedded. In strategic management literature several business strategy variables are observed to impact firm’s performance, most common of which are firm size, pricing, advertising, and R&D intensity. Among these variables however, the size of firms and R&D intensity are not related to guanxi, because they represent the firm’s economy of scale or differentiation and do not rely on contributions from other organizations or people outside the firm. Advertising and pricing too are similarly not tightly associated with guanxi, since the outcome of these tow variables is predominantly determined by the firm’s own strategies or policies (Luo¸2007, p. 190-193).

However, in case of doing business in China two other business variables are considered to be extremely important: sales force marketing and credit liberalizations, and these two factors rely heavily on guanxi. Sales force marketing usually relies on partnering forms and has become a popular and effective marketing means. Even though a particular sales person may not have a direct guanxi network, he or she can choose the members of indirect social network such as classmates, friends, and colleagues. In has been found that guanxi based personal selling can produce impressive marketing results event when the product’s attributes are not competitive. The credit-granting practice is to some extent a reflection of the culture. Sellers tend to do their utmost to avoid embarrassing customers who may be temporarily unable to pay. Maintaining extensive guanxi networks in case of buyers’ means that they have access to higher extension of commercial credit, while in case of sellers it means that they can expect to achieve higher performance in terms of domestic sales growth. To validate these issues, Luo et al. conducted a survey in Jiangsu province in 1995 consisting of a questionnaire where managers were asked to scale the above mentioned business variables based on their relationship with guanxi. The results were consistent with the proposition that sales force marketing and credit granting had the highest level of involvement with guanxi, whereas the other business variables had a fairly low level of involvement (Luo, 2001, p. 110-115).

China has world’s largest inflow of FDIs most of which are from US. The most common entry mode is the joint venture mode which is positively correlated with venture performance and significantly interacted with guanxi. The joint venture entry mode facilitates the positive role of guanxi in influencing the performance of a foreign based enterprise. The selection of an appropriate local partner is an essential way to adapt to the indigenous environment and achieve the benefits of the guanxi. Another important factor affecting the function of guanxi in the foreign based enterprise performance is the cultural proximity. Chinese commonwealth country of investment origin positively moderates the association between the guanxi and the performance of the foreign based enterprise. The length of operation not only significantly facilitates the relationship between guanxi and accounting-based and market-based performance measures, it also affect’s the foreign venture’s profitability directly. This proves that guanxi is developed and learned over a period of time and that guanxi is accumulative in nature. However, the role of guanxi in the foreign venture is not dependent on the asset size of the firm since it is dependent on the organization structure, which is essentially similar to what is being followed in the home country (Luo¸2007, p. 190-193).

4                    Present Study hypothesis

Corporate interaction takes place in a mixed system of market economy and guanxi exchange, and also to an extent through Chinese government authorities. The state economy can be excluded while considering the US based firms because US firms consider their importance to be less, which is expected to decrease in years to come. The market and guanxi system have not been properly integrated. Hence, guanxi becomes one of the two exchange systems within which foreign firms can perform business activities, choosing a pure market oriented business strategy is not optimal especially in case of a closely monitored economy like China. The consequence is that the foreign based companies would fail if they applied market based strategies only, a disturbing issue (Yeung¸ 2006, p. 111-113). Empirical evidence too corroborates that those strategies that insufficiently take guanxi into consideration have a higher rate of failure. Analyzing a survey taken in 1995 by the Economic Intelligence Unit, Wu in 1999 reported that 44% of the companies suffered losses from their overall operations in China. Moreover 36% of the ventures did not yield an operating profit. A similar survey by Hong Kong Bank of East Asia reported that 22 of the 53 companies surveyed were unprofitable (Langenberg¸ 2007, p. 9).

The importance of guanxi being established, the next stage is to see how guanxi can be utilized. While extremely experienced people can intuitively give answers to the various issues, the scenario is extremely complex. As not prescribed instructions exist, it is indispensable that repeated researches are conducted about the use of guanxi, both success and failure, by different companies. The express purpose of this research is to address this particular issue. Chiefly the research aims to provide exploratory empirical ideas and some evidence that guanxi is important while choosing partners and that origin country of FDI is important while establishing guanxi.

5                    Confirmation of hypothesis

The examination of effectiveness and efficiency of guanxi-based business strategy involves a large amount of theory. Analysis is particularly challenging for the researcher because it involves different methodological perspectives and different levels of aggregation (Yeung¸ 2006, p. 111-113).

