Section 1 - Corporations

Case Study 1.1 Alibaba and Ant Group Developing a Hybrid Chinese-International E-commerce Platform Ecosystem

Colin Hawes

1 Overview

This case study uses Alibaba/Ant Group as an example to show how the meteoric growth of e-commerce and the platform economy in China has transformed the way that business is done and has made Chinese consumers into some of the world’s most active online sellers and purchasers. It focuses especially on the constantly evolving interactions between Alibaba/Ant Group, the Chinese government, and international investors, providing evidence of the complexities of these relationships and pragmatic compromises required on all sides. The case study demonstrates that the expansion of large Chinese corporations within China and overseas, as well as their occasional setbacks, cannot be understood without a broader knowledge of the legal structures underpinning cross-border investment and awareness of the multiple competing political interests in China.

The case also gives insights into the multinational links of Chinese e-commerce firms, such as international buyers purchasing Chinese goods online through Taobao and AliExpress, investors buying Alibaba’s shares on the New York Stock Exchange (NYSE), and Alibaba acquiring e-commerce firms overseas, especially in Southeast Asia and developing countries elsewhere.

Finally, the case explains how e-commerce platforms like Alibaba/Ant Group evolved into numerous business sectors, especially online banking and financial services. Their huge size and financial complexity have led to some negative impacts and systemic risks, and this in turn has caused the Chinese government to regulate these e-commerce and fintech firms more tightly.

2 Introduction

This case study explores the meteoric growth of Alibaba/Ant Group, one of the most successful private Chinese e-commerce and financial technology (fintech) platforms. While these online platforms have opened up a whole new channel for small and medium-sized enterprises (SMEs) to do business within and outside China, creating tens of millions of new jobs, the sheer speed and scale of their growth has magnified key defects of the Chinese SME ecosystem, especially endemic fraud, product safety issues, and intellectual property violations. Because Alibaba’s e-commerce platforms now extend to more than 190 countries and regions throughout the world, both through overseas direct investment (ODI) and through providing efficient channels for global import/export direct from producers to consumers, these issues clearly create concerns well beyond China’s borders.

The case study focuses especially on the constantly evolving interactions between Alibaba/Ant Group, the Chinese government, and international investors, providing evidence of the complexities of these relationships and pragmatic compromises required on all sides. The case study demonstrates that the expansion of large Chinese corporations within China and overseas, as well as their occasional setbacks, cannot be understood without a broader knowledge of the legal structures underpinning cross-border investment and awareness of the multiple competing political interests in China – what I call the “Chinese corporate-political ecosystem.”

The case study starts with a brief review of Alibaba/Ant Group’s main businesses, demonstrating how they have transformed the Chinese commercial landscape and facilitated the rapid growth of SMEs and the private economy. The growth of Alibaba/Ant and other massive Chinese platform firms, and their expansion overseas, could not have occurred without large-scale capital from international investors. This, in turn, has relied on their ability to establish so-called variable interest entities (VIEs) listed in the United States, tacitly permitted yet technically illegal (under PRC law) hybrid structures that continue down to the present. The case study explains how this structure works, the hands-off regulatory role of the Chinese government, how it has facilitated rapid expansion within China and ODI through acquisitions – especially in Southeast Asia – and its legal and political risks.

Besides enabling e-commerce, Alibaba/Ant Group’s platform business has also diversified incredibly rapidly into a wide range of financial services, some providing the essential lifeblood for legitimate businesses while others are highly speculative and risky. The case study shows how Alibaba/Ant Group has benefited from gray areas in financial regulation and used its access to extensive customer data to offer financial and investment products to hundreds of millions of users, in collaboration with more than 100 banks and some 6,000 other financial firms.

While initially adopting a hands-off approach to platform finance, more recently the Chinese government has tightened regulations in response to widespread online fraud, official corruption, and numerous financial and e-commerce scandals. The abrupt suspension of Ant Group’s initial public offering (IPO) in 2020 was an integral part of this more interventionist approach.

3 The Case

3.1 Creating a Platform for International Trade and Domestic E-commerce: Alibaba’s Initial Growth

Alibaba’s first business venture was a simple platform website where small Chinese manufacturers could post information about their products in English, allowing internet users around the world to easily locate potential Chinese suppliers. Jack Ma and seventeen founding partners (including six women) established the business in an apartment in Hangzhou City in February 1999.¹

Hangzhou is situated in Zhejiang Province, which by the late 1990s had become home base for around ten million private firms – mostly small, efficient manufacturers of light industrial and consumer products, from socks to ball bearings and anything in between. Many had evolved out of so-called township and village enterprises (TVEs), former collective firms that sprung up in their millions after the Chinese Communist Party (CCP) relaxed its rules on state ownership in the early 1980s.²

Many businesses were keen to attract international buyers, but their knowledge of computers and access to the internet was still extremely limited. Out of China’s population of 1.2 billion in early 1999, only 2 million were internet users, mostly in larger cities like Beijing and Shanghai. Fortunately for Alibaba, these numbers expanded exponentially; by 2009, internet users had already surpassed 300 million, and by 2020, they reached 989 million.³

In early 2000, Alibaba managed to raise a combined US$25 million from a Goldman Sachs consortium and Japan’s SoftBank in return for 80% of its shares.⁴ This vital capital injection allowed Alibaba to ride out the dot.com crash and greatly improve the functionality of its platform website. It also added a Chinese-language site for small businesses to sell wholesale products to traders within China, which is now called 1688.com.⁵

Alibaba expanded very quickly, and it continues to connect both Chinese and international wholesale suppliers with buyers through several sub-platforms in more than 190 countries and regions. Enough clients are willing to pay premium fees to make it a profitable business, accounting for 5% of Alibaba’s revenues in 2020.⁶

However, Alibaba’s business did not really take off until 2003, when it launched a platform for Chinese businesses and entrepreneurs to sell products online to domestic consumers – a kind of Chinese Amazon. China’s bricks-and-mortar retail industry was underdeveloped, especially in smaller cities and towns: products were limited, and prices were high due to inefficient distribution. Alibaba set up Taobao, which allowed individual sellers and small businesses to advertise their products, arranged into easily searchable product categories on the Taobao website.⁷ Larger brands soon realized the benefits of e-commerce too, and they paid Alibaba to create virtual storefronts on its Tmall (Tianmao) site.⁸

Taobao had initially faced stiff competition from eBay, which had entered China by acquiring a local e-commerce startup called Eachnet in 2003.⁹ However, eBay/Eachnet was unable to keep up with Taobao due to various cultural and technical failures, not least its inability to establish a secure and efficient online payment system.¹⁰ Alibaba overcame the payment problem, setting up a fully digitized system called Alipay that allowed customers to make payments for online purchases via their computer (or, from 2012 onward, via mobile phone), and the money was withheld from sellers until delivery was confirmed.¹¹

The convenience and sheer volume of online traffic made Alipay highly profitable despite very low transaction fees. Alipay’s user numbers have now climbed to more than a billion, including online/mobile payments and “offline” payments made at millions of shops and service outlets throughout China (restaurants, hotels, taxis, ticketing agents, even rural farmers’ markets).

In 2011, Alipay was spun off into a separate company, Ant Financial (later renamed Ant Group), but Jack Ma remained its controlling shareholder, and Alibaba currently retains a one-third stake in Ant Group. Ant Group’s revenues from Alipay fees in 2019 totaled almost RMB 52 billion (US$8 billion).¹²

If we view the Chinese economy as a highly complex system of circulating capital, goods, and labor, the success of Alibaba/Ant Group has come from identifying the most serious blockages within that circulatory system and using the power of the internet and digital technology to open up the flows. Typical early blockages included (1) the difficulties of small Chinese manufacturers/traders to connect with foreign wholesale buyers and even Chinese buyers outside their local regions; (2) the high prices (or unavailability) of consumer goods outside the largest urban centers; and (3) the trust deficit with online payment systems.

Alibaba (and Ant Group) refer to themselves as an “ecosystem,” and the firm does now consist of a complex network of subsidiaries and affiliated companies in diverse sectors, with more than 250,000 employees.¹³ However, the firm’s success cannot be divorced from the broader corporate, financial, and regulatory ecosystem within which it operates, and it is more accurate to say that Alibaba/Ant Group provides channels to open up the flow of goods and capital within that broader corporate-financial circulatory ecosystem, both in China and overseas.

