THE CRITICAL ROLE OF BUSINESS GROUPS IN CHINA

by: Issues: May / June 2005. Categories: Global Business.

Just as Western managers have learned to do business with the chaebol and keiretsu, business groups in South Korea and Japan, along comes the challenge of climbing another learning curve, doing business with the qiyejituan, business groups in China. Managers will get a leg up on the learning curve by reading this comprehensive primer on getting along with business groups in China.

When moving into China, large and small multinational firms will encounter networks of Chinese companies – business groups called qiyejituan. These qiyejituan have influenced the competitive landscape in China, both competing against, and allying with, multinational firms. Numerous qiyejituan are enormous, in fact, large enough for several of them to be ranked near the top of Fortune’s list of the top 500 global enterprises.

More often than not, MNEs may raise the following questions when interacting with these Chinese business groups: (1) Who are they? (2) What are the similarities and differences between Chinese business groups and their counterparts in other countries? and (3) How can MNE managers deal with them? Based on our ongoing research projects involving archival study, extensive survey, and fieldwork, we present detailed information on the nature, history, and current status of these groups in this article, as well as the structure and strategy of the qiyejituan. We also try to answer the questions posed above.

Business groups in China and other countries

Similarities…

As they move into international markets, MNEs can encounter diverse forms of business organizations, other than those established in North America or Europe. Such groups take names like grupos or Grupo Economicos in Latin America, mining houses in South Africa, and family holdings in Turkey. In Asia, we can find business groups in many countries, such as Japan, South Korea, Taiwan, India, China, Indonesia, Malaysia, the Philippines, and Thailand. Table 1 at the end of this article provides examples of business groups in these countries.

Business groups in South Korea are called chaebol, a gathering of formally independent firms under the single common administrative and financial control of one family. In Japan, business groups are called keiretsu, referring to clusters of interlinked firms bound by specific ties over a long period of time. In Taiwan, these groups are family-centered collections of firms called jituanqiye, while in India, they are referred to as trading houses, collections of publicly traded firms in a wide variety of industries, with a significant amount of common ownership and control, usually by one family.

In China, according to the National Statistics Bureau of China (NSBC), a business group consists of legally independent entities that are partly or wholly owned by a parent firm and registered as affiliated firms of that parent firm. The State Administration for Industry and Commerce (SAIC) provides a more quantitative definition: to become a business group in China, the core company should have the register capital of over 50 million yuan (US$6 million) and at least 5 affiliated companies, and the total register capital of the core and other affiliated companies should be over 100 million yuan (US$12 million).

The above description of business groups in China and in many other countries points to several important characteristics of business groups. First, group member firms are legally independent. Second, member firms are tied together by various relationships such as common ownership, shared goals, cross-shareholdings, and commonalities in organizational culture. Third, member firms operate together in a more or less cohesive way.

In addition to the above common characteristics, the rationale for business groups’ existence in China is similar to other countries’. It is captured by the question: “Why are business groups ubiquitous in so many emerging economies?” To answer this question, we need to consider the state of the regulatory environment, and the capital, labor and product markets, which define the conditions under which business transactions occur. We can call these factors the “national institutional environment.” In general, the national institutional environment is weak in emerging economies. Operating in such environments, firms incur additional costs and risks related to the inefficiencies in transactions. Unlike a single company, a business group can replace the institutional environment through internal transactions and thus reduce the additional transaction costs associated with the market inefficiencies.

Chinese business groups are most similar to the business groups in Japan and Korea. In fact, the Chinese government has observed that the keiretsu had played an irreplaceable role in Japan’s postwar recovery and that chaebol had contributed tremendously to Korea’s “Miracle of Han River.” For years, Chinese officials had been visiting and learning about keiretsu and chaebol. Consequently, in parallel with their counterparts in Japan and Korea, Chinese business groups have followed the network-based group structure. They have expanded into various industries and areas and received various kinds of government support. Notably, in order to provide financing for the member firms, Chinese business groups created their own financial companies, having the same function as those of the main banks in the Japanese keiretsu.

Whatever their name, location or history, business groups are a two-edged sword for members. Firms affiliated with business groups enjoy benefits such as reduced transaction costs through internalizing the business transactions among the group members. At the same time, they have to bear group-related costs. For example, more profitable companies may suffer from the group burden due to frequent internal lending, inside trading, and debt-guarantee activities, which are usually not based on market mechanisms. Given the dominant role played by business groups in each country, chaebol, keiretsu, and qiyejituan at least partly accounted for Korea’s 1997 financial crisis, Japan’s 1990 economic bubble, and China’s endless triangular debts, respectively.

