By Cameron Wilson

Even though the Middle Kingdom is becoming a global competitor, caution is still necessary when doing business with local partners

Risk-taking is the very lifeblood of cutting-edge business, but managing that risk is even more important to building a successful enterprise. As one European business-man discovered at his own cost, keeping one step ahead of unforeseen legal pitfalls is a mammoth task in China, where things are never quite what they seem. EuroBiz speaks to Trayton Furniture CEO Simon Lichtenberg about how to avoid the legal wrangle his Shanghai-based company found itself in.

Originally from Denmark, Mandarin-speaking Lichtenberg established Trayton in 1993 in China as a timber-importing operation, before branching out into furniture manufacture in 1997 with a factory in Shanghai's Minhang district. His company currently produces around 50,000 pieces of upholstered furniture a month and exports to 20 countries. Trayton, which formerly supplied furniture to IKEA Asia Pacific, employs a workforce of 1,200 and has profits of about RMB20 million (US$2.5 million).

Although furniture production has been very profitable for Trayton, finding leather has been a problem for the company . so they had to take a risk and use Zhenjing Leather Factory, a company from a small city called Leshan in Sichuan province. Lichtenberg wasn't convinced about the company's credentials, but had little choice at that time. So, last year, Trayton bought RMB37 million worth of leather from Zhenjing, but a dispute arose over quality issues of RMB3 million worth of the goods.

Independent tests revealed genuine defects, and after prolonged negotiations to try to resolve the dispute, Trayton decided to hold back payment and return the material, having run into what Lichtenberg feels is the number one problem in China: unreliable suppliers. "If something ever happens, I can promise you It's because the suppliers are cheating- we try our level best to avoid that, but that is the risk," he says. "You might run into a supplier who says his factory is the biggest in China, and .we can do this and we can do that', but it might not even be his own factory, he's just an agent. There are tons and tons of stories of that kind in China."

Taking a stand

In March this year, court officials from Leshan court in Sichuan arrived at Lichtenberg's business premises with a court order freezing RMB3 million in cash in Trayton's bank account, and RMB4.2 million in assets at the factory. This was more than double the value of the disputed leather. Lichtenberg alleges his supplier has powerful guanxi (connections) with the local officials, and describes the proceedings, which are still ongoing, as a "classic case of legal protectionism".

The problems his company has faced are becoming more and more relevant, Lichtenberg says, because China is now rife with such disputes. But few ever reach court, and most are settled through private agreements. He believes that, in his case, the courts will do all they can to also make his company settle out of court. "That way they will avoid responsibility. If they take a stand in favor of us, they are in trouble with the local community. If they take a stand towards the supplier, they might end up in more trouble because they can see that we have been making a lot of noise about it." He adds, "I don't want to see anyone business go down, but at least people should play by the rules."

By taking a stand against what his company perceives as preferential treatment being given to local suppliers over foreign businesses, Lichtenberg hopes that he can make way for other businesses to enjoy a more level playing field. "The point is to get fair treatment and pave the way for other European businesses," he says. "We should have known that these guys were not reliable. But at the time I had no choice, there just were not any other leather suppliers. But I'm taking it as an experience. Its part of being in China, and it could cost us a lot of money."

Lichtenberg says that one of the big problems when operating in China is checking out the credentials of your business partners. He did as much homework as he could, and when he found that his supplier had attracted World Bank investment, he felt able to proceed. There wasn't any one thing that made him uneasy at the beginning, but he felt suspicious all the same.

"I could just smell a rat. It was the kind of place that was very dangerous to go; we knew the guy was very powerful, very far away, not on the coast. But the fact that the International Finance Corp had invested in the company was the convincing fact for me." Lichtenberg continued, "I thought, this guy, at least he wants to go international, he wants to do business by international rules, he understands the importance of foreign investment and management, and so we bought that story."

Sourcing materials is another aspect of business which requires careful attention, says Lichtenberg, who relates he had little choice but to buy leather for Trayton's from the Sichuan supplier if he wanted to remain competitive. "If we were to compete with our Chinese competitors who buy from people like him at a very good price, then it would be really hard to find another supplier." He adds "It's better now, but sometimes there are not that many choices - it was a case of two evils, either you cut into your profit because your supplies are too regulated and too expensive, or you have to go with some of these cowboys and you might end up in a mess."

Lichtenberg says the key to understanding, and dealing with the problem, is to recognize that the legal environment is not quite the same in the west of China as it is in the east. Other differences also exist, such as the authorities' willingness to respond to business concerns. "Things have improved a lot here but Sichuan is way behind. If this case had been in Shanghai, then if we had written to the Mayor to complain we would have definitely got a reply," he says. "No matter if we got a good one or bad one or a reply just brushing us off, we would definitely have got one. But we have heard nothing from Sichuan, and I don't know how many letters we have written there."

China is China

If Lichtenberg had it to do over again, he says he would have avoided becoming so dependent on one supplier. "When you know that this might be the type of company where you could end up in some kind of trouble, be very careful and don't put all your eggs in one basket. But to be honest I can't say we would have done it differently at the time - we didn’t have a choice as the market stood. In this particular field, there wasn't another source."

It's not easy or convenient to do background checks on all partners, but you must do what you can. Ultimately, you can't escape from the China factor. "I think the most valuable les-son is that you shouldn’t believe you should do business on Western terms in China because you can't. No matter what. Even if you are Phillips or Motorola or General Motors or whoever," Lichtenberg says. "China is China, and you have to try to understand as well as you can the way that things are done and the way they think to be able to compete, or even just to survive at all."

Making your contracts as tight as possible is also a wise step, Lichtenberg advises. But he warns: "You can have a contract but people might just not do things according to the contract, because they are not used to a society being regulated by law and contracts, but rather by connections and political parties. But at the end of the day, contracts don't mean as much as a good relationship, or people's connections with positions of power."

Things are improving, says Lichtenberg - but the bottom line is still the same. "When it comes to the crunch, things are done the Chinese way. The suppliers are Chinese, the workers are Chinese, and you can't just walk in with a bunch of lawyers from the US and a strong contract and think its going to work because It's not. It might work, but not because of the contract."

Although the picture of the future is brighter, Lichtenberg reckons it will take at least a generation before remarkable change occurs. "Some people come to China and say .Wow, Shanghai is modern, it looks great, It's Westernized, seems organized and the government is very helpful, wow, let's go, let's do it the way we used to do it.. But that's not true, even though they are working on it. The real culture is under the surface."