Reference no: EM131497820

Question: Direct Selling in China

With over 1.2 billion people China represented an extremely attractive market for direct sellers such as Amway, Avon Products, Mary Kay Cosmetics, Sara Lee, and Tupperware. Also, in the 1990s the restructuring of state-owned enterprises had reduced workforces, providing an ample supply of people interested in becoming direct sellers, many of whom made door-to-door sales calls. With the Asian and Russian financial crises beginning in 1997 the supply of potential direct sales personnel increased further. In 1995 Amway opened a factory in Guangzhou and began sales in China. By 1997 it had 70,000 independent sales agents in China producing revenue of $178 million.62 Avon's revenue in China was $75 million. Companies such as Amway and Avon operated by enlisting independent sales agents who bought product from the company and sold it door-to-door. Amway used its standard business model in China with the exception that all other markets were supplied from U.S. plants.

Its sales agents were compensated by their own sales and also were paid for the number of new sales agents they recruited. They also received a commission on the sales of those they recruited as well as those their recruits recruited. The companies operated distribution centers and provided training for their sales agents in both sales techniques and in the company's culture, which emphasized empowerment. Amway had a policy of buying back all unsold product, providing a full refund. The success of U.S. direct sales companies led to a boom in home-grown direct sales companies selling everything from foot massagers to water beds to elixirs. By 1998 some 20 million Chinese were estimated to be working in direct selling.63 It was said that 50,000 people had come to Wuhan seeking jobs selling Xingtian Company's foot massaging machine. Some of these companies operated pyramid and Ponzi schemes in which they profited by recruiting sellers and selling them products rather than making sure that products were being purchased by consumers. Other companies duped unsuspecting consumers. In a front-page article the China Daily said that these companies "have been behaving badly, getting involved in underworld crimes and preying on innocent people through their superstitions." On April 21, 1998, the State Council published a directive banning all direct sales in the country. The directive stated, "Criminals have used direct selling to set up sects and cults, spread superstition and carry out illegal activities, affecting the country's social stability." The directive expressed concern about the massive sales meetings of direct sellers in which they clapped and chanted to build enthusiasm. The directive also stated that direct selling had attracted people, including teachers, members of the military, and officials of the Chinese Communist Party, who were legally prohibited from such sales activity.

The People's Daily, the official newspaper of the Chinese Communist Party, justified the State Council's decision: "Due to immature market conditions, inadequate legislation and immature consumer psychology, direct sales have proved unsuitable for China and thus must be resolutely banned." The newspaper also referred to "excessive hugging" at the mass sales meetings held by the direct selling companies. The State Administration for Industry and Commerce, which was responsible for the distribution industry, asked local officials to enforce the ban and avoid civil disorder. Its director Wang Zhongfu said, "It's necessary to stop the operation of pyramid sales since it has begun to hurt social stability and economic development."64 Government officials said that if the U.S. direct selling companies established normal retail shops they could stay. This was not the first time China had addressed direct selling. In 1995 it had suspended all direct sales activity for several months over concerns about the "revival meeting atmosphere" used by some of the companies. Avon was forced to change its credo from "God first" to "Faith first." Once the State Council had banned direct selling, many independent sales representatives were left with goods they could not sell. Protests occurred when they were unable to obtain refunds from companies. According to press reports, 10,000 disgruntled door-to-door salesmen came to the town of Zhangjiajie seeking refunds from a company that made foot massagers, but it had closed its doors.

‘It has left me worse than bankrupt,' says Chen, an unemployed steelworker, who has been left with 60 mechanized foot massagers and, now barred from selling them, losses of roughly $4,830."65 Riots broke out leaving four people dead and 100 injured. The directive issued by the State Council came as U.S. Trade Representative Charlene Barshefsky was in Beijing making preparations for President Bill Clinton's upcoming state visit. In a news conference in Beijing she stated, "The ban has effectively shut down the legitimate operations of these and other U.S. companies in China. These companies have invested over $120 million in China and provide income to more than 2 million Chinese." She added, "It is a serious matter when the [Chinese] government simply bans the legitimate business of foreign-invested companies ... [the ban] goes well beyond China's legitimate need to pursue consumer protection." Wu Yi, China's minister for trade and foreign investment, told her that in addition to consumer protection concerns the direct selling companies were breaking the rule requiring them to sell only goods manufactured in China. Steve Van Andel, chairman of Amway Asia Pacific, said, "We understand and respect the Chinese government's decision to take additional steps to protect consumers from illegal scams, which have become a more serious social problem in recent months.

We have invested over $100 million in China over the past 5 years and we continue to believe in the longterm business opportunities of this enormous market .... While management of Amway China has established strong government relations and is hopeful that discussions with government officials will be successful, it is too early to project the shortterm and long-term impact of the directive on our business."66 Amway and other direct sellers began to evaluate alternatives for restructuring the way they conducted their sales activities. Richard Holwill, Amway's director of international relations, said, "We're frustrated that this sledgehammer approach gets rid of ours as well as the ones they're really trying to get rid of. ‘Shut it down and sort it out later' seems to be the attitude."67 Holwill also stated, "We don't want to be part of the problem, we want to be part of the solution." Holwill served as co-chairman of the Asia Task Force of the U.S. Chamber of Commerce and discussed the ban in testimony before the House Ways and Means Committee in June during hearings on renewal of most favored nation status for China. China was also in the process of negotiating entry into the World Trade Organization (WTO). This involved negotiations with the European Union and the United States regarding specific reforms and market openings in China.

1. Why did China ban direct selling?

2. How might the U.S. direct sales companies restructure their sales activities to satisfy the concerns of the Chinese government? Should they establish retail stores?

3. Should U.S. direct marketers form a coalition or act independently to address this challenge?

4. Should the U.S. companies attempt to enlist the aid of the U.S. government?

5. What nonmarket strategy should the U.S. direct sellers in China adopt?