Corruption and the Price of Coffee in China

I had a very interesting lunch last week with some foreign (overseas-Chinese) investors, the manager of one retail location of a int’l coffee chain and one of the lawyers that does some work for the same.  The discussion was centered around opening up a new western franchise food venture in southern China.  I was asked to participate and comment on foreigners managing supply chains and dealing with regular purchase negotiations in China.The interesting part of the conversation to me was not the coffee shop numbers (although those were staggeringly high for a single coffee shop on a monthly basis), but rather the open and very matter-of-fact discussion of all the “additional expenses” that the lawyer (ironically) and the manager said it cost the coffee shop both to set up and just keep their doors openIntellectually I know that corruption is everywhere here.  And I’ve seen a lot of corruption first hand too; I even wrote about it in this month’s China Sourcer magazine.   But I seemed to be the only one that was taken back by the amount and the frequency at which corruption affects their coffee business.  Afterwards, the investors focused simply on how the new numbers could be managed and how to deal with the accounting—no one even batted an eye at the stories or points where corruption would affect their potential business.  Just for perspective, the numbers they were talking about to pay for corruption were comparable to their total start-up costs for a 70-80 square meter shop in a mall in downtown Shenzhen (rental contract and deposit with additional “gifts” to the mall owners/management office, build-out, equipment, etc.).  That's DOUBLE their actual costs for the first year of business!!Here is a list (made after the meeting was over from what I remember) of the specific issues that were discussed.1. Govt corruption/cost of bribes.  Inspections were seen to be the most expensive.  Not only do you have to have a series of pre-opening governmental inspections that will not happen without appropriate sized “gifts” (read thousands of USD per square meter) but once the officials do come out you’ll have to “take care” of them while they are there (and whenever they come back too).  These aren’t fees paid to get things done illegally, these are red-envelopes that you give to govt officials or they just won’t do their job.2. Cost of goods/extras.  Apparently there are specific requirements for patented logos and other items and those cost premium prices—meaning, “a chair that should cost 100Y costs them 800Y.”  Signage was more than 500% more than typical market price as well.

Side Story: At least twice that I can remember, I've seen police drive up to street food vendors, take everything they are selling and drive off.  I've never been fast enough to get it on film.  Once when I was trying to get a quick pic of the action, my wife physically pushed my camera away and told me very directly to never ever do that  (film police) again.  Another time I was actually buying fruit and the police came and took everything.  I was trying to pull the basket back and was yelling at them and they just let me keep the basket in my hand and took everything else and quickly rode off.  No one else either time ever tried to help or stop what was going on.  Afterward a friend told me there was nothing I could do but get myself in trouble so I'd be wise just to let it go.

3. Lack of consistent quality.  Managing suppliers is probably the hardest part of the job.  The quality is never the same and qtty’s vary from day to day—some days orders don’t even show up!  In addition to cultivating and maintaining great guanxi with your main suppliers you have to have immediate options for back-ups if your small.  Busy holiday weekends, even for big famous brand stores, can be hit or miss on qtty's.4. Employee dishonesty/finances.  No way you can trust any employees to track both goods and money.  You have to separate the two and you have to have someone else that you trust completely to do the accounting.  Multiple versions of the accounting records are also needed for various interested parties. (Meaning that along with actual cooking, cooking the books is an additional full time job--see what I did there?  Cooking?)To my way of thinking there are two different kinds of corruption in China: Institutional and Systemic.What I mean by Institutional corruption is the kind that’s noted in point one above and in my own experiences with setting up an office.  It’s not paying under to the table to get things done illegally, it’s not cheating on paperwork or hiding taxes with some “official” assistance.  It’s simply “paying/gifting” extra just to get officials to come do their job—if you don’t pay, they will just “forget” their appointment or be “out of town” whenever you try to meet or just flat out tell you no unless they see an envelope.  This is a HUGE problem for most Chinese citizens as well as for anyone trying to start a new business.   Passports, hukous, school placement, registrations of any kind all require stamps from specific govt officials.  And when the enforcers themselves are corrupt, there is absolutely nothing you can do.To deal with institutional corruption I’ve consciously stayed away from getting entangled in anything do with government regulations and procedures.  Outside of annual company registration work and setting up our office we stay as far away from the govt as possible.Systemic corruption is the other kind—payments made to factories to get access to restricted IP or to get in-production sooner or to fake testing standards.  It’s the under the table deals with govt officials to get around laws or to avoid the enforcement of penalties.  It’s kickbacks or payments for “guanxi” to pay for past help or payments to ensure the lack of problems in the future.And even though corruption is endemic both types of corruption are, in my opinion, almost completely avoidable .  It’s not culture, it’s not Chinese and it’s not right.  You don’t have to participate and usually you can actively avoid most of it.  When it’s going on around you, you can do independent testing and QC and avoid much of the problems caused by the second type of corruption as well.My fear is that as the US economy continues to decline and China continues to rise what’s normal in China will slowly become normal everywhere else too.  China is #78 out of 178 countries ranked on the 2010 Corruption Perception Index.  And, as everyone now knows China is also the world’s second largest economy and world’s second or third largest manufacture (Japan, Germay and the US other top manufacturers).   So their lower status in transparency has an inordinate (negative) affect on world business.  And I fear that that effect is growing.Two other reports that confirm my fears in round about ways.  One from a Chinese blogger on Weibo via This is China blog:  (actually quoting from a WSJ article):

“When a country is corrupt to the point that a single lightning strike can cause a train crash, the passing of a truck can collapse a bridge, and drinking a few bags of milk powder can cause kidney stones, none of us are exempted,” wrote another Weibo user. “China today is a train traveling through a lightning storm. None of us are spectators; all of us are passengers.”“Egads!” I thought to myself, “I’m one of those passengers!”

I’ve had this thought myself many times in the last 3 years.  Corruption is not just wrong and a pain in the ass, it's actually dangerous.  Is living in China worth the risk to my own life and my family members?And the second from a video clip on The Wall Street Journals Realtime Report.  In an interview about his book and Chinese official statistics Tom Orlik basically says: in a country where the press and the courts are not independent and the govt’s processes for creating/reporting statistics are not transparent you have international investors questioning the veracity of the statistics themselves.  I would add that in a country where entire ministries are massively corrupt and government offices tell people to shut-up or they’ll be arrested how can you trust anything/anyone?!Related articles on fakes in China here and here and my previous post here.