Though Jack Ma and Alibaba’s other founders were quick to spot the potential of this “online platform” business model, and they worked incredibly hard over two decades to constantly adapt and extend its functions and revenue sources, they could not have succeeded without the coevolution of the Chinese commercial system and technological infrastructure, which was facilitated by Chinese government policy initiatives.

First, from the late 1990s, the Chinese government’s “informatization” policy funded a massive expansion of broadband and mobile communication networks.¹⁴ Second, the frenzied expansion of the private sector during the 1990s, which was also encouraged by the government as it downsized the state sector, provided Alibaba with a huge potential customer base of sellers among SMEs and coincided with greater disposable income of Chinese consumers due to rising living standards, not to mention private logistics firms to deliver goods efficiently.¹⁵

Third, there was also the reform of the Chinese banking system to introduce market competition from the late 1990s onward, including setting up more than 100 local city commercial banks hungry for new sources of revenue. These state-owned banks were highly receptive to collaborating with Alipay because its millions of online transactions gave them access to fees from customers who would otherwise have remained underserved by the banking system.¹⁶

Fourth, there were supportive government incentives encouraging Chinese manufacturers to export their products overseas, as well as growing awareness among CCP officials that private firms were key drivers of GDP growth. As a crucial “platform” facilitating this growth and an exemplar of Chinese hi-tech innovation, Alibaba received numerous visits and statements of support from local CCP leaders, including Xi Jinping when he was Party Secretary of Shanghai in 2007.¹⁷

Finally, inbound foreign investment was pivotal to Alibaba’s survival in its first decade, and the government’s pragmatic attitude toward partial foreign control of internet technology firms (discussed in Section 3.2) allowed Alibaba and other private tech firms to actively seek overseas capital funding when Chinese state banks and stock markets were still focusing their attention primarily on state-owned enterprises (SOEs).

At the same time, the contradictions and fragmentation within the Chinese political/legal ecosystem, the poorly regulated helter-skelter expansion of e-commerce and online banking, and ruthless competition among Chinese technology firms have harmed Alibaba/Ant Group’s reputation and potentially increased financial risks for the Chinese economy. The following sections explore these risks and negative impacts, beginning with Alibaba’s mutant hybrid corporate structure.

3.2 Foreign Funding with Chinese Management Control: Alibaba’s VIE Structure and Fragmented Authoritarian Politics

Despite extensive economic reforms and relative openness to foreign trade and investment, the CCP continues to strictly censor and control all media content in China, including newspapers, magazines, television, and movies. With the massive expansion of the internet and online news via social media, Chinese government censorship has extended its tentacles to cover all online content and to block politically sensitive foreign websites and social media from being accessed in China.¹⁸

This government censorship is also exercised through restrictions on foreign ownership of Chinese “value-added telecom services,” which includes any “internet content providers” (ICPs).¹⁹ In theory, therefore, no “foreign-controlled” ICP firm should be granted a license to operate its business in China, including e-commerce firms like Alibaba who own video streaming and media businesses.

Despite this, most large “Chinese” private internet technology firms are controlled by foreign corporations listed on American or international stock exchanges. Yet all of them have managed to obtain Chinese ICP licenses. How did this paradoxical situation arise and why has it persisted for more than two decades?

Alibaba, for example, was first incorporated in 1999 as a Cayman Islands company, Alibaba Group Holdings Ltd., and during the early 2000s the majority of its shares were held by foreign investors, with the rest (around 20%) issued to Alibaba’s Chinese founders and employees, including CEO Jack Ma.²⁰ Even since its IPO in 2014, Alibaba remains majority-controlled by a broad range of international investors.²¹ How did Alibaba get around the Chinese restrictions on foreign-controlled ICPs and telecom services?

Like other private tech firms, it used a legal sleight of hand called a variable interest entity (VIE): see Figure 1.1.1.

Figure 1.1.1 Alibaba Group VIE ownership structure

Cutting through the legal jargon, the VIE structure involves a set of agreements between the Cayman Islands firm Alibaba Group Holdings and several Chinese corporations. These Chinese corporations currently have only five shareholders who are all Chinese citizens, so the corporations are permitted to hold the ICP and telecom licenses.²²

However, the Chinese corporations and their shareholders have agreed to give all the benefits of their ICP/telecom and other licenses to Alibaba and to allow Alibaba to make all decisions on behalf of the Chinese corporations. In other words, even though Chinese corporations technically own the licenses, a foreign corporation (Alibaba Group Holdings) can oversee every major decision made by the Chinese corporations and receive all financial revenues through a series of contracts, just as if it was a 100% controlling shareholder of the Chinese corporations.²³

In other words, we see a kind of mutant hybrid corporate structure – a pragmatic compromise – that allows substantial foreign investment in these technology firms through majority shareholding, yet without giving up day-to-day management to non-Chinese shareholders or allowing them to directly own the licenses that are prohibited or restricted from foreign investment.

This VIE structure is purely designed to get around the restrictions on foreign ownership of Chinese licenses, and its legality remains uncertain.²⁴ Yet it is a very common structure among private Chinese technology firms. By 2010, more than 100 offshore-listed Chinese firms had used this structure to obtain their ICP and telecom services licenses from relevant government ministries.²⁵

Several factors will likely perpetuate this pragmatic but unwieldy regulatory fudge. China’s security establishment is still unwilling to allow direct foreign control of internet providers, yet the Chinese government relies on these private online platform firms to boost economic growth and provide tens of millions of jobs to Chinese workers and entrepreneurs. The firms are also highly reliant on foreign capital to maintain their rapid expansion.

However, it is not clear whether Chinese courts would enforce the VIE contracts when disputes occur, making investors entirely dependent on the personal integrity and goodwill of the corporations’ founders or senior managers.²⁶ More recently, the Chinese government has launched intrusive “cybersecurity investigations” into several large VIE firms on “data security” grounds, including the ride-hailing firm Didi Chuxing, leading to sudden market delisting, losses, and shareholder lawsuits.²⁷ It is unnerving to think that hundreds of billions of dollars of foreign investment in Chinese technology firms relies on such shaky legal and regulatory foundations.

A similar lack of regulatory clarity has allowed various online fraud and financial scandals to emerge over the past decade, which we will discuss after tracing the further breakneck expansion of Alibaba/Ant’s ecosystem.

3.3 ODI and Alibaba’s VIE Structure: Acquisition of Lazada in Southeast Asia

Besides its useful function as a conduit for raising money from international investors, the foreign-listed VIE structure also directly facilitates ODI in the form of overseas acquisitions by Chinese private firms. The Chinese government still imposes capital controls on foreign exchange – in other words, restrictions on Chinese individuals and corporations converting RMB into US dollars or other currencies. Exceptions are made for ODI that is encouraged by the Chinese government, but for private firms that may prefer to invest for their own purely commercial reasons, an overseas listing can give them direct access to US dollars, which can then be channeled into acquisitions without the need for foreign exchange approval.

Alibaba’s 2014 IPO provides a clear example, as the company’s prospectus stated that the net proceeds raised from the NYSE listing would be used “outside of China, and [we] do not expect to transfer such funds into China.”²⁸ By 2018, Alibaba had invested around US$4 billion of those proceeds to acquire full control of Lazada, which is Southeast Asia’s largest e-commerce platform, operating in Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Vietnam.²⁹ With Alibaba applying its advanced online platform, payment system, and logistical software to improve Lazada’s efficiency, not to mention extensive marketing campaigns, this acquisition immediately gave the company a commanding market share in the whole region and significantly increased the use of e-commerce by local consumers for their purchases. Some local intermediary merchants have since complained that Alibaba is using its market power to squeeze out the competition, similar to its alleged monopoly practices in China.³⁰

Alibaba also used its IPO funds to acquire local e-commerce companies in several other countries or regions, including Indonesia, Turkey, and South Asia, and to invest in a joint venture with three local firms in Russia. Most of these businesses will be operated under the AliExpress brand, which links international online consumers with commercial sellers in China and dozens of other countries.³¹

The potential benefits for Alibaba from this type of ODI are huge, especially in developing countries: Southeast Asia alone has a population of more than 630 million, with rapidly increasing access to mobile phones and the internet and more room for future expansion than the highly competitive domestic Chinese e-commerce market.³² At the same time, by creating efficient channels connecting domestic Chinese sellers, many of them SMEs, with international buyers, Alibaba continues to stimulate economic growth in China and (along with other large private Chinese firms) solves a perennial headache for the Chinese government of providing employment opportunities for its enormous population.³³

3.4 Alibaba/Ant Group’s Expanding Fintech Ecosystem: “Trust,” Credit, and Data

The Alibaba/Ant Group has consistently billed itself as a firm (or “ecosystem”) that promotes trust and integrity.³⁴ To a certain degree this is true, but the broader fragmented political and economic ecosystem within which it operates has facilitated numerous instances of fraud that the company must constantly try to stamp out. In the process of dealing with these trust issues, Alibaba/Ant Group has collected a gargantuan mass of data about its users, which it now employs to identify and target businesses and consumers for each of their new products and to guide their behavior.

