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ABC Chemical Company Goes Global*
Driven by competitive pressures, and the attractiveness of the industry’s fastest growing market in
the world, a U.S.-based chemical manufacturer, ABC Chemical Company (name changed to
maintain confidentiality) considered expansion into Asia, specifically, China.
William Smith is the International Marketing manager for ABC Chemical Company.
William has been tasked with expanding ABC’s manufacturing and distribution to the Asia Pacific
region. Many changes in the powder coating industry have forced ABC to reconsider its their global
strategy. To date, they have exclusively manufactured and exported from the Americas. Higher
costs and tougher competition have forced ABC to look to the Asia Pacific Region to reduce these
costs (specifically shipping) and remain competitive.
ABC Chemical Company is a U.S.-based business that manufactures and distributes specialty
chemicals to various industries for use in manufacturing finished products.
ABC Chemical
Company’s powder coating division needs to expand into Asia to remain competitive. Many of the
powder coating division’s customers are moving their plants to Asia in an attempt to expand their
markets and lower their production costs. As well, all of ABC Chemical Company’s competitors are
opening production facilities in Asia to meet their customer’s needs, to expand their markets and
lower their costs. For Asian and some European manufactures, powder coatings are a commodity
with no specific qualities or competitive advantages to differentiate one from another.
ABC
Chemical Company believes that in the future, many of these manufacturers will need more
specialized products moving away from a commodity. Gaining a foothold in Asia at this time is
critical to ABC Chemical Company’s future. As a commodity, powder coatings are purchased
strictly based on price. Shipping costs to Asia have raised prices to a point where ABC Chemical
*
This case was prepared by Kevin Hendrickson, Roberto Mandanici, and Scott Solomon of the Fox
School of Business and Management at Temple University under the supervision of Professor Masaaki
Kotabe for class discussion rather than to illustrate either effective or ineffective management of a
situation described (2003).
Company would eith`er lose money if they met their competitor’s price or lose customers if they did
not. As an example it costs ABC Chemical Company $1.50 per pound to manufacture in the U.S.
and ship to Asia and only $0.50 per pound to manufacture in Asia.
Following the lead of many of their competitors, ABC has chosen to manufacture in China.
Entering China has many benefits including a large relatively untapped market, lower overall costs,
lower restrictions on production and a central proximity to the rest of Asia. Many of ABC Chemical
Company’s direct customers are either moving to or are already located in China. As well, China
and Asia are underserved markets for ABC Chemical Company and many of their competitors.
Moving to China is necessary to maintain market share as well as seek incremental business from
new markets. One of ABC Chemical Company’s goals is to become a global supplier of specialty
powder coatings. To achieve this goal, they must expand into Asia through China.
ABC Chemical Company has chosen to build its own plant in China rather than to form a
partnership or acquire an existing company. When seeking partners, ABC Chemical Company
encountered a number of issues surrounding business practices in China. These business practices
violated ABC Chemical Company’s code of conduct and ethical objectives. While these specific
business practices are common in China and have been accepted and adopted by competitors, ABC
Chemical Company has chosen not to follow suit. Instead, ABC Chemical Company has chosen to
build their own facility.
While building has a number of advantages, there are a number of
disadvantages to consider as well. Advantages include:

Full control of the facility

Building to exacting standards rather than adapting an existing facility

Maintaining quality standards similar to other ABC Chemical Company plants

Maintaining company code of conduct and ethical standards
Disadvantages include:

One to two years to build a facility, slowing speed to market (competitors already producing,
include North American and European manufactures who have partnered with local firms as
well as thousands of small local competitors)