5.1              Effect of partner

The choice of partner is likely to influence the degree of adaptability of foreign investment to local environment and business practices. As a result, the linkage between guanxi and foreign business performance can be affected by the mode of entry. Foreign investors can opt for either joint venture i.e. equity-based or contractual or wholly foreign-owned subsidiaries as an entry mode upon entering the Chinese market. Although the wholly foreign-owned subsidiary mode has been gaining popularity in recent years, the joint venture remains the dominant mode of entry and accounts for more than 50% of the total value of actual FDI in China. In light of this data, the selection of a local partner is of fundamental importance to foreign investor. Indeed, when a foreign firm enters a host country in which the cultural, political, and economic systems greatly differ from its own, it is more likely to cooperate with a local partner, which has already developed specific skills and advantages that are very costly, if not impossible, to duplicate by a foreign firm. The foreign investors who have local partners are more likely to have better access to powerful Chinese guanxi networks than any others. These joint venture advantages can be reflected in cheap and reliable material supplies, market access, preferential tax treatment, low land rent, priority in obtaining infrastructure services, and the provision of assistance from the authorities when problems arise. In light of these considerations, the relationship between guanxi and foreign-invested enterprise will be stronger if the partner chosen has excellent and relevant connections (Luo, 2007, p. 155-160).

Example – HP China Medical division is a joint venture of HP medical group and china National Corporation of Medical Equipment Industry. It was formed in 1997, and provides medical technology designed specifically to meet the needs of doctors, clinics and hospitals in China, and eventually in other emerging markets of the world. The creation of the division reinforces HP’s commitment to the Chinese market and will allow HP to locate design and marketing teams to meet the distinct needs to China’s medical professionals and provide the resources and independence necessary to fulfill the Chinese market. In addition to entering the market via a joint partner, HP has also established a very large and intricate guanxi network. HP is a significant contributor of China’s Sustainable Development Networking Program SDNP, by supplying a broad range of equipment, software and services designed to meet the need for a high-performance network infrastructure which is robust, scalable and easily managed. In addition to this HP’s analytical instrument division is also a part of a joint venture with China, with he actual design being done in the country, which proves the company’s commitment towards establishing a business. These are all a part of the HP’s donation towards Chinese development, which has had an extremely positive impact upon its sales infrastructure in China. The result has been satisfactory as HP is one of the top US companies with their biggest stakes in China (Chen¸2003, p. 232).

5.2              Effect of origin

FDI in China mainly originates from two sources: Chinese community investors and Western multinationals. Although more than 40 countries form all over the world have direct foreign investments in China, about half of the total FDI in the country has come from the Chinese community territory – Hong Kong & Macau, Taiwan, and Singapore. One primary factor contributing to this situation is the cultural proximity between these business people and their Chinese counterparts. The Chinese commonwealth area nurtures a network of entrepreneurial relationships and an array of political and economic systems that are bound together, not by geography, but by shred tradition. Guanxi-based business dealings are not foreign to investors from this area. Indeed, for many generations, emigrant Chinese entrepreneurs have been operating comfortably in a network of guanxi, laying the foundations for stronger links among businesses across national borders. As a result, an interconnected yet potentially open-system has arisen, which provides a new market mechanism for conducting global business. Through well- established guanxi networks within China, forein investors form Chinese commonwealth territories more readily gain access to and benefit more from inside information, scarce resources, and access to controlled industries as opposed to other foreign investors. Thus, the relationship between guanxi and foreign invested enterprise performance will be stronger than those for non-Chinese commonwealth origins (Luo, 2007, p. 161-163).

While there is no doubt that many western companies have developed their own guanxi in China, usually foreigners are often at a disadvantage in building and developing guanxi due to language and cultural barriers in comparison with local and ethnic Chinese. The liability of foreigners propels the costs of guanxi construction and difficulties of guanxi cultivation. Hence, hiring local people who possess both necessary skills and useful guanxi helps the companies to fulfill their requirements. Both western-educated Chinese and Chinese immigrants are hence a valuable asset to a company seeking to do business in Mainland China. It is even more helpful if such people have kept up their social and cultural relations in Asia. In fact many companies have entered the Chinese market through bicultural third parties – usually Asian-American employees or consulting companies. Researchers also suggest the western companies operating in china should conduct guanxi audits in order to assess the strengths and weaknesses of their various relationships and to cultivate or nurture important links with outside stakeholders such as customer suppliers and government bodies (Chen¸2003, p. 236-240).

6                    Managerial Implications

China is being increasingly regarded as one of the most likely countries to become the largest economy in the world, in the years to come. The country’s growth rate stands at an enviable rate for the past decade. This is largely due to the pragmatic economic reforms and its unabated opening to the outside world. In the course of economic development, both local and foreign, are re-engineering and restructuring the organization in an effort to pursue realistic strategies and accommodate firm’s strengths and weaknesses to environment where industry and market structures are being drastically transformed and government policies frequently change. The change has brought about the interest of more and more foreign companies, who are keen on taking the advantages the country offers for companies setting up their business. However, the culture of the west is completely different from the east, and China has just emerged from a period where the government tightly held all the privileges, in fact still does. This means that the rules are not always as clear as they should be or even what they appear to be. Hence, cultivating local ties is extremely important. The purpose of this paper is to present the importance of such ties, which are so important that they have a name attached to them – guanxi.