…and differences

To understand the differences between business groups in China and other countries, we need to look at the unique state of China’s institutional environment. Unlike Japan and Korea, China today is a transition economy, moving from a centrally-planned to a market-based economy. As such, the government and its state-owned enterprises still play a critical role in the economy.

This unique state of China’s institutional environment has given rise to two striking features of Chinese business groups. One is that while groups in other countries are private, groups in China are of two types – state-owned and non-state-owned. The other is that Chinese business groups, although somewhat diversified, are more focused than those in other countries. Moreover, in the different development stages of Chinese business groups, non-state-owned groups distinguish themselves from state-owned ones in terms of the diversification strategies. Tables 2 and 3 summarize these two unique features of Chinese business groups. Details of these characteristics are discussed in the next section.

The evolution of Chinese business groups: State-owned versus non-state-owned

Since the state introduced its economic reforms in 1978, there have been four types of enterprises in terms of ownership: state, collective, private, and foreign-invested firms. If its core company or parent corporation is an SOE (State-Owned Enterprise), the business group is classified as state-owned. Similarly, a business group is regarded as non-state-owned when its core company or parent corporation is a collective or private entity. Foreign-invested companies are usually not considered to be Chinese domestic firms.

State-owned and non-state-owned groups have different stories with regard to the government policy and institutional support during China’s transition period. As with the Japanese and Korean governments, the Chinese state actively participated in the development of business groups. Business groups have thus gone through four stages in their development, during which the government has tried to reform its SOEs and economic systems since 1978, mainly by following Deng Xiaoping’s famous pragmatic expression – “touching the stones to cross the river.”

Stage One: 1978-1986

In 1978, the Communist Party Central Committee (CPCC) first encouraged links among Chinese SOEs that imitated those of the Japanese keiretsu. Six years later, the CPCC proposed further economic reforms and allowed the existence of non-state-owned sectors. The year 1986 saw the concept of a “business group” appear in the State Council’s official documents for the first time, a signal indicating that the state was serious about the formation of state-owned business groups.

Stage Two: 1987-1992

During this period, groups came out quite rapidly in the state-owned sector thanks to various policy inducements. In 1987, the government articulated the concept of business groups and provided incentives for state-owned firms to form groups. As a result, the following year saw 1,630 state-owned business groups booming across the country. In 1991, the State Council chose the first batch of 57 groups as the national trial groups. The selection of these groups was clearly biased towards state-owned sectors and these groups were explicitly given a dual role: to lead a particular sector into international markets and to absorb large number of poorly performing small SOEs.

Stage Three: 1993-1997

The year 1993 was the turning point in China’s transition to a market economy as the Party decided to establish “a socialist market economy” and officially began to regard private ownership as a “supplementary component of the economy.” Encouraged by this decision, many non-state firms were formed and the gross output value of private enterprises in 1994 was almost 15 times what it was in 1988.

Entrepreneurs in the non-state sectors recognized the benefits of business groups, regardless of the fact that there were also risks associated with controlling and managing too many group members. To avoid uncertainty, achieve economy of scope, and gain a prestigious position, many entrepreneurs formed their own business groups. By 1995, there were over 20,000 business groups in all the economic sectors across the country. Since the economy would not be able to sustain so many groups, the State Council selected a second batch of 63 trial groups in 1997. These two batches of groups have thus been known as National Trial Group120.

Stage Four: 1998 – present

In this period, efforts were made to let the state sector concentrate on key “pillar” or “life-blood” industries in the national economy using strategic adjustments to create “highly competitive large business groups.” In 1998, the 15 industrial ministries were eliminated and the central-level, state-owned groups were controlled directly by the State Council. By the end of 1999, the number of approved business groups at the provincial and departmental levels was 2,767 and their value was 51.3 percent of the assets of all state-owned and large non-state-owned enterprises.

The establishment of SASAC (the State-owned Assets Supervision and Administration Commission of the State Council) in 2003 marks a milestone in the reform of state-owned business groups because it takes over the supervisory function of all the former industrial ministries and performs its full responsibility as the shareholder of central-level state-owned enterprises. In 2003, SASAC announced a list of 189 large state-owned enterprises/business groups that came under its supervision. Table 4 provides examples of the SASAC Groups.