In terms of building trust, we noted how Alipay provided a secure online payment system that would not release funds to sellers until buyers had approved the goods received. This system increased user confidence in e-commerce but still left gaps for potential fraudsters. Alibaba/Ant realized that the data it collected on its sellers and their transactions, along with buyer ratings, complaints, and lawsuits, could be used to fill these gaps by calculating a comprehensive “trust score” for each seller (also known as a Sesame Credit Score). Having a high trust score would make a seller more attractive to buyers, whereas a low trust score would lead to warnings and ultimately exclusion from Alibaba’s e-commerce platforms.³⁵

Alibaba/Ant’s most important and financially lucrative insight was that they could then employ this extensive data on hundreds of millions of users to diversify into financial services. To start with, they could offer small business loans to their merchants who had high trust scores and had achieved certain revenue levels and numbers of successful transactions. This kind of short-term finance was crucial for SMEs to survive and expand their operations, but state banks were not interested in lending amounts less than RMB 1 million at a time (around US$200,000) due to high administrative costs and risks of default, whereas SMEs on average only required loans of RMB 36,000.³⁶

By June 2020, Ant Group’s small business loan program had expanded very rapidly, approving credit for around 20 million SMEs in the previous twelve months, with a loan balance of more than RMB 400 billion (US$61 billion) through its private bank subsidiary MyBank.³⁷

However, Ant Group’s largest revenue generator is not SMEs but consumer credit and loans. Since 2014, Ant has used its trademark data-crunching methods to develop a kind of virtual credit card for Alipay/Alibaba users called “Huabei” (which means literally “Why not spend?”). In 2015, Ant also introduced a consumer small loan program called “Jiebei” (literally “Why not borrow?”).³⁸

These two consumer credit products filled another large gap for the majority of Chinese people who didn’t meet the criteria for bank loans or credit cards or wanted a quicker and simpler way to borrow money. Huabei and Jiebei generated an incredible credit balance of more than RMB 1.7 trillion by 2020 (US$262 billion), around four times the amount of Ant Group’s SME loan balance.³⁹

The other crucial plank in Ant Group’s evolving financial services ecosystem is investment and wealth management products (WMPs). Interest rates for depositors at traditional Chinese banks are very low, so Ant developed a low-risk money market fund in 2013 called Yu’ebao (literally “Leftover Treasure”) that allowed their Alipay users to deposit their unused e-wallet cash balances and earn interest higher than a bank account, while having instant access to the money via their Alipay mobile phone app. Yu’ebao soon became the largest money market fund in China with more than 600 million users. Ant Group earns money from the spread between deposit rates and its own investment of the funds.⁴⁰

Ant has also promoted a wide range of higher risk mutual funds and other WMPs to online users through its InvestmentTech apps, aimed at China’s growing middle classes. For most of these products, Ant acts as an intermediary, first vetting investment firms and working with them to develop online consumer products, then mining Ant’s user data to target those in the right income brackets who would be likely to invest in specific funds. Ant receives a “technology services fee” from the fund management firm for locating and recommending the investors. By mid 2020, Ant was already working with around 170 asset management firms, including mutual fund companies, insurers, banks, and securities firms, to offer more than 6,000 products through Ant’s platform.⁴¹

The total amount under investment in Yu’ebao and other investment products offered through Ant’s platform by June 2020 was a staggering RMB 4.099 trillion (US$633 billion), and its revenues from InvestmentTech amounted to RMB 16.9 billion (US$2.61 billion) in 2019, or 14.9% of Ant’s total revenues. Clearly, Ant has become a major financial services conglomerate in its own right and has developed a huge customer base in the hundreds of millions.⁴²

Although Alibaba only owns one-third of Ant Group’s shares, one reason that Alibaba and Ant refer to themselves as an “ecosystem” is that their various businesses constantly interact and feed off each other in a kind of symbiotic relationship: see Figure 1.1.2. Ant Group’s success has therefore depended to a great extent on Alibaba’s ability to develop new lines of business and constantly attract new users previously neglected by traditional business networks.⁴³

Figure 1.1.2 Alibaba/Ant ecosystem

Other sectors that Alibaba has expanded into include cloud computing services for businesses (Alibaba Cloud, or Aliyun); logistics and product delivery (Cainiao Network); fresh food delivery and smart supermarkets (Freshippo and Fengniao); online restaurant ordering and delivery (Ele.me, literally “Are you hungry?”); as well as travel ticketing and bookings (Fliggy).⁴⁴

Finally, the company has also ventured into pharmaceutical sales and healthcare through AliHealth, mostly focused on online ordering and delivery of safe medical drugs using blockchain and QR codes, to counter the dangers of fake medicine suppliers, which is one of the deepest concerns of Chinese consumers along with tainted food.⁴⁵

These are just some of the key business sectors that Alibaba/Ant has expanded into over the past decade. Their aim is to provide a so-called “seamless” group of business and lifestyle apps that are all integrated and downloaded onto users’ mobile phones, so that virtually all their daily life activities will be conducted through an Alibaba or Ant Group platform. As Alibaba put it in a recent Annual Report, “we envision that our customers will meet, work and live at Alibaba.”⁴⁶

Like any natural ecosystem, Alibaba/Ant is also continually testing, negotiating, and breaking through the boundaries that separate its own ecosystem from others. Is a small business that sells most of its products online through Taobao/Tmall and distributes them through the Cainiao Network, while paying for promotion by Alimama, storing its data on Aliyun, receiving payments through Alipay, obtaining loans from MyBank, and investing its profits in one of Ant Group’s sponsored WMPs really independent, or is it simply a component element of Alibaba/Ant’s ecosystem? Has this mutant hybrid (Chinese-foreign) superstructure evolved so quickly and sucked in so many diverse entities that it is now beyond effective control by the supposedly powerful CCP and Chinese government – even, possibly, beyond the control of its own managers? As the next section shows, there is strong evidence that this has already happened, and that the Alibaba/Ant monster cannot be fully tamed. All that government regulators (and Alibaba/Ant itself) can hope to do is act strategically, using market discipline whenever possible, to address its worst abuses and mitigate the potential systemic risks that emerge from all directions.

Of course, Alibaba/Ant is not the only entity seeking to occupy these business niches. It faces fierce competition from other private Chinese firms such as Tencent, JD.com and Meituan. Yet this only increases the urgency of consistently regulating these new corporate ecosystems.

3.5 Alibaba/Ant Group’s Scandals and Tussles with Chinese Regulators

The main problem with being primarily a “platform” or channel business “ecosystem” is that when user numbers expand rapidly into the hundreds of millions, it becomes extremely difficult to monitor and control their negative behavior.

Alibaba has long faced criticism for failing to prevent fraudulent activities on its platforms. The US Trade Representative (USTR) has been especially vocal about counterfeit products sold on Alibaba.com and Taobao, especially those that impact consumer safety, such as fake medicines, contaminated pet food, and children’s toys. Both platforms have been placed on the USTR’s list of “notorious” infringing copyright/trademark markets from 2008 to 2010, and again from 2016 to the present.⁴⁷

The Chinese government has also repeatedly censured Alibaba through its corporate regulator, the State Administration for Market Regulation (SAMR).⁴⁸ A 2015 White Paper briefly posted on the regulator’s website claimed that only 37% of sample purchases in its investigation of Taobao could be considered authentic products.⁴⁹ Far from meekly accepting the censure, Alibaba publicly criticized what it called the regulator’s flawed and biased investigative methods, and the White Paper was abruptly removed from the regulator’s website. The lack of official sanctions demonstrated the company’s strength and the government’s reluctance to punish the company for fear of impacting China’s economic growth.⁵⁰

Several features of the broader Chinese corporate-political ecosystem combine to make Alibaba’s task of ensuring “trust” virtually impossible. First, the Chinese government itself is highly fragmented, with local government officials and police frequently turning a blind eye to counterfeit manufacturers in their regions, either because of the employment/tax revenues they provide or because of well-placed bribes aimed in their direction.⁵¹ Second, despite the Chinese government’s reputation as an all-seeing force that can track every citizen’s online identity, it is still very common for users to create fake internet and social media accounts to engage in fraud.⁵² Third, during its incredibly rapid growth phase, more than 100,000 new merchants were signing up to Taobao every day, and it is very difficult to predict which of them will become fraudsters.⁵³ Fourth, Alibaba and other Chinese e-commerce firms provide indirect employment to millions of honest SME owners and significantly boost China’s economic growth, something China’s SOEs have failed to do.