Exporting from US facilities at a loss

Lack of local partners and knowledge may impede entry into market
While ABC Chemical Company builds their factory in China they will continue to supply Asian
customers from its North American manufacturing facilities, at a substantial loss due to logistical and
transportation costs.
Company Overview
ABC Chemical Company is one of the world’s largest manufacturers of specialty chemicals –
technologically sophisticated materials that find their way into applications in a variety of major
markets. Consumers never see most of ABC’s products; rather, they are used by other industries to
produce better-performing, high quality end products and finished goods. The history of ABC
Chemical Company has been a series of innovative technical contributions to science and industry,
usually taking place behind the scenes.
Markets where extensive use is made of ABC's products include the paint and coatings
industry, electronics, household products/detergents/personal care, water treatment, adhesives,
plastics and salt. In every corner of the world, ABC products are Quietly Improving the Quality of
Life.™
In the late 1990s, ABC acquired two great companies – Ronlea (name changed), a maker of
electronic chemicals, and Tomro International (name changed), a global producer of specialty
chemicals and salt.
ABC has sales of approximately $6 billion and more than 17,000 employees. It operates
nearly 140 research and manufacturing locations in 27 countries. The company has more than one
hundred ISO 9000 and more than twenty-five ISO 14000 EMAS registrations around the world.
Worldwide headquarters are located in the United States. ABC is a Delaware corporation whose
stock is traded on the New York Stock Exchange under the symbol ABC.
ABC is committed to being a good neighbor and responsible corporate citizen. At various
places on their web site there are discussions of a number of initiatives, including Responsible
Care®, Community Advisory Committees, and activities centered on the health and safety of
employees, customers, the communities where they are located, and the environment.
ABC Chemical Company’s Code of Conduct
ABC Company stresses the importance of its code of conduct to each employee worldwide. The code
is strictly embraced and enforced at all levels of the organization: from the CEO and the Board of
Directors to each entry-level salaried staff position. In fact, once a year each salaried employee is
asked to: 1) sign the Code of Conduct and certify that he/she has not violated any of the ethical
provisions contained in it; and 2) certify that he/she is not aware that any other employee has violated
the code.
Portions of the Purchasing section of the code of conduct are reported below:
Relationships between ABC Company and its suppliers should be based on mutual respect
and integrity. These relationships should be maintained at the highest standards of business ethics.
[…] Under no circumstance may an ABC employee misrepresent a competitive situation to a
supplier.
ABC Company does not require nor does it expect any form of entertainment, promotional
gifts or holiday cards as a condition for doing business. It is strictly prohibited for an ABC
purchasing agent to solicit any gifts or entertainment or accept spontaneous nominal gifts valued in
excess of $50; accepting any cash gift; traveling at a supplier's expense or participating in a
supplier-sponsored training seminar that is extravagant in nature. […] Any supplier or employee
who suspects that an ABC employee is not operating within the Code of Conduct, should promptly
report their suspicion anonymously to the ABC Compliance Hotline at 1-800-123-4567.
The General Code of Business Conduct repeats, in part, the provisions mentioned in the
Purchasing Code, and adds the following:
Gifts of cash or property may not be offered or made to any officer or employee of a
customer or supplier or any government official or employee unless the gift is legal, nominal in value
(less than $50) and approved in advance by a Director or Business Executive (n most countries it is
illegal to make gifts to government officials).”
Conflicts of interest: any employee who has a financial interest or performs work for a
company with which we do business or compete, must disclose such conflict to the respective
Director or Business Executive.
Securities Transactions: at times, some ABC employees may become aware of confidential
information that has not yet been disclosed to the general public. In those cases, the information
must be held in strict confidence. Those who became aware of such information may not buy or sell
company stock, nor advise others to do so, until the information has been made available to the
general public.
Safety, Health and Environmental laws: ABC conducts its worldwide operations and
manufactures its products in a way as to not harm the environment and the health and safety of its
employees, customers and the public. ABC is also committed to complying with all local applicable
laws and regulations.
Accounting records: ABC's financial statements and the books of record on which they are
based must accurately reflect all corporate transactions. All receipts and disbursements must be
accurately reflected on the accounting books, and ABC's records must disclose the nature and
purpose of all corporate transactions. […] ABC employees are instructed to cooperate fully with
both internal as well as external auditors and withhold no information from them.
Other accounting and internal control provisions pertinent to the case study are as follows:
1. Bank accounts: the corporate treasurer must approve the establishment of all bank
accounts.
2. Financial arrangements: the corporate treasurer must approve all financial
arrangements with banks such as: loans, sales or purchases of securities; dealing in
foreign currency; etc.
3. Cash disbursements: every disbursement (with the exception of petty cash) must be
supported by an approved Purchase Order or Check Request. The full name of the payee
must be recorded on the payment. Checks may not be made payable to "cash", "bearer"