As most of these SASAC groups are also the trial groups, the term “120 national trial groups” has seldom been mentioned in recent governmental documents. Like the trial groups, these groups have been empowered to develop their own strategic plans, set up finance companies to raise capital, decide the composition of the management teams of member firms, and conduct international economic activities.

Moreover, since all these groups are central-level, state-owned, and directly under the supervision of SASAC, and hence the CPCC, they are often called “party-owned” business groups or SASAC groups. Thus, these “party-owned” SASAC business groups are China’s national team because the team’s position is supposed to “determine the nation’s position in the international economic order in the new century.” They are the counterparts of the Japanese keiretsu or Korean chaebol. Eight of these SASAC groups were ranked in the 2003 Fortune Global 500 and they include the State Grid Corp, CNPC, Sinopec, China Telecom, China Mobile, Sinochem, Shanghai Baosteel and Cofco.

It is clear from the history of Chinese business groups that the state has provided much institutional support for the development of China’s state-owned business groups. Beyond more or less the same assistance of governments in other countries like Japan and Korea, the Chinese government has displayed a paternalistic attitude to its state-owned business groups, because it is the ultimate investor in all of the SOEs in China: It is the state that introduced the concept of a business group in order to encourage SOEs to form groups, selected the national trial groups to free them from the constraints of the old systems, and supervised the SASAC groups to form China’s national team. Such institutional support and paternalism can also be found in local governments’ continuous efforts to help the development of state-owned business groups at provincial and municipal levels.

Strategy, structure, and intra-group relationships

Diversification strategy

Our research results might surprise some readers, namely that Chinese business groups are less diversified than their counterparts in many other countries. The findings also question the popular myth that business groups are supposed to be diversified. However, if you go back to the definition of a business group in any country, you would agree that the group structure does not necessarily mean it will be highly diversified.

Compared to their counterparts in other emerging economies, Chinese state-owned groups are actually more focused. At a first glance, it may be true that most large manufacturing-based state-owned groups have some affiliates operating in completely unrelated industries, mostly in service sectors. But a deeper investigation indicates that most of these unrelated, diversified affiliates had existed for decades long before the formation of the business group. This is because the Chinese economy was a planned system and the planners viewed state-owned factories as both production and social welfare units. As a result, it is not uncommon to see that many Chinese state-owned groups are also running social welfare-related businesses such as restaurants, hospitals, schools, and even kindergartens. Clearly, the group structure itself is not the reason for the presence of these completely unrelated operations.

Thus, if you look at the strategy of state-owned business groups after they were formed, you would find that they are more focused on their core businesses. Moreover, even if they are diversified to some extent, most of the industries are in financial services, logistics operations, or highly related upstream and downstream sectors. This is partly due to pressures from the state that requires them to become the leading players or even national champions in their own industries. The recent trend is that more and more Chinese state-owned business groups have gradually got rid of those social welfarerelated affiliates and have concentrated on their core businesses only.

Compared to state-owned business groups, non-state-owned business groups, particularly those in the private sectors, have a dissimilar diversification strategy with regard to either the timing or the scope of diversification initiatives. The founders of Chinese private business groups can be considered as entrepreneurs who used to be farmers, cadres, or professionals. Over time, some of these entrepreneurs have organized themselves along more formal lines, managed in a better way, and become larger and more visible. For example, the largest private group in China during the 1990s, the Hope Group, could trace its roots to private farming. Another example is the Lenovo Group (formerly the Legend Group), China’s largest non-state-owned business group in the high-tech area, which was founded by eleven IT scientists and engineers in 1984.

Entrepreneurs in China’s private business groups have two distinct characteristics, namely an entrepreneurial spirit and guanxi-based mindset, both of which have significantly influenced the groups’ diversification strategy. An entrepreneurial spirit means they are more likely to take a risk as long as they think there is a good opportunity. Guanxi literally means relationships and stands for any type of relationship. During China’s institutional transition, however, it is also understood as the network of relationships among various parties that cooperate together and support one another.

Before entrepreneurs established their groups, they were often very familiar with one or two products whose price gaps were huge because of the so-called “shortage economy.” Unlike state-owned enterprises which had to provide many social welfare-related operations, private firms focused on their core products in the beginning of China’s transition economy. These entrepreneurs put much effort in to cultivating their personal relationships – guanxi – with governmental cadres and executives of other companies in order to market and sell their products.

