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Many businesses base decisions concerning the Chinese market on knowledge and expectations that are not necessarily accurate, with unfortunate consequences. If I knew two years ago what I know now about doing business in China, I might never have embarked on my China venture. At the very least, I would have started with the strategy that I eventually molded in response to experience gained from my many early mistakes.

This is a cautionary tale about the challenges facing companies in China–especially small, entrepreneurial firms–that offers insights into how one can turn China's unique playing field to one's own advantage. The story is relevant for any small-to-mid-sized company operating or considering operating in an industry characterized by strong government involvement and the need for special approvals or interpretation of existing laws or regulations.

What Led Me to China

The education business in both the United States and China is much more dynamic and fast-growing than is apparent to outsiders. There is a growing movement in the United States and elsewhere for the private sector to play a larger role in managing schools. Private companies are doing everything from running primary schools and universities to offering advanced computer training and standardized-testing preparation. Dozens of education companies have listed on US stock markets. In recent years, for-profit education companies such as the Apollo Group (which owns the University of Phoenix), Sylvan Learning Systems, and DeVry have attracted much attention for their successful education models and high-flying stock prices. Michael Milken founded and built Knowledge Universe into a company with more than $1 billion in revenue.

In China, education is an exciting new industry in the early stages of development. There are already hundreds of small, private education companies running all sorts of schools. Elite primary and secondary schools are the most common, with investments sometimes topping $10 million a school. Business training and education in particular is a field with great potential, as the country is sorely in need of skilled middle managers.

First attempt: A Comedy of Errors

With work experience at several large multinationals and an MBA from The Wharton School of the University of Pennsylvania, I believed myself well-qualified to start my own company. Fluent in both Japanese and Mandarin Chinese and having worked for over six years in Asia, I also figured I knew how to do business in the PRC, and decided to start a chain of for-profit universities in China with the aim of eventually developing a much larger education company. My confidence in the usefulness of my education, professional experience, and cultural knowledge was my first big mistake.

Following the Letter of the Law

Most businesspeople know that China's government bureaucracy plays an enormous role in the country's economy. But few newcomers actually understand the implications of this bureaucratic involvement for planning and executing a company's strategy in China. The combination of a huge bureaucracy and an incomplete legal system make a company's strategy and chances of success dependent on factors very different from those in the United States.

Chinese law on foreign involvement in education is nonetheless quite explicit. There are specific procedures to follow, documents to provide, requirements for a local partner, and limitations on the type of joint venture that may be established. Our company's first step was similar to that of any US-based start-up: we listened to people who had excellent local experience and hired the best local lawyer we could find. This, we reasoned, would not only keep costs down, but would provide us with a more Chinese perspective of how things work in China. Our lawyer, who was a PRC citizen, had spent two years at an American law school and gave advice that made sense to us.

We started by approaching the provincial education commission–the body that grants joint-venture approvals–and asking its officials how to follow the regulations to gain approval. In retrospect, this meeting was a big mistake. As we were to learn, the last thing we should have done in the highly regulated and guanxi-intensive PRC education industry was to enter through the front door with a lawyer and start asking questions. We found out later that the bureaucrats thought we were planning to sue them!

For nine months, we relied on our savvy Chinese lawyer's seemingly logical advice about negotiating with the Chinese partner and dealing with government officials. It didn't work. The lawyer was too Westernized and too confrontational. He did everything a Westerner would–talked plainly and showed his hand too early. The end result was that after months of negotiation, we were not only without our approval, but also without a local partner. To top it all off, we had earned a bad reputation among the approval authorities.

Mistakes in the Partner Search

We assumed from the beginning that the ideal local partner would be another school, probably a well-known institution whose reputation would enhance ours and whose contacts or students would help our business expand rapidly. The very best schools–the city's only state-run university and its top college–turned us do wn. They wanted more money and more control over the joint venture than we were comfortable offering. We found seven potential partners in our target city and met them one by one, eventually narrowing our choices to two institutions. The two schools were both introduced to us by friends who promised to help.

A man whose family owned one of the largest private companies in the city suggested the first school. His relative worked in the local economic commission, which controlled the school. We considered this school because I thought my friend could help us secure approval and because the school was not directly beneath the education commission–we feared too much bureaucratic involvement. In addition, the school was by far the most enthusiastic of the ones we had met, yet showed no interest in running the joint-venture school itself.

Negotiations progressed exceedingly slowly, with this would-be partner constantly assuring us that they would take care of us, that they were very powerful, and that we needed them. Finally, we realized that they were stalling because they lacked the necessary guanxi and did not know how to get approval. Their real motivation to work with us seemed to stem from the fact that a partnership might provide them with a source of funding to renovate one of their buildings.

