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Opportunities & Challenges to Joint
Ventures in Vietnam
A Study Of the Origin Of A Basic Problem: Lack Of Trust
by Peter N. Sheridan
Identifying a problem is often the first step in finding a solution. While no solution is offered at present, we have ascertained the identity some major problems. A task force of foreign invested enterprises met to discuss the opportunities and challenges of joint ventures. Each individual, and his/her company, has considerable experience with joint venture formation and operations, both in Vietnam and in other nations.
The conclusions drawn from that study are:
(1) Joint Ventures between Vietnamese and non-Vietnamese companies can be good investment vehicles provided the parties reach a real (not just an apparent) agreement, and real (not just apparent) trust can be established between them. In the event of a breakdown in trust, there will be a commensurate breakdown in the agreement. There must be a requirement for compliance or the joint venture will fail; and
(2) A joint venture is based upon an agreement where the parties are in accord and concur on the essential elements, and where there is mutual trust, meaning each party accepts his own responsibility to meet agreed commitments that the other can depend upon. Mutual trust is earned (not given) when performance warrants it. Trust builds upon itself.
Reasons for the failure of Joint Venture (JV) enterprises in Vietnam include a loss of compatibility (as when one partner can no longer meet the expectations or demands of the other), and frustration of purpose, such as the development of an unexpected conflict of interest (as where one partner individually or in concert with others competes with the JV enterprise).
Another underlying reason why many JVs do not succeed, the one this paper addresses, is the absence or the breakdown of trust between JV partners. This paper explores trust, its formation, and its breakdown, as a key element in the success or failure of a joint venture enterprise.
We intend this paper to help those interested in forming joint venture enterprises to understand the problem and identify paths towards solutions. Paths towards building and sustaining trust that we suggest include: (i) increased communications and consultations between foreign investors and government authorities, and (ii) an education campaign to help both sides understand their respective expectations and limitations.
The Absence or the Breakdown of Trust. The belief of many Vietnamese that Vietnam is the ideal location for investment due to its natural beauty, bountiful resources, literate & talented people, and otherwise ideal conditions, seems to come in part from the completion of a 2,000 year struggle to achieve freedom and independence, more than the commercial and economic reality of doing business in the world market.
This fundamental error seems to have led the State to a restrictive outlook on growth, and even a fear of economic take-over by outsiders, thus driving a strong protectionist position in many of the States dealings with investors.
However, recent world economic history (Japans investment in America is only one example) demonstrates that foreign investment does not rob the host nation of its sovereignty. Rather, local economies flourish from foreign investment when the investor economies are rising. Conversely, the host nations are able to acquire the foreign developed properties at a fraction of the original cost when the investor economies decline.
Protecting the State sector reduces business opportunities for both domestic and private companies to the point where economies of scale needed for international standard business usually cannot be achieved by the private sector in Vietnam.
As a result of limited opportunities, the domestic private sector is not growing quickly, and foreign direct investment finds better opportunities in other countries.
Another negative consequence of protectionism is that State companies are supported regardless of whether they are efficient or not. Ultimately this builds weaker indigenous companies, not stronger ones.
In order to create the strongest economy, AmCham urges the Government to consider a policy of equal opportunity for all sectors state, private, and foreign. This is what we mean when we call for a "Level Playing Field". We understand that an open market will probably enable foreign companies to win a large market share, but their capital and know-how will also stimulate economic growth for everyones benefit. By Leveling the Playing Field, Vietnam will be able to revitalize its domestic and foreign private sectors and build an economy which is more competitive with its vigorous regional neighbors in ASEAN and elsewhere in Asia.1
Trust is the basic building block of successful partnerships. Parties who do not initially trust each other are yet able to achieve comfort (and build trust) when each at a minimum upholds his investment commitment.
A long standing complaint by the State, indicative of the break-down of trust, is that foreigners dont pay-in their hard currency fast enough, send outdated and less valuable machinery & technology to the JV, and overpay foreign staff. Each complaint leads to disputed refutation, and even more challenges and charges. Each of these initial complaints by the State is founded on the principal that the Vietnam State-owned partner has previously contributed fully and fairly its own share to the JV. However, this is not supported by the facts as discussed below.
Additional complaints against JV partners concern foreign-driven JV management and operational matters. These include wasting money and other resources "unnecessarily" on advertising, marketing, and foreign salaries, and then burdening the JV enterprise with expansion by incurring "unexpected" additional debt.