nor the individual approving the transaction.
4. Employee compensation: all payments to employees must be justified based on services
rendered. Employees may not be asked to refund a portion of their compensation or
spend it in an illegal or unethical manner.
5. Billing: all shipments must be billed promptly and accurately.
6. Cash Receipts: all checks made payable to the Company must be deposited in an ABC
checking account promptly. Checks received from customers may not be endorsed to a
third party as a means of payment for our purchases.
7. Sales agents and commissions: only respected and competent agents or distributors may
be hired to represent ABC Company. All commission payments must be properly
recorded on the accounting books with full documentation including the name of the
payee, the commission rate, the product sold and the customer orders involved. Cash
payments, payments to unnamed individuals or disguised bank accounts are not
permitted.
8. Consultants: all engagements with consultants and advisors must be based on ABC's
needs for technical or professional assistance. The background and professional ability
must be scrutinized carefully before engaging a new consultant. All invoiced received
and paid must accurately describe the services rendered and the basis for the fees
charged.
9. Unusual business transactions: all transactions outside the normal course of ABC's
business (sale of scrap material, leasing of buildings and equipment, entering into a new
business activity, etc.) must be authorized by a Business Unit Manager or a VicePresident.
10. Accounting records: all corporate transactions must be reflected in the accounting
records. Any fictitious or unauthorized entries are strictly forbidden.
Industry Overview
Powder Coatings (dry paint), a relatively new technology, is an economical and environmental
improvement over the traditional liquid paint. It is mostly used by Original Equipment Manufacturers
(OEMs) and by small custom "job-shops."
The application characteristics of powder coatings provide superior consistency and
uniformity of finish. They provide extremely tough, durable coats, enhancing the high quality, valueadded image of consumer products. In general, performance properties, such as impact resistance and
corrosion resistance of powder coatings are better than liquid paints. Powder coated parts resist
cracking and peeling during handling and normal service use. In many cases, merchandise is
specifically being advertised as "powder coated" because of the quality image it projects.
"Environmental issues are of significant interest and importance to the government and
general public today. Unlike many liquid paints, powder coatings are compliant with environmental
regulations. Liquid paints often contain solvents, which can contribute to air pollution and, in some
cases, ozone depletion. Powder coatings are free of such pollutants. Wet painting processes can
generate sludge, which must be disposed of into hazardous waste landfills. Properly formulated
powder coatings generate no such hazardous waste. The consumer can feel good about buying a
powder-coated product, which is environmentally responsible." 1
The Global Powder Coatings market registered an estimated $ 3.5 billion in sales in the year
2002. The three major markets are Europe (with sales of $1.3 billion), North America (with sales of
$1billion) and Asia Pacific (with sales of $0.85 billion) (See Exhibit 1).
1
Source: ABC's website
Exhibit 1
Global Powder Coatings Market
$200
$150
$ 1 ,0 0 0
N o rth Am e ric a
AG R 6 -7 %
E uro pe
AG R 3 -4 %
$850
As ia P a c ific
AG R 1 2 -1 5 %
La tin Am e ric a
AG R 1 0 -1 2 %
R e s t o f W o rld
AG R 1 0 -1 2 %
$ 1 ,3 0 0
Values are 2001 estimates in Millions of
US$ and Estimated Annual Growth
Rate (AGR) for the next 5 years
The global powder market is dominated by three major players (See Exhibit 2):
1. Wooden Shoes, a Dutch company, is the market leader commanding 13% of the
worldwide market. Wooden Shoes is the leader in Europe and in Asia Pacific.
2. Delco, a U.S.-based corporation, owns 11% of the global market, with a second-place
position in all three major markets, including Asia.
3. ABC holds a 6% global share, with a narrow number one position in the USA, and the
second position in Europe. ABC's presence in Asia is negligible at 0.2%.
4. Eight other smaller producers own 26% of the market. These Powder Coatings
manufacturers operate in select regional markets, concentrating their efforts on singletype customers and speed of delivery.
5. The remaining 44% of the market is comprised of over 1,000 single-plant producers who
serve a handful of local customers and specialize in a narrow line if products. They
compete on speed and price, since their low-tech and high-volume production of similar
products allow for economies of scale.
Exhibit 2
Global Powder Coatings Market Positions
AB C Co mpan y
6%
W o o de n Sh o e s
1 3%
1 ,0 0 0 O th e rs
4 4%
D e lc o
11%
F
5%
P
4%
G
2%
H
3%
T
3%
V
3%
B
3%
J
3%
Although Europe is the largest market, it represents a mature industry where margins are low
and the Powder Coating product is considered a semi-commodity. Estimated growth rates for the
next five years are approximately 3-4 % per year, while customers are not willing to pay higher
prices for improved technology. In fact, technological improvements are a means to retaining
business rather than increasing prices and margins. ABC holds the number two position in Europe
(behind Wooden Shoes) using low-cost, consistency, an established network of agents and
distributors as well as speedy delivery as its differential advantage.
The North American market is a younger market, and benefits from larger margins, with
estimated growth rates of 6-7% over the next five years. North American OEMs require a higher
degree of technological innovations from their Powder Coatings suppliers, and thus are willing to pay
a higher price per pound. ABC Chemical Company is the market leader in North America,
specializing in highly customized and specialty powders. ABC's strengths are:

Color-matching abilities

Speed of delivery

Innovation

Low-temperature curing powders, which lead to energy savings

Powders that can be applied with a thinner film, thus being able to cover more surface
per pound

A highly-skilled sales force
Asia Pacific is the smallest of the three major markets (with $0.85 billion sales) but offers a
very attractive growth rate of 12-15% per year. Although this is the youngest market, it already
shows signs of price and margins erosion. Customers consider Powder Coatings as a simple means
for painting parts, and place little to no value on technological differentiation. The environmental
benefits of Powder Coatings are also of little importance to the Asian market (due to less stringent
environmental regulations).
The Asian Powder Coatings manufacturers arena is dominated by over 1,000 small
entrepreneurial businesses representing 78% of the market share (See Exhibit 3). Wooden Shoes and
Delco control 9% and 4% of the market. Powder Coatings are used mainly to cover small parts for
export to the industrialized countries. Many American manufacturers that are moving their operations
to Asia in order to capitalize on lower labor and raw material costs fuel the high degree of growth.
ABC's vision is that these manufacturers will require the same degree of service and technology that
was demanded in their North American facilities, thus providing for higher margin sales in the future.
Exhibit 3
Asia Pacific Market Positions
AB C
W oode n Shoe s
D e lco
0%
9%
4%
F
3%
N
3%
D
3%
1,000 + O the rs
7 8%
While ABC decides on the course of action, it will supply Powder Coatings to the Asian
market from its North American manufacturing facilities. Although this is a strategic choice to
establish a presence in the new market, ABC faces losses due to shipping charges and tariffs, as well
as having to lower price in order to compete against local Asian manufacturers capable of producing
at a fraction of ABC's costs.
China – Shanghai Region
The rationale to locate in Asia was driven by several factors, most notably the increasing size and
importance of the powder coatings market in the Pacific region and the ability to enjoy lower labor
costs. Additionally, the logistics of shipping U.S. produced powder coatings to Asia made selling to
the Asian market in a profitable manner impossible. Since this region is home to much
manufacturing as well as several developed and emerging markets, ABC needed to have a production
facility in Asia in order to serve that region. In fact, its major competitors are already operating
there!
When choosing which country in Asia from which to operate, the answer quickly became
obvious: China. China is home to the lion’s share of the manufacturing facilities that require powder
coatings. Traits common to China that are not all present in most other Asian countries being
considered are access to cheap raw materials (petroleum based resins), lower environmental
regulations, competitors and customers are already there and the access to cheap unskilled and semiskilled labor. All of these factors would allow ABC to maximize its profit potential.
ABC Chemical Company had been considering several sites in China, all along its populated
and developed eastern shore (See Exhibit 4). Markets that met the final cut included Guangzhou,
Shanghai and Fuzhou. Each market had its strengths; Guangzhou benefited from its proximity to
Hong Kong, which led to capitalistic laden tendencies in this part of China that might help ABCs
business operations from a functional standpoint. The port provided access to major shipping routes
to the rest of the world, which was attractive to ABC’s customers. Fuzhou had similar attributes and
was close to Taiwan as well. Shanghai was a major port city and in the areas surrounding it, much
manufacturing capability was present and much new construction was taking place.
Exhibit 4
China and Neighboring Regions
In the end,
locate
in
the
Shanghai
ABC chose to
Shanghai
region of China.
While
market
serve
needs,
would
each
ABC’s
management
felt that Shanghai made the most sense based on their current needs and future expectations.
Management guessed that many potential future customers would likely choose to enter China or
expand their presence in China via a Shanghai area production facility. Thus, ABC would be close to