In other words, these aspects of the Chinese corporate-political ecosystem have led to a kind of symbiotic codependency of the Chinese government on private firms, limiting its regulatory capacity to situations where firms might endanger the financial or social stability of the whole society or directly threaten the CCP’s rule.

The limits of government control are clear from two other major scandals involving Alibaba. The first was its use of market power to engage in monopolistic and anti-competitive practices. Merchants who refused to sign exclusive agreements with Alibaba would be penalized on Tmall/Taobao by adjusting search algorithms to prevent customers from locating their storefronts; or their orders would not be fulfilled efficiently; or their accounts would be temporarily suspended on Alibaba and Ant Group’s various sites to disrupt their businesses. These practices had been ongoing since at least 2015, and the firm had repeatedly ignored government warnings, but it was only in April 2021 that the SAMR finally fined Alibaba RMB 18 billion (US$2.8 billion) for breaching the PRC Anti-Monopoly Law.⁵⁴

This was the largest financial penalty ever exacted on a corporation in China, but it was only 4% of Alibaba’s 2019 sales revenues, so it will not have a major impact on the firm’s finances, not least because Alibaba’s main competitors like Tencent, JD.com, Didi Chuxing, and Meituan were also penalized.⁵⁵

The SAMR’s future ability to control abuses of market power will continue to be limited by its own understaffing as well as resistance by numerous powerful state and private interests who benefit from Alibaba’s continuing expansion and profitability.⁵⁶

The other major tussle with the government was the sudden suspension of Ant Group’s planned IPO on the Shanghai STAR Market and Hong Kong Stock Exchange. This was a major shock, as the IPO was expected to become the largest ever global public offering, raising around US$34 billion from investors.⁵⁷

Some claimed that this “crackdown” was a first step in the CCP’s plan to renationalize private technology firms, but this has not occurred.⁵⁸ A more plausible explanation is that Ant Group had consistently neglected warnings about the financial risks of its breakneck expansion. With the increasing liberalization of China’s financial services industry, especially since 2010, numerous state banks and other firms (both SOEs and private) have offered a broad range of retail investment products.⁵⁹ An increasingly large portion of their business has come from products marketed through Ant Group or Alibaba’s platforms. When promoted in this way, it is not clear to investors whether they are investing in an Ant-backed fund or a third-party fund.⁶⁰

The fact that more than 6,000 financial products are now offered on Alibaba/Ant’s platforms involving huge numbers of borrowers/investors with rudimentary investment knowledge triggers anxiety among regulators about potential social instability. Numerous collapses of large financial firms have occurred in recent years due to corruption and reckless growth. There have also been hundreds of peer-to-peer lending scandals in which millions of ordinary investors lost their savings, with many protesting outside the headquarters of the People’s Bank of China (PBOC) in Beijing.⁶¹ And high-risk WMPs have often involved huge amounts of unauthorized local government borrowing and guarantees, which has worsened a massive local government debt crisis.⁶²

Ant Group claims that its sophisticated online data analysis can carefully vet investment products to minimize risks.⁶³ PBOC’s officials were not convinced by these assurances, as they had already encountered numerous situations where third-party investment funds had collapsed, leaving investors without their life savings and totally confused about why they could not seek compensation from the platforms that had marketed the funds to them.⁶⁴

This explains the sudden suspension of Ant Group’s IPO until it implemented tighter regulations requiring these platform firms to adopt similar risk-control measures as banks.⁶⁵ Rather than viewing this as a power grab by the CCP, or an attempt to stifle private enterprise, it is more accurate to see it as a struggle between financial regulators, especially the PBOC, which justifiably fears financial instability, and powerful technology firms working in conjunction with financial service SOEs, who utilize big data to maximize their profits and channel customers’ savings into all manner of financial products. To claim that this is a battle between government and private enterprise is to ignore the fact that powerful state interests are involved on both sides of the struggle.⁶⁶

We will conclude with an analysis of this complex codependent relationship that has evolved between Alibaba/Ant Group and the Chinese government/state at many different levels.

4 Conclusion: Alibaba/Ant Group and China’s Codependent Corporate-Political Ecosystem

Despite Alibaba/Ant Group’s regular run-ins with Chinese regulators, it has become an indispensable private sector partner to the CCP by promoting the Party’s policies of economic growth, entrepreneurship, and poverty alleviation among hundreds of millions of lower-income and rural Chinese citizens. Of course, while this approach may indirectly help to guarantee the CCP’s hold on power, it also greatly benefits Alibaba/Ant’s own bottom line, and makes the CCP (and broad swathes of the Chinese populace) highly dependent on Alibaba/Ant’s continuing growth and success.

Like many large private firms, Alibaba set up an in-house CCP branch (in 2008), which had attracted 2,094 members by 2017, around 4% of total employees.⁶⁷ However, being a CCP member within a private firm does not necessarily mean prioritizing the Party’s interests over the interests of the firm, especially as these CCP members are not paid by the Party but are full-time employees or managers of the firm, with a vested interest in maximizing the firm’s profits. For example, Alibaba’s CCP Secretary, Shao Xiaofeng, was ranked at number 277 on the Forbes 2020 list of richest Chinese people, with an estimated net worth of RMB 14 billion (US$2.16 billion), due to the value of his shares in the company.⁶⁸ Former CEO Jack Ma, ranked number one on the Forbes 2020 China rich list with a net worth of around US$42 billion, has also been a CCP member since his university days.⁶⁹

Though the firm’s profits may come first, these political links and the necessity of maintaining a positive relationship with the CCP mean that the company will frequently assist the CCP to implement its policies and maintain its legitimacy. The most obvious contribution is through opening markets and distribution channels for tens of millions of SMEs, helping them to sell their products and services, and removing many obstacles that blocked the flow of capital, goods, and resources and prevented SMEs from accessing bank loans. This was something the CCP had failed to achieve through its traditional state banks and logistical networks, despite its claims to be the Party of the common people.

Alibaba/Ant is also helping to tackle other social issues that have threatened social stability and the CCP’s legitimacy, such as high costs of healthcare (through its cheap insurance products), food safety (through blockchain-secured food supply chains), and rural poverty (through working with hundreds of local governments and telecom SOEs to bring e-commerce supply and distribution networks to remote villages, as well as assisting farmers to market their produce online to customers who would otherwise never see them). Despite its regulatory run-ins, in February 2021 Alibaba still won an award from the CCP for being an “advanced model enterprise” due to its poverty alleviation efforts.⁷⁰

Like other private technology firms, Alibaba/Ant has also assisted with the CCP’s attempts to improve governance through technology, especially at the local level. For example, they have codeveloped tax payment and other government apps linked to Alipay and helped to improve enforcement of court judgments by cooperating with local courts to blacklist defaulting judgment debtors on Alibaba/Ant’s platforms until they repay their debts, or to prevent them from buying luxury items like plane or high-speed rail tickets.⁷¹

Behind all these activities is the ever-looming potential risk that these private Chinese firms will fall foul of powerful CCP leaders, or that CCP policies will abruptly change, leaving them without a viable business, as occurred in recent years with many of China’s largest private tutoring firms.⁷² Even a few unguarded criticisms of government policies in a public speech can lead to a private technology firm’s founder being called in for a “chat” with powerful government officials and forced to stay out of the public eye for months, as occurred with Jack Ma in 2021. Large private Chinese firms like Alibaba/Ant must therefore constantly seek to make themselves indispensable to the government to reduce their vulnerability to political risks.

All these evolving interactions point to a highly codependent private firm/government corporate-political ecosystem. Yet to conclude that this is clear evidence of monolithic Chinese government or CCP control over Alibaba/Ant and other private technology firms is too simplistic. While these private firms certainly need to demonstrate their support for the government/CCP by engaging in these kinds of initiatives, in most cases they also benefit greatly through extensive positive promotion of their platforms in the official Chinese media, through setting up e-commerce and physical trading networks that make local communities highly dependent on their services, and through setting the technological agenda in ways that will make the government more reliant on their products and services, in other words, becoming indispensable.