After they were formed, Chinese private business groups began to diversify their businesses. However, these groups entered only a few industries such as real estate,  information and communication, and biotechnology, provided that the projects were attractive enough to get the bank loans. Clearly, it is the founders’ entrepreneurial spirit that has pushed private groups to enter these high-risk and high-profitability industries. Meanwhile, it is the entrepreneurs’ guanxi that has helped private groups obtain the necessary licenses from government agencies and capital from commercial banks.

Organizational structure

As in many other countries, a business group in China is likely to start a new company when it enters a new industry. According to the Company Law in China, if the new industry is not included in parent company’s charter, it is required to either amend its charter or register for a new company. However, because the amendment procedure in China is more time-consuming and even more costly than the regular registration procedure, business groups often choose to register new firms.

Even if a group corporation operates in exactly the same industry as approved by the charter, but decides to enter a different area in China, it is also likely to register a new company in that particular region. The reason is that Chinese local governments have their own agenda – to have more companies registered in their administrative region and thus collect taxes from these companies. If a subsidiary of a corporation is not registered as an independent company in its location, this subsidiary is likely to encounter various interventions from the local government.

In such an environment, a typical Chinese business group has more and more new companies registered under the group’s umbrella whenever it enters new industries or operate in new regions in China. As a result, Chinese business groups often adopt a network structure, which means that the group members are bounded by various formal and informal ties. Nonetheless, the structure itself is a relatively minor issue compared to the complex intragroup relationships of Chinese business groups.

Intra-group relationships

Essentially, there are three types of intra-group relationships among Chinese group affiliates: ownership ties, internal trading and inside loans, and other informal connections. In a Chinese business group, if the major shareholder of a firm is the parent corporation, this firm is considered a child company of the group. Similarly, a child company can also have its own children that are regarded as the grandchildren companies of the business group. Informal connections within a Chinese private group refer to the family ties or other personal relationships; in a state-owned group the informal ties are presented by the fact that the Communist Party members belonging to the same branch may occupy the major positions of the group affiliates.

As with business groups in many other countries, internal trading networks are embedded in Chinese business groups and group members can conduct extensive internal selling and purchasing of intermediate and final goods. Further, firms that are members of some business groups have access to financing through the group’s finance company, a specialized firm that collects and redistributes funds within the group. Moreover, group members can also solve the problems of cash flow through internal loans. Both internal trading and inside loans are based on trust, which can be enhanced by the abovementioned formal or informal relationships among group members.

Chinese business groups and MNEs

Given the prominent role of business groups in China, it is inevitable MNEs entering the country will encounter groups that are alliance partners, acquisition targets, and/or potential competitors.

Alliance partners

It is well known that a strategic alliance with local partners is a more popular strategy for MNEs’ entries into less developed countries than into developed countries. It is no exception in China. To some extent, it is not a choice but a requirement for entry into China, especially in the early stage of China’s transition economy. Accustomed to dominant positions in protected markets, Chinese state-owned business groups suddenly face foreign rivals, and the very survival of these local incumbents is at stake. To protect their own turfs, state-owned groups have endeavored to lobby the state to restrict the issuing of licenses to foreign entrants. As a result, international joint ventures (IJVs) are the dominant strategy used by multinational firms in China’s emerging market.

It is also well known that the choice of a “proper” or “right” partner contributes to the success of international strategic alliances. Partner selection is important to IJV success everywhere and it is even more critical when investing in emerging economies. A group-affiliated member seems to be a “qualified” local partner, because by partnering with a Chinese business group member, MNEs and their subsidiaries may leverage the distinctive competencies – group-based resources such as group reputation, trading networks, and internal financing – to mitigate the location-based disadvantages, fill the institutional void, and gain competitive advantages in China.

At the same time, this Chinese group-affiliated alliance partner may bring group-related costs to the local IJV. Such costs arise from the over-dependence on internal lending and trading, which places the group-affiliated local partner in a position to potentially exploit the IJV for its own or the group’s economic gain. Specifically, Chinese business groups have traditionally been vehicles for government policies which may well lead to potential differences in goals between the partners. Moreover, given the backup of business groups who have abundant resources, group-affiliated partners may be less cooperative than non-group affiliated firms in the joint ventures’ daily operations.

