China companies shouldn't jump too early or take on too much in acquiring foreign suppliers

Gasgoo.com: Now the auto parts suppliers in European and North American auto markets are experiencing a bankruptcy boom, with the financial crisis pushing more suppliers onto that road. Do you think it a good time for Chinese companies to acquire some of the businesses?

Bill Russo: The time we are in right now is pretty historic in terms of the development of the automotive industry. No one expected the global financial crisis could hit the industry as hard as it has. It’s creating economic problems for many companies, but it also presents opportunities for restructuring the industry.

Clearly there is a need, on the part of the European and North American OEMs and suppliers, to find additional sources of funding in order to keep their operations going, while the rapid growth of China auto market in recent years has provided Chinese companies more capacity to invest. However, there are real challenges in finding suitable partners. Partners in the west are not necessarily going to be compatible, for a lot of reasons, both from a technological and from a cultural standpoint. When a Chinese company invests in a western company, they need to know they are getting a partner that is committed to work in cooperation with them, and provides access to capital as well as technological development know-how.

Lenovo’s successful partnership with IBM’s PC business is largely a result of the compatibility in the two parties’ interest. Even though there are economic problems, you can work through those, as long as there is compatibility. But there is another notable example that does not work very well – SAIC’s acquisition of Ssangyong, where there was much conflict of interests. The two companies have very different agendas in terms of what they want out of a partnership, and they were not successful.

One thing the Chinese auto industry is trying to do is trying to get the domestic manufacturers, whether they are OEMs or suppliers, to improve their participation in the China domestic market. The Chinese companies are very new in the auto industry, and when they start to get involved in cross-border acquisitions with foreign partners, it tends to take a lot of management attention, and they can lose focus on doing the business that they originally intended to do. It’s relatively easy to do the deal, and relatively easy to come to an agreement, what’s much more difficult is the integration of the business of the newly merged company.

The other thing I think is important is the financial health of the organization on both sides. Before the deal is completed done, there should be thorough due diligence. Before completing the transaction, a lot of emphasis needs to be placed on evaluation of the target company that is to be acquired. The process of assessing the value of a target company is well understood in normal times. But these are not normal times. The reason why these companies are in trouble and looking for partners is because they have a fundamental problem with their business. When Chinese companies invest they assume a financial risk, because the company that is to be acquired may no longer be a viable company any more.

Now the question is: can they become viable, if they are bought into a business of a growing market like China? It could be a significant opportunity if the company is well integrated to the Chinese environment, but that requires a lot of work on post-merger integration. After the acquisition, the company needs to exist in the context of the newly merged company. I have the experience of being involved in such transactions and it’s never easy. When you get the companies together, you have all the cultural differences, all the different ways of thinking about the business……

Gasgoo.com: To acquire a financially troubled company in financial crisis is easier than to acquire the same kind of company in normal times? Can you specify more about the risks?

Bill Russo: It is definitely easier to get a deal done during a crisis, because acquired company needs help. You can get more done because in the times of crisis, there is a stronger case for action than in normal times. In normal times people get lazy, they don’t think they need to change. That certainly isn’t true now. I think there will be opportunities that come out of the crisis, but the risks are not insignificant. I would summarize the risks as:

1) Lack of synergy, where the companies are not complementary. When you bring two organizations together, you expect synergy to come out of that, which means you can eliminate duplication or find areas where capabilities exist in one organization that don’t exist in the other. There should be some synergy or complementary aspects of the organizations that are coming together.

2) Legal and political risks, such as anti-trust risks. If a Chinese company is buying a foreign company, will the government and regulators of the foreign country look favorably on the transaction? Will the public opinion of that country be favorable to the idea of a Chinese acquisition? If the deal is approved, another important factor is retaining the key people in the organization who are needed to ensure a successful integration. Their attitude toward the staying with the company will be shaped by the public opinion of the deal. If a lot of key people leave the organization after the acquisition, they will lose a lot of intellectual capital. Acquiring companies need to anticipate and manage these risks.

3) Financial risks. As I mentioned earlier, the investment needed to do the deal must be considered in addition to future capital requirements. The ongoing viability of the future business plan must be carefully evaluated.

4) Operational risk. If a Chinese company is to acquire international assets, they need qualified managers, who have experience in international business to manage a more global operation. Most Chinese automotive and supplier companies have only done business in the China automotive industry, so they will need to hire and develop people with multi-national experience.