many of its customers and be able to ship to them quickly at a low cost. Furthermore, the
infrastructure between cities in China is quite poor. Shanghai is centrally located along the coast and
thus if land based transportation options broke down, ABC could utilize ocean based shipping
options to serve China. Another important benefit was that Shanghai provided good geographic
proximity to most other Asian manufacturing and consumer markets in Japan, Korea and Taiwan.
Business Practices in China
Ideologically, China is a socialist country, but in an economic sense, the country is displaying some
capitalistic tendencies. The country has been willing to embrace some concept of a free market in
order to foster economic growth. Examples of this relaxing of ideology may be seen simply in the
fact that foreign multinational corporations (MNCs) are operating in the country.
Despite the fact that China has opened somewhat, there are still systems (both stated and
implied) in place, which restrict freedom for economic growth. In the more official sense, China’s
equity markets are closed to private startups and there is widespread piracy, restricting economic
growth. As well, the government maintains price controls in over twenty industries, censures the
press and does not allow full Internet access. Unofficial systems in place in the country, which tend
to impede efficient markets, are the nuances of getting things done, namely bribery and facilitating
payments.
In China, there are many rules, but not necessarily laws. The rules are subject to change at
anytime by anyone, provided you have the right access to government officials willing to alter their
views. Additionally, there are multiple government agencies/ministries with overlapping
jurisdictions. The main government body is known as the State Council, which is the highest
administrative body in the country. Other government agencies that have an effect on commerce,
particularly international trade, include the Ministry of Foreign Trade and Economic Cooperation
(MOFTEC), State Administration for Industry and Commerce (SAIC) and the State Bureau of
International Trade (SBIT).
Political Risk in China
Countries that lack political stability or are inconsistent in the application of laws create a reputation
among international firms that they are more risky. While China has made great efforts to open its
doors to international business, the country is still considered very risky. This is because China does
not have an effective legal system, or reliable commercial code establishing rules of commercial
interactions and obligations. This is due to the fact that situations often fall under the jurisdiction of
multiple government bodies, which often contradict one another. These elements make firms less
willing to invest large amounts of money. While the amount of foreign investment in China is large,
metaphorically speaking, it amounts to no more than a toe in the water with respect to the value these
firms would be willing to invest if the government were run differently.
Code of Conduct in China
Many nations have enacted legislation attempting to control the behavior of domestically
based firms in their operations abroad. Such laws are meant to limit corrupt or immoral behavior in
dealing with other countries. The laws were particularly expected to apply to dealings with second
and third world countries. The most relevant international accords relating to this fact are

The United Nations Universal Declaration of Human Rights – 1948

The European Convention on Human Rights – 1950

The Helsinki Final Act – 1975

OECD Guidelines for Multinational Enterprises – 1976

The International Labor Office Tripartite Declaration of Principles Concerning Multinational
Enterprises and Social Policy – 1977

The United Nations Code of Conduct on Transnational Corporations
Over time, these accords have set up a series of explicit guidelines for the behavior of international
companies in countries in which they operate; outlining codes of conduct, basic obligations and
upholding policies benefiting basic human rights. The broad categories regulated are employment
practices, consumer protection, environmental protection, political payments and basic human rights.
The political payments section is most germane to ABC's entry in to China. The various
accords noted above speak on this topic say the following:

MNCs cannot pay bribes or make improper payments to public officials

MNCs should avoid improper or illegal involvement or interference in the internal politics of
host countries

MNCs should not interfere in intergovernmental relations.
While these guidelines were expected to limit corruption, bribery remains pervasive. The United
States went a step further than the U.N. dictates and passed the Foreign Corrupt Practices Act
(FCPA) in 1977. The law specifically allows facilitation payments, but does not permit bribery. This
law makes it illegal for a U.S. citizen to make a corrupt payment to a member of a government for
the express purpose of having that office grant a contract or other business back to the firm. The law
also includes making payments to intermediaries (who would in turn make bribes on the firm’s
behalf). Penalties for individuals found guilty of the FCPA law include five years imprisonment and
a fine of $100,000. Firms can be fined up to $2 million. Because bribery is often necessary to make
things work in China, many U.S. based firms could not legally do business there.
Potential Target Companies Evaluated
In order to evaluate potential Chinese firms that ABC may partner with, ABC hired the Shanghai
office of PriceWaterHouseCoopers (PWC). PWC was hired to analyze the accounting and business
practices of a number of companies. Two companies, Target #1 and Target #2 (names changed to
protect confidentiality) rose to the top and a synopsis of PWC’s report follows.
PWC reported that part of Target #1's financial information was not reported to government
authorities and tax liabilities were under-recorded and under-paid. In fact, Target #1 keeps two sets
of financial statements. One set of financials is audited and used for external reporting purposes such
as the basis for tax assessments. The second set is used for management reporting and includes
revenue and assets not reported on the external statements. To understand the magnitude of this
phenomenon, PWC provided documentation showing that in the year 2000 Target #1 reported only
33% of sales and 12% of revenue on the external statements.
PWC advised that since a significant portion of the company’s revenue and expenses was not
reported to government authorities, significant tax liabilities (VAT and income tax) are underrecorded and under-paid. In addition, penalties arising from these unreported tax liabilities may be
incurred as the above activities violated the People's Republic of China (PRC) accounting and tax
laws.
Local management further advised the PWC partner that over 60% of Target # 1’s sales were
made to Taiwanese companies.
Most of this revenue was not reported to PRC government
authorities as sales invoices were not issued. As a common business practice in the Shanghai region,
Target #1 has agreements with these customers under which the sales revenue will be collected by
Target #1’s parent company in Taiwan in foreign currencies (Taiwan New Dollars or Hong Kong
Dollars) from the customers’ parent companies in Taiwan. When Target #1 needs cash, management
will bring foreign currencies from its parent company to China without declaring it to customs.
Consequently, these foreign currencies will be exchanged into Yuan Renminbi (Chinese Currency,
Rmb) in the black market. As these transactions violated the PRC foreign currency administration
regulations, significant contingent liabilities exist.
Another major issue is the treatment of the Value Added Tax (VAT). As required by certain
customers, VAT invoices were not issued so that those customers can report less revenue and VAT
liabilities to government authorities.
Management advised that it is a common business practice in Shanghai that suppliers are
requested not to issue sales (VAT) invoices to customers. In 2000, 67% of Target # 1’s sales did not
have VAT invoices. This enables customers to exclude these purchases from their official accounting
records and consequently exclude sales revenue from the official accounting records and report less
tax liabilities to government authorities.
As this practice is not consistent with ABC's Code of Business Conduct, the risk of losing
customers and sales revenue exist should ABC Chemical Company take over Target #1’s business
and insist on issuing VAT invoices to customers. As a consequence, the following may occur:
1. Customers may terminate business with ABC Chemical Company as VAT invoices are audit
trails which may raise the suspicion of the tax authorities and lead to the eventual discovery
of the previous improper practices.
2. Customers may be unwilling to pay VAT for purchases from ABC Chemical Company as
they do not need input VAT to offset their VAT liabilities. Accordingly, ABC may have to
absorb the VAT as part of the cost of sales. This will lower ABC Chemical Company’s gross
margin. (For example, if Target # 1 had to absorb VAT for customers in 2000, its gross
margin would be lowered from 17% to 6%).