So far, they have managed to do this without giving up their private ownership. Ant Group, for example, is still controlled by the same group of private shareholders that owned its shares prior to the suspension of its IPO in 2020, even if Jack Ma has now given up his veto power over their collective decisions.⁷³ In fact, firms like Alibaba/Ant Group have grown so large that even when they get into trouble with regulators, the penalties only act as a temporary brake on their relentless expansion.

It is crucial to understand how Alibaba/Ant operates, and its rapid diversification into financial services, as the firm is already exporting its e-commerce model globally through ODI acquisitions. If Ant Group is able to resolve its restructuring to the satisfaction of Chinese regulators and proceed with its own long-awaited IPO, its plan for the proceeds would involve further global expansion of Ant’s online payment services and financial products, technological upgrading through recruitment of top global talent, and further ODI through acquisition of “leading technologies including AI, … machine learning, natural language processing, man-machine interaction, … as well as computing and technology infrastructure.”⁷⁴

5 Discussion Questions and Comments

This case study uses Alibaba/Ant Group as an example to show how the meteoric growth of e-commerce and the platform economy in China has transformed the way that business is done and made Chinese consumers into some of the world’s most active online sellers and purchasers.

The case also gives insights into the multinational links of Chinese e-commerce firms, such as international buyers purchasing Chinese goods online through Taobao and AliExpress, investors buying Alibaba’s shares on the NYSE, and Alibaba acquiring e-commerce firms overseas, especially in Southeast Asia and developing countries elsewhere.

Finally, the case explains how e-commerce platforms evolved into numerous business sectors, and especially focuses on their rapid diversification into financial services. Their huge size and financial complexity have led to some negative impacts and systemic risks, and this in turn has caused the Chinese government to regulate these e-commerce and fintech firms more tightly. The following questions will explore some of these issues in more detail.

5.1 For Law School Audiences

1. 1. Briefly summarize how the variable interest entity (VIE) structure works and why it is necessary for Chinese e-commerce and internet firms like Alibaba to use it. How does the structure facilitate ODI by Chinese private firms? What are the key legal risks of the VIE structure?

2. 2. What are the legal risks of Ant Group’s online finance businesses, especially in the area of wealth management products (WMPs)? Why was the Chinese government so concerned about those risks that they suspended Ant Group’s IPO in 2020? How has Ant Group been required to restructure its financial businesses, and will this help to reduce the risks to consumers and the broader financial system?

3. 3. Why is Alibaba considered to be a Chinese firm when it is actually a Cayman Islands company listed in New York and the majority of its shares are owned by non-Chinese investors? Think about this question in terms of where the legal risks to investors would be resolved if there was a dispute, who actually manages the firm’s businesses, and where the firm’s core businesses are regulated.

5.2 For Policy School Audiences

1. 1. How did the Chinese government facilitate the rise of platform firms like Alibaba/Ant Group since the late 1990s, either directly through its policies or indirectly through its failure to strictly enforce specific policies? Why was the government willing to allow the growth of these private firms – in other words, how do these firms indirectly benefit the Chinese government?

2. 2. More specifically, why did the Chinese government allow such platform firms to expand so rapidly into online finance (even without banking licenses prior to 2015)? What market demands were they meeting that state-owned banks were unable to meet, and what political risks did this cause from around 2016 onward? Does this explain the government’s “crackdown” on these online finance firms in 2020?

3. 3. What political risks are faced by Alibaba/Ant Group due to their status as private firms in China? How can they try to mitigate those risks, and does this create potential problems for them when they try to expand overseas?

4. 4. What is the “symbiotic codependency” of the Chinese government and private Chinese technology/e-commerce firms? Use Alibaba/Ant Group as an example to show how this relationship involves compromises on both sides, and how it has hampered the government’s ability to regulate such large firms. Does this case study also reveal competing interests within the Chinese government (and SOEs). If so, what are they? Many political scientists have referred to China as a “fragmented authoritarian” political system: How does the case of Alibaba/Ant Group support this characterization?

5.3 For Business School Audiences

1. 1. Alibaba’s business growth has been incredibly rapid, from an unknown startup in 1999 to China’s largest e-commerce firm by 2014, when it held its IPO on the NYSE. What were the key factors that allowed Alibaba to grow so fast in these initial years? Why were traditional (offline) businesses not able to meet customer and market demand? Which of the key factors were due to Alibaba efficiently filling gaps in the market, and which factors were external, such as technological and policy developments? Could Alibaba have survived as a private e-commerce firm in China if it had started operating in 1990 instead of 1999? Why or why not?

2. 2. Ant Group was initially not an independent corporation but simply the payment service for Alibaba, called Alipay. How did Alipay help Alibaba to win its early competition with eBay in China, and how has it diversified into financial services after being spun off into a separate affiliated corporation called Ant Group since 2011? What gaps in the financial services market did Ant Group fill and who were its main target customers?

3. 3. How do Alibaba and Ant Group work together synergistically to attract more customers and grow their respective businesses? What role does their customer (or user) data play in this, and how is such data shared between the two affiliated firms?

4. 4. What impact has Alibaba/Ant Group had internationally? Think about this in terms of both investment markets (i.e., raising money from international investors) and ODI (i.e., acquisition of businesses overseas). Why does Alibaba’s ODI depend so heavily on raising money from international investors? Why do you think those Chinese government restrictions (especially on private businesses and individuals) are in place?

5. 5. Using Alibaba/Ant Group as an example, explain what is a Chinese corporate ecosystem, and how does it interact with the Chinese political ecosystem? Are there some key differences between such Chinese corporate ecosystems and multinational firms in similar business sectors in other jurisdictions, such as Amazon? Think about both the differences in their target markets and the types of “social responsibility” activities they must engage in to remain viable.

Case Study 1.2 Chinese M&A in Latin America Jiangsu Yanghe Distillery’s Stake Acquisition in VSPT Wine Group in Chile

Ignacio Tornero

1 Overview

In 2018, baijiu giant Jiangsu Yanghe Distillery Co., Ltd. acquired 12.5% of one of the most well-established and largest global wine conglomerates in Chile, VSPT Wine Group (Viña San Pedro Tarapacá S.A.), for US$65 million. The transaction was the first of its kind in the South American country, in which a Chinese baijiu producer purchased a stake in a Chilean wine company listed on the Santiago Stock Exchange. The transaction involved considerable strategic and business planning and the support of experienced legal and financial advisors in both China and Chile. As a window into Chinese companies’ strategic entries into emergent markets, this case study first analyzes how a change in alcohol consumption habits in China was a critical factor for Yanghe in deciding to carry out the transaction and the rationale behind choosing a target from the “new wine world” instead of the “old wine world.” It then explores how the Chile-China Free Trade Agreement (FTA) has increased the amount of wine exported to China and how Chilean wine is perceived as “value for money” among Chinese consumers. Finally, it discusses how this transaction is an example of how Chinese state-owned enterprises (SOEs) have learned rapidly from their outward foreign direct investments (FDIs) and how Chinese investors are increasingly using experienced advisors to help inform their overseas investments.

2 Introduction

Toward the end of 2016, on a cold winter day in Beijing, I was sitting in my office located in the Central Business District when I received a phone call from an unknown number. On the end of the phone was Mr. Tom Li, who introduced himself as the investment director of Jiangsu Yanghe Distillery Co., Ltd. (“Yanghe”).¹ He told me that he had received my contact information from South Pagoda Law Firm, a leading Chinese law firm that had worked with Yanghe for more than fifteen years. He also mentioned that they knew that I had spent some time at their Beijing office on secondment a few years ago representing Chile Andes Law Firm. Mr. Li told me that there was an urgent matter that they wanted to discuss, and he asked whether I would be able to go to Nanjing in the coming days. He would meet me at the train station so he could drive me to Yanghe’s offices and explain the company’s idea. He also told me that, as part of the Chinese tradition, they would host a lunch for their guest afterward and that this would be a good chance for me to meet Yanghe’s vice president and the wider team.

Initially, I could not believe what had just happened. I had been working hard to attract Chinese investment into Chile for years, investment that had been almost nonexistent prior to 2016, and it seemed that the first transactions were just starting to materialize (see Figure 1.2.1). I also felt that there was a certain degree of coincidence in this invitation, not just considering where the referral was coming from but also because I had spent time at Nanjing University studying Mandarin. I went back to my computer and bought a train ticket to Nanjing for the following week to meet Mr. Li and Yanghe’s team.