Given that there are two distinct types of business groups in China, MNEs should take the differences into consideration if they decide to partner with these groups. Because state-owned groups have their special channels for obtaining direct institutional support and are the object of paternal care from the central government, partnering with these groups can make the entry into some of China’s highly-protected industries smoother. For example, when ManuLife, a leading Canadian-based financial services player, entered China’s insurance market in 1996, it chose FOTIC as its partner to set up a joint venture – Sinochem-Manulife. FOTIC is a member of Sinochem, one of China’s largest state-owned business groups. It is this prestigious central-level and state-owned Chinese business group that made the “mission impossible” possible – Sinochem- Manulife came out to be the first foreign invested joint venture life insurance company in China.

Acquisition targets

Compared to forming an alliance, acquiring a company has been a less popular entry strategy for MNEs, primarily due to the lack of transparency and market imperfection. With the improvements in the institutional environment in China, we expect that acquisitions will grow in popularity as an entry strategy for MNEs. Similar to the partner selection for alliances, the choice of acquisition targets is critical to the post-acquisition performance and business development.

Affiliates of Chinese state-owned business groups will emerge as major acquisition targets of multinational firms. As mentioned earlier, stateowned groups often hold many affiliates that had existed in unrelated industries even before the groups’ formation. These group affiliates are legacy burdens for the business groups and most of them are technically bankrupt. The good news is that since China joined the WTO in 2001, the state has issued some rules and regulations that will reduce the restrictions on the foreign acquisition of state-owned sectors.

Meanwhile, state-owned groups are required to focus on their core businesses only. Because local governments see foreign acquisition as one of the key means to reform their business groups, it will take much less time and fewer procedures to complete such a deal. In 2004, for example, the Shanghai municipal government provided one-stop service to foreign firms in order to encourage them to acquire several affiliates of Pacific Mechatronic Group, a leading, 30-member, state-owned business group in China’s textile machinery industry. Moreover, because Chinese state-owned groups are more than willing to sell their under-performing members as soon as possible, MNEs can acquire ‘qualified’ targets at attractive prices in the forthcoming fire sales of the “unimportant” affiliates of state-owned groups.

Affiliates of Chinese private business groups can also serve as qualified acquisition targets. Although many entrepreneurs of private groups are good at grasping business opportunities to enter high-profitability and high-risk industries, most of the investments are ultimately regarded as short-term projects. Lacking long-range plans, these projects are likely to be sold after the private groups have collected their expected profits or cannot tolerate the temporary losses. Being familiar with the life cycle of certain high-tech products or valuing the strategic importance of the Chinese market, multinational firms can approach these private groups to negotiate acquisition deals for such short-term projects.

Since private business groups tend to be family-owned and feature a centralized decision-making and administrative system, the negotiation and acquisition procedures will not take much time. Moreover, the growth of these private groups in a local setting leads to further connections and an understanding of the local institutional environment. These resources can make affiliates of Chinese private groups attractive targets and can be redeployed by the MNEs for their business development in China.

Potential competitors

With tremendous support from the government, state-owned business groups can become multinational firms’ competitors, as can the entrepreneurial non-state-owned groups. More importantly, Chinese groups are embedded in the local business networks, giving them a competitive advantage that foreign entrants can not gain without years of interactions with local stakeholders such as governments, banks, suppliers, and customers.

At the same time, Chinese business groups can go use their highly secure and protected home markets as a platform for international expansion. Chinese business group leaders see multinational enterprises coming in from all over the world; they want to be one of those, not just local corporate chieftains. The fact is that several Chinese groups have already entered the Fortune Global 500 Enterprises list.

In some cases, Chinese groups enter foreign markets in a very aggressive way – that is, by international acquisition – to seek natural resources and advanced technologies. The need to secure resources is, of course, the most immediate and pressing need for a Chinese economy estimated to be continuously growing at more than 8 per cent annually. Hence, it is the state-owned groups’ unshirkable task to go abroad to feed China’s resource appetite. In 2004, for instance, this appetite for resources pushed a Chinese state-owned business group, Minmetals, to enter into exclusive negotiations to buy Toronto-based Noranda, which controls nickel and copper assets, as well as interests in zinc and aluminum. Although Noranda was too big for Minmetals and the premium was projected at US$6.7 billion, this state-owned Chinese business group might have few concerns about the funding sources because such a big deal would definitely be supported by the government-controlled banks.