However well intended, these complaints are indicative of fundamental misunderstandings of the operations of a company in a market economy.
In the context of Joint Venture opportunities, the long-standing (but recently changing) requirement of valuing the domestic component at a mandated minimum 30% of the whole, without regard to actual value of the contribution, creates a burden on a JV from its inception.
Speculators in the early days of Doi Moi willingly accepted entry barriers. These include (i) an inflated valuation of domestic capital contribution based upon artificially high land use fees, and (ii) the need to service a huge initial debt. The early speculators tried to "level the playing field" by withholding cash and by importing less valuable machinery and technology.
Subsequent, more solid, and-long term investors did not follow that path. They realized that the field could not be leveled and either terminated their JVs or converted them to fully foreign owned.
A protectionist concept of a minimum domestic capital contribution drives the State to limit Total Legal Capital to the minimum permissible, often a mere 30% of Total Investment Capital. Given the poor state of skills and technology in Vietnam, a false picture of total investment is given, which itself becomes a cause of the inability of a new JV enterprise to thrive, or even to survive.
With a minimum Total Legal Capital and a minimum State contribution, burdens are place on a new JV to both (i) service a large debt (up to 70% of Total Investment Capital) and (ii) pay land use fees (rent that grossly exceeds actual market value) in excess of the States contribution.
Consider a new enterprise with (for example only) a need for hard currency in the amount of $10 million. As Total Legal Capital must be at least 30% of Total Investment Capital, Total Investment Capital is driven up to $14.3 million ($4.3 million will be Total Legal Capital).
Where the State contributes land only, the States 30% share is repaid over the licensed term in the form of State-inflated rent rates. The foreign investor is expected to contribute $3 million in cash and state of art machinery & technology, making up its 70% contribution.2
One result is that the new JV enterprise is thus compelled to borrow $11 million in hard currency, or $1 million more than its initial hard currency needs. That may be good for the short term needs of the State to accumulate hard currency, but it is a near disaster for the economic survival of a new JV enterprise.
It is fair that Vietnam places land in three separate categories. However, to the extent that the land use rent assigned by the State is driven by the size of the total investment and not the net present value (or even actual local market prices), a second burden is forced upon a new JV. To be fair, the value of land contributed and rents paid should be at actual market value.
However, in most cases, the assigned "international" value used in determining land use fees for foreign invested JV projects is multiples above actual market value in Vietnam. This method of valuing land use is historically based upon comparisons with truly international cities such as Hong Kong, Tokyo, Seoul, and Singapore. Given the relative absence in Vietnam of skilled labor pools and the existing low levels of infrastructure found here as contrasted with such cities, international valuation of land is a fiction that cannot be economically justified, much less supported by a new JV enterprise.3
The State sets land use value by decree, not by allowing free market forces to determine the fair market value of the rent. Such elevated rent over the term of the license, to the extent that it exceeds the States minimum contribution, is the second burden on the new JV enterprise. It also makes a fiction of the States position that the right to use land is a capital contribution.4
The State-elevated land use fees thus artificially inflates the actual value of the Vietnamese contribution of even its 9% minimum "contribution" to the total investment capital. This places a burden upon the JVs economic performance with the need to pay interest on a debt of 70% of total investment capital plus land use fees in excess of the Vietnamese partners "contribution."
There is also a burden placed on the foreign investor who is yet expected to pay its full share (21% of total investment capital) in hard currency and state of the art technology & equipment.
The breakdown in trust: (i) in the cold light of a post-licensing economic review, the actual value received by the JV in the form of the contribution by a State company is not accepted by the foreign investor at its assigned value; (ii) the land "contributed" carries a burden for the JV to pay rent; (iii) the land contributed cannot be mortgaged as the worlds banking community does not recognize the States arbitrary high valuation and the relatively short-term lease granted by the State; and (iv) interest paid in servicing the huge debt on the domestic or international market is not deductible from taxes due to the State.
Foreign investors should be aware of these start-up barriers and the difficulties in proving initial assumptions before they reach "agreement." However, if early investors were aware, it is likely that the barriers were either not well understood, or they were ignored in the mistaken belief that the barriers could be overcome without difficulty.