Figure 1.2.1 Evolution of Chinese FDI into Chile

This case study tells the story of how Chinese baijiu company Yanghe planned and executed its entry into the Chilean VSPT Wine Group (Viña San Pedro Tarapacá S.A., hereinafter, “VSPT”), in which it acquired a minority stake of 12.5% for US$65 million. The case covers the early conversations during 2016 to the closing of the transaction in 2018. In doing so, it provides interesting information for a number of reasons. First, it sheds light on how Chinese companies (both private and SOEs) follow consumers’ changes in habits and preferences when designing their global strategies (as a business dimension). Second, it provides insights into how policy elements – like the Chile-China FTA – can impact the direction of Chinese outward FDI. Finally, it provides a practical resource for analyzing how Chinese enterprises are increasingly becoming more sophisticated in their outbound investment activities by relying on specialist advisors (i.e., legal services).

The case is structured as follows: (1) an introduction to the baijiu market, Yanghe, and VSPT; (2) a description of the change in alcohol consumption habits among Chinese buyers; (3) an overview of the Chile-China FTA and how it has increased the amount of wine sold to China and its competitive position in the Chinese market; (4) a summary of the preliminary conversations of the transaction; (5) an explanation of the execution and closing of the deal; and (6) a general reference to the integration phase and a conclusion.

3 The Case

3.1 What Is Baijiu?

Baijiu (“clear or white liquor”) is a traditional Chinese alcohol that has been enjoyed throughout China’s history. Even though there is no clear date as to when baijiu production started in China, some historical records trace it to before the second century BCE.² Baijiu is usually produced from sorghum, but it can also be made from other grains such as rice. It can be categorized following different criteria (e.g., distillation techniques, fermentation starters, etc.), but it is most commonly classified based on its aroma (e.g., strong aroma, sauce aroma, light aroma, and rice aroma). Even though baijiu’s alcohol content has a wide range of 35–60% alcohol by volume (ABV), it is usually above 50% ABV.³ Baijiu has a special significance in Chinese society because it is closely related to its local culture and traditions, and it has been a unique symbol of people’s social and business interactions for centuries. Baijiu production is localized in different provinces in China by different liquor manufacturers.

3.2 Jiangsu Yanghe: An Iconic Baijiu Producer

Yanghe is one of China’s largest baijiu producers (Table 1.2.1) and, along with Moutai and Wuliangye, it is one of the top baijiu brands in China.⁴ The official origin of the company goes back to 1949 when the group was established; but Yanghe’s distillery has been producing baijiu for hundreds of years following an ancient recipe. The company is located in Suqian, a prefecture-level city in northern Jiangsu Province that has a long tradition in the production of liquor and is considered to be one of the three most famous wetland liquor-producing areas in the world. This unique location gives Yanghe access to specific qualities of water, soil, and air crucial for baijiu production. As such, these conditions produce a beverage that is similar to whisky in Scotland in terms of its quality and popularity.

Table 1.2.1 Main producers of baijiu in China, 2020–2022

Company	Year	Production volume (ton)	Operating revenue (CNY)	Net profit (CNY)
Yanghe	2022	197,590	¥ 30,104,896,186	¥ 9,377,832,429
Wuliangye	2022	129,328	¥ 73,968,640,704	¥ 26,690,661,397
Moutai	2022	91,885	¥ 124,099,843,771	¥ 62,716,443,738
Yanghe	2021	204,332	¥ 25,350,178,204	¥ 7,507,682,797
Wuliangye	2021	188,717	¥ 66,209,053,612	¥ 23,377,074,353
Moutai	2021	84,721	¥ 106,190,154,843	¥ 52,460,144,378
Yanghe	2020	161,498	¥ 21,101,051,131	¥ 7,482,228,633
Wuliangye	2020	158,831	¥ 57,321,059,453	¥ 19,954,809,594
Moutai	2020	75,160	¥ 94,915,380,916	¥ 46,697,285,429

US$ to RMB exchange rate (January 2024) 1 US$ = 7.1 RMB.

Source: Prepared by author with data from companies’ annual reports for 2020–2022. Ranked by production volume.

The Yanghe group has more than 19,500 employees at the parent level and throughout all its subsidiaries. In the “2023 Fortune China 500” it ranked 430,⁵ and 53 in the “2023 BrandZ’s Top 100 Most Valuable Chinese Brands.”⁶ Yanghe was listed on the Shenzhen Stock Exchange in 2009 (code 002304).⁷

3.3 VSPT

VSPT has also been a key player in the alcohol industry albeit not for hard alcohol but for wine. The company was established in Chile in 1865 and has since become one of the largest producers and oldest exporters of Chilean wine. It has a presence across several valleys in Chile that have a long tradition of wine production (e.g., the Maipo, Colchagua, and Casablanca valleys) and has an international presence in the Uco Valley, Argentina (Mendoza). The company is considered among the top-twenty world producers of wine. Its portfolio of brands includes Altaïr, Sideral, Cabo de Hornos, Kankana del Elqui, Tierras Moradas, 1865, Castillo de Molina, and GatoNegro 9 Lives. In June 2023, the company announced the strengthening of its international presence – it already had offices in the United States and the United Kingdom – and commitment to the Chinese market through the opening of an international office in Shanghai.⁸ Based on the information gathered by the Chilean Customs Office, VSPT ranked second – behind Viña Concha y Toro S.A. – in the total exported volume of bottled wine between January and November 2023: 4,618,838 boxes (of nine liters each) with a total value of US$114,017,736. In relation to the Chinese market – for the same period – VSPT ranked in seventh position with a total volume of 119,665 boxes and a total value of US$4,227,564 (these figures represent an important decline from previous years).⁹ The company is listed on the Santiago Stock Exchange.¹⁰

3.4 Baijiu Consumption and New Trends

I arrived at Nanjing South Railway Station early in the morning and was met by Mr. Li. After having exchanged a few words, I quickly realized that my companion was a very experienced executive. His English was great, he had obtained an MBA at a US Ivy League business school, and he had worked in the industry for more than a decade. I felt excited about what was going to happen. Once at the Nanjing offices of South Pagoda Law Firm, Mr. Li introduced to me the managing partner of the law firm, Mr. Fred Wang, and they explained the proposed deal.

Mr. Li started the conversation by introducing Yanghe’s history and current position in the Chinese market. He told me that sales for the previous year (2015) had reached more than RMB 16 billion, that the net profit attributable to shareholders was more than RMB 5 billion, and that the company was expected to produce close to 200,000 tons of baijiu.¹¹ He also told me that Yanghe was the market leader in the premium segment (with a market share of more than 20%), the segment that was forecast to experience the highest growth in the coming years (expected to be more than 15%).¹² He also mentioned that Yanghe benefited from a consolidated portfolio of brands. Another comparative advantage of the company was the number of its salespeople and distributors. In the former, it had more than 5,000, compared to less than 600 in Wuliangye and less than 700 in Moutai. Regarding its strong distribution network, it had more than 8,000 distributors, while Moutai had just over 3,000 and Wuliangye just over 1,100. This gave Yanghe access to a wide, flat, and very efficient network of distributors. He also explained that Yanghe, unlike some competitors, offered a diversified portfolio of products and that it was constantly developing new ones to meet changing consumer tastes thus providing a unique corporate culture of continuous innovation.¹³

Mr. Li ended this brief introduction by saying that the aspiration of the company was to become a market leader in the alcohol industry in general and not limit itself to baijiu. This would enable the company to maintain sustainable future growth and to keep serving customers’ changing preferences. In this regard, he thought that there was considerable room to keep expanding the wine business in China and continue diversifying the company’s offering and revenue source, since wine represented less than 2% of the total revenue of Yanghe.¹⁴ He added that Chile and its wine were not new to the company as it had launched its Sidus private label in 2012 through a cooperation with Chilean wineries. If the company already had a wide network of distributors and selling points, the strengthening of the wine category could create strong synergies to the current offer.

Mr. Wang then joined the conversation by saying that he had noticed that Chinese people’s alcohol consumption habits have been changing; younger generations were not drinking as much baijiu as more senior Chinese people do and they prefer alternatives such as wine, whisky, and vodka. He also referred to how the industry had been affected by the anti-corruption campaign started by President Xi in 2012, a policy that limited the hosting of luxurious banquets in which expensive baijiu was regularly drunk. This situation reaffirmed the idea that Yanghe needed to prepare for the future and that wine from the new world (like Chile) could be one solution.