Although Chinese non-state-owned business groups are unlikely to play such a role, namely to seek resources for the country, they are hungry for world-class technologies that they can acquire and turn into their own competitive advantage. Recently, the Lenovo Group, China’s largest non-state-owned business group in the high-tech industries, acquired IBM’s personal computer division. With a purchase price of US$1.25 billion and assumed liabilities of US$0.50 billion, the total transaction was worth about US$1.75 billion, one of the biggest Chinese overseas acquisitions ever. Lenovo Group will take over research, development, and manufacturing, using the IBM name under a licensing agreement. As pointed out by Liu Chuanzhi, Lenovo’s founder and chairman, the acquisition makes Lenovo the third-largest PC maker in the world.

If this brief introduction to Chinese business groups could contain only one message, it would be that Chinese business groups, though ubiquitous in China’s transition economy, are of two distinct types – state-owned and non-state-owned, and that both can play three different roles when interacting with multinational firms – alliance partners, acquisition targets, and potential competitors. Care should be taken by multinational firms when they try to cooperate or compete with these groups in China’s market and beyond. Otherwise, as Chinese military strategist Sun Tzu pointed out in The Art of War more than two millennia ago, “If you know yourself but not the counterpart, for every victory gained you will also suffer a defeat.”

 

 

When moving into China, large and small multinational firms will encounter networks of Chinese companies – business groups called qiyejituan. These qiyejituan have influenced the competitive landscape in China, both competing against, and allying with, multinational firms. Numerous qiyejituan are enormous, in fact, large enough for several of them to be ranked near the top of Fortune’s list of the top 500 global enterprises.

 

More often than not, MNEs may raise the following questions when interacting with these Chinese business groups: (1) Who are they? (2) What are the similarities and differences between Chinese business groups and their counterparts in other countries? and (3) How can MNE managers deal with them? Based on our ongoing research projects involving archival study, extensive survey, and fieldwork, we present detailed information on the nature, history, and current status of these groups in this article, as well as the structure and strategy of the qiyejituan. We also try to answer the questions posed above.

 

(H2) Business groups in China and other countries

 

(H3) Similarities…

 

As they move into international markets, MNEs can encounter diverse forms of business organizations, other than those established in North America or Europe. Such groups take names like grupos or Grupo Economicos in Latin America, mining houses in South Africa, and family holdings in Turkey. In Asia, we can find business groups in many countries, such as Japan, South Korea, Taiwan, India, China, Indonesia, Malaysia, the Philippines, and Thailand. Table 1 at the end of this article provides examples of business groups in these countries.

 

Business groups in South Korea are called chaebol, a gathering of formally independent firms under the single common administrative and financial control of one family. In Japan, business groups are called keiretsu, referring to clusters of interlinked firms bound by specific ties over a long period of time. In Taiwan, these groups are family-centered collections of firms called jituanqiye, while in India, they are referred to as trading houses, collections of publicly traded firms in a wide variety of industries, with a significant amount of common ownership and control, usually by one family.

 

In China, according to the National Statistics Bureau of China (NSBC), a business group consists of legally independent entities that are partly or wholly owned by a parent firm and registered as affiliated firms of that parent firm. The State Administration for Industry and Commerce (SAIC)

provides a more quantitative definition: to become a business group in China, the core company should have the register capital of over 50 million yuan (US$6 million) and at least 5 affiliated companies, and the total register capital of the core and other affiliated companies should be over 100 million yuan (US$12 million).

 

The above description of business groups in China and in many other countries points to several important characteristics of business groups. First, group member firms are legally independent. Second, member firms are tied together by various relationships such as common ownership, shared goals, cross-shareholdings, and commonalities in organizational culture. Third, member firms operate together in a more or less cohesive way.

 

In addition to the above common characteristics, the rationale for business groups’ existence in China is similar to other countries’. It is captured by the question: “Why are business groups ubiquitous in so many emerging economies?” To answer this question, we need to consider the state of the regulatory environment, and the capital, labor and product markets, which define the conditions under which business transactions occur. We can call these factors the “national institutional environment.” In general, the national institutional environment is weak in emerging economies. Operating in such environments, firms incur additional costs and risks related to the inefficiencies in transactions. Unlike a single company, a business group can replace the institutional environment through internal transactions and thus reduce the additional transaction costs associated with the market inefficiencies.