5) Language, culture and values -- generally cultural risks. Most of the time, if there is a problem in a cross-border acquisition, it’s because of misunderstanding. The majority of issues that come up are areas where the communication isn’t precise, because people are not understand each other perfectly. So it’s very important to understand the language, the gaps, the differences in thinking and how a western culture interacts and communicates versus the Chinese culture. It is very normal, but sometimes it creates bigger problems because each side lacks an understanding or appreciation of the cultural differences.

Gasgoo.com: What kind of business is more suitable for Chinese companies to acquire?

Bill Russo: You have to do an assessment of benefits and risks. The benefits may be financial, or technological, or purely operational. Chinese companies today lack critical skills, and they likely don’t have the volume or the global reach needed to ensure their long-term participation in the global auto industry. If they lack a critical piece of technological know-how, acquiring a company that has that is a very good opportunity, provided that there is a clear pathway to retain the intellectual capital. So Chinese companies need to understand what capability gaps they are trying to fill and devise integration plans for closing that gap. They must also determine whether the financial risks of acquiring that organization is offset by the benefits of increased skill and a more complete product and technology portfolio.

It’s important to note that it may not be necessary to acquire an entire company. There may be part of the organization, a product line, a brand, or other assets available. So Chinese companies need to be very careful that they don’t jump too early and acquire an organization before it is restructured, or they don’t take on too much - especially the poor performing parts. You only need to focus on what you need.

Gasgoo.com: and M&A is not the only way of investing in a foreign company. So what do you think Chinese companies should do to take good advantages of the M&A opportunities and risks?

Bill Russo: China can play a role in helping restructure the industry; there are definitely opportunities there. But as I said, the risks are very high; especially if their intention is to operate those plants and continue to run these operations in the current configuration.

I think the Chinese government has tried to guide the Chinese auto industry toward focusing on restructuring its internal domestic market. The first priority is to build strong Chinese car companies capable of competing in the China domestic market. For any foreign acquisition, the focus should be on how the foreign acquisition helps improve the competitiveness of the Chinese companies primarily in the Chinese domestic market. The Chinese companies in 2008 had about 35% share of the total market with Chinese brands, that’s not enough to generate a lot economies of scale – especially with over 150 companies licensed to produce vehicles. So the question is how those foreign acquisitions can help the Chinese company or help the China auto industry improve its competitiveness, first in its own market.

Then the second thing they need to think about is how to select appropriate assets that can be effectively integrated into their operation. There have been some of acquisitions, such as Geely’s acquisition of London taxi and Drivetrain Systems, and SAIC’s acquisition of Rover that have been pretty successful. There are many opportunities both in the supply base as well as on the OEM’s side. But it should be a selective acquisition. Buying a whole company is difficult, but buying specific assets that the China auto industry needs increases the chances for success.

The third area I think they need to focus on is to build capacity to do the work of acquisition, and more importantly integration. Most of the Chinese organizations do not have a lot of experience in doing M&A, which is a process that needs to be understood and managed effectively. So it’s very important to retain and hire experts that understand how to do international acquisitions, and also how to manage the process of bringing those assets into an organization and effectively transfer the intellectual capital associated with the development of those assets.

About Booz & Company:

Booz & Company is a leading global management consulting firm, helping the world's top businesses, governments, and other institutions.

In 2008, we separated our operations from our U.S. Government consulting business, which retains the name Booz Allen Hamilton. We continue our work with businesses, governments, and organizations around the world, now under the name Booz & Company.

Since entering the Greater China market in the 1990s, Booz & Company now has offices in Shanghai, Beijing, Hong Kong, and Taipei, serving both multinationals and local companies, in the private as well as public sector.

About Bill Russo:

Bill Russo is the Founder and President of Synergistics Limited. He has extensive experience in the automotive and electronics industries, with more than 25 years of experience at driving strategy and performance improvement in Fortune 500 environments.

In his role the first Vice President of North East Asia automotive operations, Bill successfully negotiated and secured government approval for 6 vehicle programs within a 3-year time period with 3 different Asian partners. In this time period, he launched a regional holding company as well as 2 distribution companies. Bill oversaw the industrialization of the first Chrysler and Dodge-branded vehicles in Asia.

As head of Product & Business Strategy, Bill led the integration of 3 key planning functions: strategic planning, long-range product planning and the capital investment plan. He had played a major role in achieving a major business turnaround by strengthening operational transparency through deployment of a system-wide balanced scorecard. His work earned international acclaim and was featured in leading business journals (Harvard Business Review, Controlling magazine).

As a Business Transformation Consultant, Bill has led global cross-functional multi-disciplinary teams in the identification and implementation of business improvement initiatives throughout key value streams and functions. He holds a US Patent for his innovative efforts towards reducing automotive New Product Development cycle time.