Mr. Li emphasized that the key behind this move was to understand the preference of younger generations, who represented less than 30% of baijiu sales – a figure that has been decreasing.¹⁵ One of the reasons that Chinese millennials do not enjoy drinking as much baijiu as older generations, he said, is because they associate it with a more banquet/business environment, usually with a government component as well. In those dinners, it is quite common to see people finishing their glasses of baijiu at once (ganbei) and that situation usually ends up leaving many “in trouble.” Millennials, in general, do not like this and often prefer drinking alcohol on other occasions like relaxing at home, during vacations, and at social gatherings. There is also interesting data that shows that many Chinese consumers prefer lower-alcohol alternatives and that they tend to see wine as a healthier option and therefore a lifestyle choice. In addition, younger Chinese consumers are more open-minded than before; some of them have traveled or lived overseas while many international brands are now available in China. As a result, Chinese people are increasingly willing to try different products and experiences.¹⁶

After all this, Mr. Li told me that the intention of Yanghe was to make a minority investment into one of Chile’s leading wineries. “What are your thoughts on this idea?” he then asked.

3.5 The Importance of the Chile-China Free Trade Agreement and the Appeal of the New World Wine

When responding to this question, I reminded Mr. Li and Mr. Wang that the strong relationship between Chile and China relied on certain key historical milestones. Chile was the first South American country to establish formal diplomatic relations with China in 1970 and the first Latin American country to support the entry of China into the WTO in 1999. Chile was the first country in the region to recognize China as a market economy in 2004 and the first single economy in the world to sign an FTA with China in 2005. This last point was of critical importance for the matter under discussion.

I then provided additional background of the process to conclude the FTA. I mentioned that before this FTA with Chile, China had just signed a framework agreement with the Association of Southeast Asian Nations (ASEAN) in November 2002,¹⁷ and that China proposed this idea to Chile in the middle of 2002 considering, in part, the important milestones achieved with the South American country in the previous decades.

I then explained that official discussions started in January 2005 in Beijing, and that there were five rounds of discussion that ended in October of that year. One of the reasons for the speed of the negotiation process was the fact it was structured in stages: a first agreement for the trade of goods was signed in November 2005 and entered into force on 1 October 2006; a supplementary agreement regarding the trade of services was signed in April 2008 and entered into force in August 2010; and a final agreement regarding investments was signed in September 2012 and entered into force in February 2014.¹⁸

Afterward, I pointed out that one of the critical measures included in the FTA was a progressive elimination of tariffs based on a set schedule (Table 1.2.2). For this purpose, five categories were established and in the case of Chilean exports the category “Immediate” stipulated a zero tariff for 37% of the products exported to China that represented 92% of the total US dollar amount from the date that the FTA entered into force.¹⁹ This was a considerable reduction in the tariff rate in force prior to the FTA when the average tariff in China was 10%.²⁰ Wine was included in the category “year 10,” so in 2015 it started entering the Chinese market tariff-free.

Table 1.2.2 Schedule of tariff reduction in the Chile-China FTA

Category	No. of items	% of items	Exports to China 2004 (US$ thousands)	% US$ amount
Immediate	2,805	37	2,953,478	92
Year 1	1,947	26	489	0
Year 5	973	13	11,251	0
Year 10	1,611	21	221,300	7
Exclusions	214	3	23,384	1
Total	7,550	100	3,209,902	100%

Source: Prepared by author with data from Chilean Congress National Library.

I kept emphasizing the importance of the FTA and the elimination of tariffs in the wine industry for building a more competitive global product. I showed evidence of how Chilean wine exports to China increased after the execution of the FTA (Figure 1.2.2).

Figure 1.2.2 Increase in wine exports from Chile to China, 2003–2018 (in US$)

Mr. Li agreed that the elimination of tariffs on Chilean wine had been a critical consideration for Chinese consumers when choosing options from an increasing number of choices from different countries. Chilean wine has been consolidating this perception that it is “value for money”; it is as good as more traditional players like French wine but, at the same time, is considerably more affordable. While the average price for a case (9 liters) of Chilean wine is around US$31 (free on board [FOB]) the price for French wine is approximately 50% higher, with an average price of US$47 (FOB).²¹ But price isn’t everything, he then added. Chilean wineries have also proven to be flexible and creative players by designing private labels pursuant to clients’ requests,²² and by launching very strong localized marketing campaigns. Another important factor has been good public–private coordination, and the role that the Chilean wine association (Wines of Chile) has played in supporting the image and consistent value proposition of Chilean wine in China and the rest of the world.²³

“Well, let’s find a target for Yanghe then,” I said.

3.6 The Transaction

I was aware that this represented a great opportunity for my law firm in terms of a potentially iconic transaction within the wine industry. However, Chinese companies were new players with respect to FDI in Chile and there were considerable risks involved. During my previous research, I had noted that some studies put Chinese M&A failure rate as high as 70%,²⁴ and that there were several common mistakes made by Chinese companies in their overseas operations (Table 1.2.3), many of which I had witnessed in the past such as the lack of proper and timely use of professional advisors. In order to enable a successful M&A operation, careful planning was required.

Table 1.2.3 Main risks and challenges faced by Chinese companies in their ODIs

1. Enter the project too late; slow to act.	7. Focus only on targets which are “for sale.”	13. Inadequate tax structuring or postponed too late in process.	19. In emerging markets, rely more on government support, not legal documents.	25. Fail to ensure compliance with regulations governing operations.
2. Do not have a clear international investment strategy or plan.	8. Reluctant to pay retainer to financial advisor to conduct search.	14. Negotiate MOU without help of external advisors.	20. No decision maker at negotiating table.	26. No post-closing integration plan.
3. Unfamiliar with international deal structures.	9. Fail to make persuasive case to seller on buyer’s strategic goals.	15. Inadequate due diligence.	21. Long gaps between negotiating sessions with no updates.	27. Lower negotiation success rate compared to international standard.
4. Do not utilize external advisors effectively.	10. Chinese buy-side introductory materials not up to international standard.	16. Let seller’s lawyers draft the deal documents.	22. Inadequate transparency as to internal process and timing.	28. Risk of non-completion results in sell-side demanding a “China premium.”
5. Overreliance on government officials to find targets.	11. Not sufficiently familiar with international business practices.	17. Fail to utilize the protections under the SPA [Sale and Purchase Agreement] fully.	23. Retract concessions made in prior rounds of negotiations.	29. Because slow to act, lose out on good investment opportunities.
6. Use inexperienced overseas Chinese “finders.”	12. Acquisition funds not in place up front.	18. Sometimes ignore applicable legal requirements on FDI.	24. Significant communication and culture gaps.	30. Fail to achieve anticipated synergies/incur heavy losses.

Source: Robert Lewis, ‘Rules of the Game of Global M&A: Why So Many Chinese Outbound Investments Fail’ (China Machine Press 2017). Reproduced with permission.

At this preliminary stage, and after convincing Yanghe to formally retain our law firm, I suggested two actions: (1) find and retain a financial advisor in Chile and (2) start looking for potential suitable targets. Regarding this last point, Yanghe was searching for a top-ten player in Chile with a prestigious brand that could be easily sold to the Chinese market. I was happy to see that Yanghe acknowledged its lack of prior M&A experience in South America and that it was looking for experienced advisors that could help it with the transaction’s structure and execution. This was, from my point of view, a good starting point that could bring the required expertise and flexibility to achieve the intended objective.

Mr. Li stated that he was very satisfied with the outcome of this first meeting and that it was time to enjoy a good Chinese lunch and meet the rest of the team. He asked that I brief my firm about the potential work, start preparing a formal proposal, introduce a reputed financial advisor, and also initiate preliminary market research to identify suitable companies in Chile for Yanghe to consider. They agreed to meet in a couple of months to review all this.

After receiving approval from my firm to move on, I proceeded as agreed with Mr. Li. I introduced to Yanghe one of the most respected investment banks in Chile (Chile Patagonia Financial Advisors) so they could also start preliminary conversations with Yanghe. At the same time, our team and I conducted some preliminary research identifying around ten potential targets that may be willing to sell a minority stake to the baijiu giant. This was challenging as many of the largest Chilean players with a long tradition in the industry were not for sale or were not listed companies. One senior partner at Chile Andes Law Firm started making a few phone calls to some of his contacts to explore whether there were chances for this project to become a reality.