 

Chinese business groups are most similar to the business groups in Japan and Korea. In fact, the Chinese government has observed that the keiretsu had played an irreplaceable role in Japan’s postwar recovery and that chaebol had contributed tremendously to Korea’s “Miracle of Han River.” For years, Chinese officials had been visiting and learning about keiretsu and chaebol. Consequently, in parallel with their counterparts in Japan and Korea, Chinese business groups have followed the network-based group structure. They have expanded into various industries and areas and received various kinds of government support. Notably, in order to provide financing for the member firms, Chinese business groups created their own financial companies, having the same function as those of the main banks in the Japanese keiretsu.

 

Whatever their name, location or history, business groups are a two-edged sword for members. Firms affiliated with business groups enjoy benefits such as reduced transaction costs through internalizing the business transactions among the group members. At the same time, they have to bear group-related costs. For example, more profitable companies may suffer from the group burden due to frequent internal lending, inside trading, and debt-guarantee activities, which are usually not based on market mechanisms. Given the dominant role played by business groups in each country, chaebol, keiretsu, and qiyejituan at least partly accounted for Korea’s 1997 financial crisis, Japan’s 1990 economic bubble, and China’s endless triangular debts, respectively.

 

(H3) …and differences

 

To understand the differences between business groups in China and other countries, we need to look at the unique state of China’s institutional environment. Unlike Japan and Korea, China today is a transition economy, moving from a centrally-planned to a market-based economy. As such, the government and its state-owned enterprises still play a critical role in the economy.

 

This unique state of China’s institutional environment has given rise to two striking features of Chinese business groups. One is that while groups in other countries are private, groups in China are of two types – state-owned and non-state-owned. The other is that Chinese business groups, although somewhat diversified, are more focused than those in other countries. Moreover, in the different development stages of Chinese business groups, non-state-owned groups distinguish themselves from state-owned ones in terms of the diversification strategies. Tables 2 and 3 summarize these two unique features of Chinese business groups. Details of these characteristics are discussed in the next section.

 

(H2) The evolution of Chinese business groups: State-owned versus non-state-owned

 

Since the state introduced its economic reforms in 1978, there have been four types of enterprises in terms of ownership: state, collective, private, and foreign-invested firms. If its core company or parent corporation is an SOE (State-Owned Enterprise), the business group is classified as state-owned. Similarly, a business group is regarded as non-state-owned when its core company or parent corporation is a collective or private entity. Foreign-invested companies are usually not considered to be Chinese domestic firms.

 

State-owned and non-state-owned groups have different stories with regard to the government policy and institutional support during China’s transition period. As with the Japanese and Korean governments, the Chinese state actively participated in the development of business groups. Business groups have thus gone through four stages in their development, during which the government has tried to reform its SOEs and economic systems since 1978, mainly by following Deng Xiaoping’s famous pragmatic expression – “touching the stones to cross the river.”

 

(H3) Stage One: 1978-1986

 

In 1978, the Communist Party Central Committee (CPCC) first encouraged links among Chinese SOEs that imitated those of the Japanese keiretsu. Six years later, the CPCC proposed further economic reforms and allowed the existence of non-state-owned sectors. The year 1986 saw the concept of a “business group” appear in the State Council’s official documents for the first time, a signal indicating that the state was serious about the formation of state-owned business groups.

 

(H3) Stage Two: 1987-1992

 

During this period, groups came out quite rapidly in the state-owned sector thanks to various policy inducements. In 1987, the government articulated the concept of business groups and provided incentives for state-owned firms to form groups. As a result, the following year saw 1,630 state-owned business groups booming across the country. In 1991, the State Council chose the first batch of 57 groups as the national trial groups. The selection of these groups was clearly biased towards state-owned sectors and these groups were explicitly given a dual role: to lead a particular sector into international markets and to absorb large number of poorly performing small SOEs.

 

(H3) Stage Three: 1993-1997

 

The year 1993 was the turning point in China’s transition to a market economy as the Party decided to establish “a socialist market economy” and officially began to regard private ownership as a “supplementary component of the economy.” Encouraged by this decision, many non-state firms were formed and the gross output value of private enterprises in 1994 was almost 15 times what it was in 1988.

 

Entrepreneurs in the non-state sectors recognized the benefits of business groups, regardless of the fact that there were also risks associated with controlling and managing too many group members. To avoid uncertainty, achieve economy of scope, and gain a prestigious position, many entrepreneurs formed their own business groups. By 1995, there were over 20,000 business groups in all the economic sectors across the country. Since the economy would not be able to sustain so many groups, the State Council selected a second batch of 63 trial groups in 1997. These two batches of groups have thus been known as National Trial Group120.