China's contaminated milk powder scandal, like its previous food safety problems, contains many lessons for foreign investors, as well as others. Those lessons also apply to foreign investment in other Chinese industries, and in other countries, too.
New Zealand's Fonterra Corporation, the world's largest trader in dairy products, has undoubtedly learned much from its 43 per cent ownership of a China venture with the Sanlu Group that became China's biggest producer of baby milk formula. Its Sanlu venture's sale of melamine-tainted products has led to horrific human suffering, financial disaster for the partners and further damage to China's reputation.
This latest food tragedy may make some foreign investors conclude that the risks of manufacturing in China outweigh the potential rewards. Yet, such is the allure of the China market, most multinational firms will probably want to maintain their interest. The challenge is how to do it better.
Fonterra's fiasco should stimulate foreign joint venturers in China to consider following the example of the many multinationals that have established wholly foreign-owned enterprises (WFOEs) there. Or, in situations where Beijing does not permit a WFOE, the foreign firm may seek to negotiate a dominant ownership interest and other arrangements that will allow it to control the joint venture's management.
If government policy or business considerations preclude it from controlling the venture, the foreign investor must review the adequacy of its participation in the day-to-day management. The investor should try to obtain new contractual guarantees from its partner. At a minimum, it must improve its knowledge of how its partner is running the operation.
As the Fonterra case illustrates, learning the truth is only half the battle. What, then, should the foreign investor do? Obviously, it must immediately raise any matter that threatens public health with relevant local officials, as well as its partner. But how long should it rely on unconvincing assurances that the matter will be properly handled?