Contact with Yanghe moved quickly. Both the law firm and Chile Patagonia Financial Advisors were formally engaged by Yanghe, so detailed planning could start. Chile Andes Law Firm explained to the client the general steps involved in an M&A in Chile (Figure 1.2.3) and introduced the list of potential targets available together with the likely chances of acquiring a minority stake in each of them. After a detailed review of the potential targets, Yanghe decided to pursue VSPT after considering its history, brand, and sales. In addition, VSPT was a listed company on the Santiago Stock Exchange, so the chances of entering into partial ownership of the winery by acquiring a certain percentage from minority stakeholders were more feasible than for other alternatives. VSPT was a great target itself; it had become the second largest Chilean wine exporter after the merger of San Pedro Winery and Tarapacá Winery in 2008 and was a leader in premium wine in the domestic Chilean market. Additionally, VSPT was aligned with the definition of China as a “priority market” by Wines of Chile.

Figure 1.2.3 Main steps of M&As in Chile

The whole deal required close coordination between the work of Chile Andes Law Firm, South Pagoda Law Firm, Chile Patagonia Financial Advisors, and the preparation of documents and approvals in China by Yanghe. The advisors prepared a very detailed plan divided into three main parts: pre-acquisition, acquisition, and post-acquisition steps (Figure 1.2.4). This allowed Yanghe to have a very clear roadmap of the transaction, including estimated timelines, areas of responsibility, the required information/documents, and the current status of each stage. As of 31 December 2017, the main shareholders of VSPT and their ownership were the ones listed in Table 1.2.4.

Figure 1.2.4 Roadmap of the project

Table 1.2.4 Main shareholders of VSPT as of 31 December 2017

Shareholder name	No. of shares	Ownership (%)
CCU Inversiones S.A.	26,866,493,503	67.22
Compañía Chilena de Fósforos S.A.	2,794,649,759	6.99
Bank of Chile (on behalf of nonresident foreign investors)	1,988,796,991	4.98
Bank Itau Corpbanca (on behalf of nonresident foreign investors)	1,385,536,989	3.47
Bank Santander (on behalf of nonresident foreign investors)	1,376,502,915	3.44
Compass Small Cap Chile Fondo de Inversión	1,264,834,547	3.16
Siglo XXI Fondo de Inversión	660,769,848	1.65
Fondo de Inversión Santander Small Cap	491,906,385	1.23
Larrain Vial S.A. Corredora de Bolsa	477,368,885	1.19
BCI Small Cap Chile Fondo de Inversión	397,191,944	0.99
BTG Pactual Small Cap Chile Fondo de Inversión (Cuenta Nueva)	260,162,716	0.65
MBI Arbitrage Fondo de Inversión	207,039,548	0.52
Total	38,171,254,030	95.49

Source: Prepared with data from VSPT Annual Report 2017.

The advisors considered different plans for Yanghe to acquire the required ownership in VSPT in order to obtain a seat on the board and thus have a certain degree of decision-making power inside the company. One alternative was to purchase shares on the Santiago Stock Exchange from minority stakeholders, another was to buy a certain proportion from the main shareholder (Compañía de las Cervecerías Unidas, CCU), and an alternative was to perform a capital increase. The advisors also analyzed the benefits and disadvantages of different financing structures (equity, debt, or equity/debt). They also informed Yanghe about the possibility of a potential mandatory public offer of shares by CCU and the corresponding tender price, which is the scenario that ultimately happened.

On 12 December 2017, CCU acquired 1 million additional shares in VSPT, thus triggering the legal provision that required it to launch a mandatory public offer of shares for the remaining shares (33% approximately) in VSPT not owned by CCU, as a result of owning two-thirds or more of the shares issued by a publicly traded company. CCU carried out the formalities of announcements and the publication of the prospectus, including a tender price of CLP 7.80 per share. VSPT’s directors also issued their personal opinions in relation to the tender as required by law. The offer lasted from 28 December 2017 to 26 January 2018 and CCU acquired 6,310,613,119 additional shares in VSPT resulting in an ownership increase to 83.01% interest in the company. In the meantime, Yanghe informed the regulators that it had acquired 4,996,212,080 shares (12.5%) of VSPT at CLP 7.90 per share from Compañía Chilena de Fósforos S.A. and other minority shareholders.²⁵

4 Conclusion

Yanghe’s aim of acquiring an interest in one of Chile’s main wineries was ultimately successful. This case study shows how Yanghe used expert market analysis by its Chilean advisors to inform its decisions and how it sought to anticipate changing consumer trends in the baijiu business by investing in VSPT. It also provides considerations for a policy discussion on how the Chile-China FTA was a critical factor in allowing Chilean wine to become an appealing product to Chinese consumers. Finally, it highlights the importance of detailed planning and execution and the need to rely on experienced advisors in order to carry out a successful M&A operation.

Can Yanghe claim victory? At least not yet. The last phase of the M&A process is in its initial stage: the integration. This is when partners usually encounter the biggest challenges to building a sustainable approach and where skillful advisors are needed to guarantee a good fit. In addition, the wine sector has been heavily affected by the COVID-19 pandemic, and whether the industry is able to return to pre-COVID levels of sales is an ongoing question.

5 Discussion Questions and Comments

The case “Yanghe – VSPT” provides insights into Chinese approaches to outbound investment from law, policy, and business perspectives. When reading the case, consider the following:

• Exploring how changes in consumer behavior in China may redefine Chinese companies’ strategies and their outbound activities.

• Analyzing the importance of bilateral trade agreements as suitable frameworks for increasing international trade.

• Showing how Chinese companies (private and state-owned) have become more sophisticated in their M&A strategies by relying on experienced legal and financial advisors.

In relation to this last point, Chinese companies’ familiarity with international transactions has not always been the norm. As shown in Figure 1.2.3, Chinese overseas M&A has not been exempt from challenges, and there is abundant evidence of certain common pitfalls faced by Chinese enterprises in their early outbound activity across different jurisdictions.

For example, in 2012, during one of the first attempts by a Chinese company to acquire a hydropower asset in Chile, the Chinese party was unable to complete the deal due to different mistakes made. In that transaction, the Chilean legal advisor was approached by a well-renowned international financial advisor based in Chile. This advisor had, in turn, been hired by a reputable Chinese financial advisor in order to assist a Chinese SOE in the acquisition of energy assets located in the south of Chile on sale by a Chilean private company. The acquisition process was structured as a private competitive tender process. The potential Chinese buyer was the international arm of a Chinese central SOE that had some previous international experience in other acquisitions worldwide.

Unlike the Chinese financial advisor, who proved to be very familiar with international best practices and standards in the M&A industry, the Chinese client lacked basic skills required for this type of international transaction. For instance, some of the decision makers who attended the negotiation sessions that took place in Chile did not have the required language skills (spoken English), seemed to be unfamiliar with international M&A processes, and had a political background rather than a technical or business one. One of the biggest challenges faced during the acquisition was the poor communication between the team of advisors and the Chinese company. In addition, decision-making inside the potential buyer was considerably slower than for other participants in the tender, and it required multiple regular approvals from the headquarters in Beijing. This circumstance was not duly understood by the Chilean seller and caused miscommunication and even some distrust throughout the sale.

During the final stage of the selling process, it was expected that some assets were going to be awarded to a British company participating in the tender and the other to the Chinese buyer. However, due to circumstances that were never made clear, the Chinese party suddenly “disappeared” from the negotiation table. Therefore, all assets were acquired by the British offeror. This example is just one of many that demonstrates how far Chinese companies have come in their overseas M&A transactions.

5.1 For Law School Audiences

1. 1. How is the approach adopted by Yanghe different from other transactions carried out by Chinese firms overseas that you know of (including, for example, the 2012 case mentioned above)? What are the most common mistakes made by Chinese firms in their overseas transactions?

2. 2. Can you provide any examples of Chinese M&As that have failed due to a lack of proper legal or financial structuring?

3. 3. If you were advising Yanghe and VSPT in their integration strategy, what would your plan be to guarantee that the cooperation is successful in the long term?

5.2 For Policy School Audiences

1. 1. Why has the Chile-China FTA been a critical tool for positioning Chilean wine in China? Can you provide a comparative example in your country that illustrates this?

2. 2. What is the specific competitive advantage granted by the FTA? Did this happen upon its execution or at a later stage?

3. 3. Do you think that FTAs are effective policies to promote international trade? Could the Chile-China FTA be adversely affecting the wine industry in Chile?

5.3 For Business School Audiences

1. 1. If baijiu is still the most consumed liquor in the world, why did Yanghe decide to acquire a minority stake in a Chilean wine group?

2. 2. What were Yanghe’s comparative advantages that placed it in a good position to diversify its business? What were the synergies that the company could benefit from in purchasing a stake in VSPT?

3. 3. Why did Yanghe not acquire a winery from France, considering that French wines are well positioned within the global market, perceived as high quality, and have a higher average price than Chilean wines?