Guanxi based business variables have a profound and favorable impact on the accounting and marketing performance of the Chinese firms. In other words, high performance is a positive function of good guanxi. The Chinese build the relationship and, if successful, transactions and profits will follow whereas Westerners believe that one should build transactions and if they are successful, a relationship will follow. As an example MacDonald’s was evicted from a central Beijing building after 2 years, despite having a 20 year contract, simply because the newcomer from Hong Kong had strong guanxi with the Chinese government, whereas McDonald’s has disregarded to maintain its own. This difference underlines many of the failures of foreign venture formation and operation in China (Langenberg¸ 2007, p. 9). This fact is pointed out by some of the statistics that were mentioned earlier in the paper.

As is mentioned earlier Guanxi is a necessary but not sufficient condition for form success. Despite the conventional wisdom suggesting almost unlimited benefit from guanxi, managerial tied alone do not account for all performance variations. This suggests that, while managerial ties are important a firm also needs to have quality products and services in connection with appropriate payment terms, efficient delivery, and the right pricing strategy, in order to perform well in China’s emerging economy. US companies do not really have to worry about these aspects, as most of them have quality of money, as an ingrained principle. The services too are efficient, which has been responsible for the success of the large number of US companies and their products in the various foreign markets. Hence, the main concentration for the US firms would be to concentrate on guanxi ties. An underestimation of the importance of managerial ties may reduce the firms’ ability to preempt opportunities and expand in the market. An overestimation of the role of managerial ties may make the firm vulnerable to contextual uncertainties and difficulties in responding to changes in industrial competition and market demand. Culturally, the propensity of Chinese managers to rely on informal ties is very high; hence this is the prevalent and general business practice in China. However, many theorists have also argued that this propensity is not just because of a tendency to be informal but also due to the failure of hierarchy and market based government structures. As a result, a network-based strategy emerges, which is neither hierarchy nor market. Hence US companies opening up a venture in China need to cultivate guanxi to get things done, which would no doubt have a direct influence on the company’s overall performance.

The section starts with the statement that guanxi is not essential or a guarantee for success, but in Chinese business environment, its absence usually leads to failure. He study concentrated on the two important ways how US companies can utilize guanxi in China – by having a local partner, and by having managers or coordinators who are basically from mainland China. Policy makers and officials in China and other emerging economies have been suggesting that they would call for the elimination of corruption, but they themselves are so much embroiled in the bureaucratic maze that it is difficult to expect anything radical in the near future. Hence, this study also showed that managers attached extremely high importance to their ties with the government. As long as the boundaries between the state and the firm remain blurred, managers will always have the incentive to cultivate ties with the officials.

7                    Conclusions

Although managers all over the world devote a considerable amount of time and energy cultivating interpersonal ties, in China the reliance on the cultivation of personal ties or guanxi is extremely higher. Building guanxi centers on the notion of networking. As a jargon use din business, networking means knowing the right people and making connections to accomplish individual and organizational goals. Managers in firms cultivate guanxi with other managers in different businesses as well as with business officials. These ties act as lubricants in exchange relations which serve to reduce transactional complexity, time and ultimately cost. Guanxi has a direct impact on the market expansion and sales growth of firms in China by affecting resource sharing and social, economic and political context in inter-firm interactions. Superior ties help firm’s infrastructure access, distribution arrangements, wholesale networking, and even project location selection. From all this it is extremely clear that any US firm deciding to open its operations in China needs to have either extremely good guanxi or should either hire consultant or have a joint partner whop has such dealings. All the successful firms in China have acted upon this principle, which though is extremely hazy to have a reference framework yet is tangible enough to forge and maintain.

8                    REFERENCES

Chen MJ, (2003), “Inside Chinese Business: A Guide for Managers Worldwide”, Published: Harvard Business Press, Boston, Massachusetts

Gold, Guthrie, Wank, (2002), “Social Connections in China: Institutions, Culture, and the Changing Nature of Guanxi”, Published: Cambridge University Press, New York

Langenberg EA¸ (2007), “Guanxi and Business Strategy Theory and Implications for Multinational Companies in China: Theory and Implications for Multinational Companies in China”, Published: Springer, New York

Luo Y, (2001), “Strategy, Structure, and Performance of MNCs in China”, Published: Greenwood Publishing Group, Westport, Connecticut

Luo Y, (2007), “Guanxi and Business: Asia pacific Business Series – Vol.5”, Published: World Scientific, Danvers, Massachusetts

Tsui AS, Gutek BA, (1999), “Demographic Differences in Organizations: Current Research and Future Directions”, Published: Lexington Books, Maryland

Vinten G, (2005), “Managerial Auditing Journal: Financial Regulation”, Published: Emerald Group Publishing

Wong YH, Leung TK, (2001), “Guanxi: Relationship Marketing in a Chinese Context”, Published: Haworth Press, New York

Yeung HWC, (2006), “Handbook of Research on Asian Business”, Published: Edward Elgar Publishing, Northampton, Massachusetts

9                    APPENDIX

①      Bases of Guanxi (Tsui, Gutek, 1999, p. 120)

②      Perspectives of viewing Guanxi (Chen, 2003, p. 51)

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