Research: How Political Connections Help (and Hurt) Chinese Startups

By Matt Dallisson, 10/09/2019

New ventures need resources to survive, let alone thrive. In emerging markets, their survival also depends on their ability to deal with what academics call the “institutional void” — the lack of strong market intermediaries ensuring the smooth flow of business. In this void, where rules are loosely interpreted, and information hard to come by, fledgling companies can struggle to find a firm footing in the ecosystem.

Although China has come a long way, its entrepreneurs must still overcome this institutional void. A common solution has been to create strong bonds with local government officials. According to a survey of Chinese SMEs led by the World Bank and the Department of Small and Medium Enterprises of China, 54%  of Chinese B2B startups include a founding team member responsible for building proper relations with local government. While such efforts used to involve bribery, they have largely become about aligning private and public interests in the wake of President Xi Jinping’s long-running anticorruption campaign.

In a new study, Ling Yang, Xiaobin He (both of Tsinghua University) and I found that in China, having strong political ties can be a double-edged sword for new B2B ventures. While political connection can boost a startup’s credibility and access to resources — helping it win suppliers — it can also increase its bargaining power, putting off business customers who would prefer dealing with a weaker partner. In these supply chains, buyers typically want to control startups in order to demand lower prices, better delivery terms, and favors such as risky product co-development. Politically connected startups can be viewed as difficult to control and turn away potential buyers. Startups should thus carefully weigh the pros and cons of political connection.

We analysed a subset of data from the survey mentioned above. The respondents were representatives from 337 privately owned startups in operation for less than eight years. These firms are all B2B ventures, predominantly in manufacturing. The survey asked about how firms built a relationship with the government and about their supply chains. In addition to the survey data, we also conducted 30 open-ended interviews with Chinese entrepreneurs and their supply chain partners to gain a better understanding about the key concerns in their supply chains.

What does a firm’s political connection look like? Typically, the founding team has members dedicated to government relationship-building who are already well connected politically. Sometimes they used to work in government themselves. Their activities may involve: inviting local government officials to visit the new venture, ensuring they understand its critical aspects; co-organising an industry-specific expo or creating a platform to help the venture attract needed resources, such as partners or foreign investors; and discussing how the venture may help the government achieve its own goals in terms of infrastructures or local employment.

The benefits of having local government relationships

The supply chain in China typically features post-delivery payment, meaning that suppliers have to wait until after delivery to receive full payment. This tends to make suppliers particularly concerned about whether a startup can survive and pay in time. A founder we interviewed shared that suppliers wanted his business, but were nervous about getting paid: “They asked various questions to figure out our cash position. I told them that one of our founders has been building strong ties with the local government, and dropped some names. It definitely helped. At least they knew that our access to bank loans and government subsidies could sustain us longer than other startups.”

According to our study, having a founding team member dedicated to government relationship building has a measurable effect on winning suppliers. While the majority of startups in our sample had one to six suppliers, firms with a team member in charge of government affairs increased the predicted count of suppliers by 1.59. This was after taking into account control variables such as whether a new ventures had obtained an ISO certificate (suggesting product quality) or the gender or education level of the entrepreneur, as these characteristics may affect the firm’s social networks and in turn its partners.

“When I see a customer with strong government backing, I feel better because it probably will not disappear the next day. You do not know how many of my customers disappear” a supplier told us.

The downsides of having strong government backup

The Chinese norm of post-delivery payment eliminates most of the risks to downstream customers – since no one pays upfront, there’s no financial cost if one’s supplier goes belly up. Compared to suppliers, buyers are not quite as worried about a startup’s survival. In fact, they will often demand low prices, product customisation, and even free product co-development, without any guarantee they will buy again. From their perspective, a new venture with good government relationships is more difficult to control (and in our research context, manufacturing industries in China, buyers tend to be much bigger than suppliers and have control over them). It’s easier to dictate terms when dealing with weak new ventures with low bargaining power.

In a competitive environment like that of China, the chief desire of B2B buyers – beyond necessary quality concerns — is to retain full control of their suppliers. When a startup has strong political connection, buyers surmise it has strong bargaining power, since it could at least theoretically fall back on government help and resources. Because it’s less likely to fall into a cash crunch, it can afford to shop around to get a higher price for their products and to resist costly or risky demands from buyers. As a buyer said, “New ventures are usually eager to find a customer. But in our experience, new ventures that have invested in government relations tend to be difficult in price negotiation.”

In our sample, having a founding team member in charge of building government relationships decreased the predicted count of buyers by 1.65. This was a significant difference considering that the majority of these new ventures had between one and six buyers.

The more a new venture has a better bargaining position to begin with (due to having large assets or high margins or not being easily substitutable), the more potential buyers may view its political connections as a business deterrent. One buyer described a politically connected new venture from a high-profit industry as being “too bully niú,” meaning like a buffalo, overconfident and aggressive.  The buyer decided not to buy from this new venture, believing it impossible to win fair prices.

What to remember

The fact that more than half of Chinese startups try to build government relations reflects not only the country’s institutional void, but also its cultural emphasis on reciprocity. This relationship building seeks to align the interests of the new ventures and that of the government. It can help startups navigate the tough Chinese market, while officials — who increasingly think like entrepreneurs — can gather detailed information on how best to increase their country’s competitiveness at all levels.

However, as we’ve shown, having political connections can pose a dilemma for new B2B ventures. These relationships can help them gain credibility, but also put off buyers worried about losing bargaining power. (We can exclude other political reasons for steering away from suppliers with political relationships, given that the startups we studied are in competitive manufacturing industries, rather than highly regulated or monopolized industries where political relationships matter for different reasons.)

Although our study was set in China, a similar environment would exist in many emerging markets, such as Russia, Brazil, India and certain countries in the Middle East where market institutions remain weak and the state plays an important role in the economy. In such places, government officials tend to serve as market intermediaries, and close collaboration may pay off. However, all new ventures should be cognizant of the potential trade-offs, notably in terms of customer acquisition. After all, the most important thing for startups is not profitability, but survival.