Nourishment and growth. There is a continuing need for cash to be paid into all new enterprises. Early, and often substantial, reinvestment is necessary to make any new business strong. One feeds a healthy supply of nutrients to help make cash crops, farm animals, and small children grow in their early development stages. In the same way, substantial, long-term foreign investors who want their local companies to grow strong also need to feed cash into a new enterprise for it to grow strong with a sufficient share of its market sectors.
However, Vietnamese JV partners and the State do not often acknowledge or accept the need for early reinvestment by foreign invested JV companies. Both State-Owned and even private Vietnamese companies instead seek an early distribution of gross receipts.
Equal Pay for Equal Jobs. A key economic factor becomes a circuitous emotional debate when the State argues that "directors and staff, performing the same job, working as hard as the foreign counterparts, get paid less that foreign workers."
It is recognized that education, work experience, outlook and knowledge of business culture helps to build confidence of executive management in their employees, managers, and directors who have similar backgrounds. Workers, managers, and directors with equal education, work experience, outlook and knowledge of business culture, performing similar jobs, generally get paid similar, but not always equal, wages.
While desk and field work may appear to be similar, there is often no equality (or even similarity) between Vietnamese and foreigner workers, managers, and directors in any of these important elements of employment.
Additionally, Vietnamese live on a dong-based economy where costs of basic needs (housing, meals, transpiration, utilities, and services) and recreation needs are priced on the local costs. As long as the State and private Vietnamese retain the fiction that foreigners should pay more for the same goods and services, it is fallacious reasoning that foreigners should not also be paid more.
Unlike many domestic Vietnamese who seek overseas work that pays multiples over that available in Vietnam, most foreigners do not leave their homelands in search of higher wages. A further complicating factor that may not be understood by the State is that not every foreigner wants to be stationed in Vietnam. In many cases employers need to pay foreign workers and managers a higher wage to encourage them to uproot their homes and families to live far from home.
Summary. Thus is born the death of trust between Joint Venture partners as they both, too late, struggle to overcome the burdens built into the process.
Failing to see the presumptive benefits first envisioned from the enterprise formation, the inability to trust each other brings about the ultimate failure of the venture.
The problem is not alone the breakdown of trust. It is also that trust may not have ever been achieved in the first instance.
One cause of the underlying lack of trust is due to the foreign investors initially incomplete investigations when forming a JV enterprise. The foreign investors expectations may have been based more on hope than on a financially justifiable, economic analysis. Foreign investors have not been thorough or wise in their understandings of the limitations imposed on forming JVs that are burdened with many artificial restrictions on their economic development, and even survival.
To succeed in Vietnam, foreign investors must make realistic appraisals of actual opportunities in Vietnam, and allow sufficient time for those opportunities to mature.
Another cause of the underlying lack of trust is that the State offers little in the form of a real contribution to the success, less to the profitability of a JV. And offering few incentives, the State expects that investors will be content to simply put foreign funds into Vietnam without being able to recover their initial investment and make a reasonable rate of return on that investment (net profit).
The lack of trust by the State is both historical and due to is present incomplete understanding of (or ability to allow) a free market determination of costs.
To be competitive with other investment locations that also seek foreign investment, the State must provide incentives sufficient to (i) attract foreign investors, (ii) allow the investors to recover their investment, and (iii) allow the investors to make a profit on their investment. Foreign investors must work carefully with the State to help achieve the goals of both.
Some areas worthy of exploration by both foreign investors and the State to build trust are:
1. Amcham (Hanoi) Remarks: Consultative Group, Presented by Anthony Salzman, 30 November 1998
2. The situation does not improve if, in addition to land, the State contributes a building, machinery, a distribution system, and a management team, all of which need complete overhauling upon the infusion of foreign capital.
3. State owned enterprises are also compelled to pay International Rates when they lease downtown space. However, this paper addresses only the issue of an equitable valuation of a partners contribution to a JV. Certainly the fiction created that encourages the over-valuation land use also erodes or destroys the profitability of State enterprises as well as JV companies.
4. When the State insists at the time of licensing that the partners limit Total Legal Capital to 30% of Total Investment Capital, and insists that the minimum 30% Total Legal Capital must increase over time without making any additional capital contribution, large development JVs will need to pay land use fees above the States share. Conversely, there is room for the State to question the size of royalties a JV must pay to the foreign investor for the use of its contributed technology. However, royalties can be compared to current world market prices to make this determination. While a comparison is made by the State to international city rentals, that is not an equitable comparison as discussed above.
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