Furthermore, during a plant visit, PWC noticed returned and obsolete inventories. However,
no provision for inventory obsolescence was made. Management estimated the costs of these
obsolete or returned inventories to be Rmb 640,000. These inventories either had quality problems or
did not have market demands. As these inventories will be of little value to ABC, ABC may wish to
consider excluding these aged inventories from the proposed acquisition. Local Management
acknowledged that Target #1 has been utilizing obsolete inventories in production and this could
cause quality problems. Accordingly, sales returns and quality disputes may occur in future. In 2000,
sales returns accounted for 2.5% of total sales.
PWC partners also found that Target #1's management has also been understating the
reserves for doubtful accounts, and overstating assets. Both accounting practices should be carefully
examined by ABC company, as they have the effect of inflating the market value of the Target
company. Additionally, in 1997, Target #1 purchased certain equipment and machinery from its
investor in Taiwan. These assets were exempt from VAT or custom duties according to PRC tax
regulations. However, the exempted VAT and custom duties would become payable if these assets
are sold within the next 6 years.
Other matters of concern are the following:
1. Target #1 provides kickbacks to customers to boost sales. Although management indicated
that kickback payments to customers were not a key incentive to promote sales, as most of
the customers are private companies, the amounts recorded over the previous two years
would be considered material by government officials.
2. Over 60% of sales are made to Taiwanese companies. Management stated that Taiwanese
firms prefer to do business with other Taiwanese firms due to cultural reasons and flexible
payment arrangements and acknowledged that it was very difficult for non-Taiwanese
companies to sell products to Taiwanese customers. Accordingly, the risk of losing
Taiwanese customers may exist if ABC Chemical Company acquires Target #1.
3. A proper accounting system has not yet been established in Target #1. Some accounts do not
have accounting ledgers and financial statements are prepared manually from vouchers at
period end. Additional investments to improve working efficiency will be required if ABC
Chemical Company acquires Target #1.
PriceWaterHouseCoopers was also involved in analyzing the business practices of a second
Chinese based company named Target #2 (name changed to maintain confidentiality). Many of the
issues found at Target #2 were similar to those affecting Target #1.
Target #2 also keeps two sets of financial statements; one for external and tax purposes, and
one for management. Furthermore, as seen with the first target company, this enterprise does not
issue VAT invoices in their entirety. In fact only 20% of sales are invoiced. However, in early 2001,
Target #2 issued more sales invoices and only 37% of its sales did not have VAT invoices.
Management advised that the reason for issuing more invoices and paying more VAT was to make
local tax authorities believe that it was a good taxpayer so as to avoid a comprehensive tax audit.
This approach also led Target #2 to request its suppliers to invoice a higher percentage of their
purchases in order to offset the VAT charged to its customers. This created some tension with Target
# 2's supplier base.
As stated above, if ABC Company takes over the operations of Target #2 and insists on
issuing VAT invoices in their entirety, customers may terminate their business relationship since
VAT invoices are audit trails that may raise the suspicion of the tax authorities and lead to the
eventual discovery of the previous improper practices. Another option would be for ABC Chemical
Company to absorb VAT into their cost of sales, thus lowering the overall profitability of the
operations.
As with Target #1, obsolete inventories and inadequate accounting systems were observed
during the analysis of Target #2. Kickbacks, although in lower amounts, are also paid to employees
of their customers as a way to attract and retain business.
William’s Dilemma
As William’s plane flies over the Bering Sea after two weeks in China, he reviews the
independent auditor’s report on ABC’s two target companies. His meeting with the CEO is only 12
hours away and he is concerned about his presentation. William’s dilemma is that ABC must either
enter at the sacrifice of their company code of conduct or delay entry by two years and lose money
on current customers in that time.
Discussion Questions
1. Should ABC enter the Asian market?
2.
Because of the Code of Conduct that ABC adheres to, there were no appropriate joint venture
candidates with which to partner. Why not operate in Taiwan or Korea and then export to China?
3. Is there anything that ABC can do to enter China with a Joint Venture partner and still operate
within its Code of Conduct?