The second school we considered was referred to us by a friend who was completing her master's degree at Fudan University, one of China's finest schools. Personable and always helpful, she introduced me to her former employer at the city's top technical high school. This school seemed like a good fit because it was the only one of its type in the city to have an approved joint venture and had close connections with government officials. Furthermore, as the best and largest technical high school in the city, it would provide a steady supply of students. Moreover, my friend assured me that the principal–her ex-boss–was an extremely ethical man who would take good care of us.

I spent almost a year trying to figure out this enigmatic man who was always saying one thing but appearing to mean something else. He was more typical of a businessman than a school principal. Though my friend continually reassured me about his character, his description of the requirements for government approval changed as he sensed the chance to get a better deal from us. He kept insisting that only a school with a strong principal could get government approval, which we eventually realized was a negotiating tactic aimed at maximizing his control in any eventual partnership.

Finding the Right Consultant

During this fruitless period, I became convinced that a good consultant familiar with the industry and its players would be a more effective advocate for us than a lawyer who knew the law but not the practical aspects of setting up a joint venture in our industry in China. We decided to switch, yet had no idea where to find a suitable consultant.

We first engaged an ex-teacher who was quite a talker and a doer, but not knowledgeable about school approvals and a bit too eager to swallow our money before getting anything done. Then there was the frank lawyer-consultant, who concluded that we had made such a mess that he did not have sufficient contacts to undo it. Finally, we were introduced to the extremely capable–but ultimately untrustworthy–man who would come to our rescue, but later succumb to greed.

This last consultant taught me a lot about doing business in China. He showed me that a talented consultant can perform amazing feats, such as obtaining approval for a school quickly. Over three months, this consultant negotiated with all the parties involved until he confidently announced that he was approaching the end of his work and that we could expect our approval shortly. It was only at that stage that we learned just how close the technical high school was to the government officials. Following the principal's advice, the government insisted that we rent a certain building from him at an extortionate price. We never contacted the principal again.

A Learning Experience

I learned a number of lessons from all of this. I came to understand that Chinese government officials may place as high a priority on preserving their own positions in the bureaucracy as on implementing the letter of the law. As in other highly bureaucratic societies and environments, including many large Western government agencies and companies, this usually means inertia rather than pure corruption, because it is always safer to do nothing than to take responsibility for action. In such cases, however, personal relationships can make a difference.

PRC government agencies may implement laws and rules flexibly depending on the situation, and–more important–the people involved. If you have good relations with the right people, laws and rules can be interpreted extremely liberally in your favor, or even changed on your behalf. Alternatively, it only takes one government official to delay or penalize your project. In the education business, one unhappy parent with good contacts can sue you, create bad publicity in the media, or cause unforeseen problems with the government.

But finding people with the right connections can be difficult. Those who say they are useful or well connected usually are not, while those who are modest often turn out to be extremely capable. "Friends" in the loose sense of the term are everywhere. Some mean well but do not know what they are doing, while others are just looking after their own interests. Once found, however, truly capable, trustworthy employees deserve special support and flexible human-resource policies. Finding the right people to manage operations and develop government relations should be a high strategic priority for any company in China, far more so than in many other countries.

Thus, I learned from my mistakes and from watching others–possibly the only way to truly understand how to do business in China. Throughout this lengthy and frustrating process, persistence, and the ability to admit and learn from mistakes, were crucial.

Second Attempt: Older and Wiser

We started over, switched cities, and changed everything we did. We worked with our Chinese consultant, rather than a lawyer–this was one lesson we had learned early. We had previously tried to save money by staying at budget hotels and working for a swift conclusion to negotiations. This time, we acted as big as we could, staying in fancy hotels and making clear we were ready to stay for weeks, if necessary, to make a deal. We had also become more savvy about negotiating: at the beginning, we never spoke Chinese and allowed the potential partner to think we knew little about China and depended on them for everything. We promised the leaders of the local partner a trip to Singapore after the negotiations and approval–and kept this promise. We became very patient and comfortable with the Chinese negotiating pace, and set no deadlines, so that there was no pressure for speed. The consultant represented us so well that the new potential Chinese partner voluntarily sped up the negotiating pace.

In our search for a new partner, we focused on finding a high-ranking government body. We decided that our worries about government involvement were outweighed by the benefits of a government partner who could work the system to our mutual benefit. However, to ensure minimal interference and maximum management control, this government body had to be outside the education commission's system. As the body we eventually chose was not a school, there was no conflict in objectives and no desire on their part to manage the operation.

Choosing an entity higher than the education commission in the government hierarchy as we did meant we would have an easy time getting approval and dealing with all other government issues in the future. Finding such a partner was also a marketing coup–their status meant that Chinese students and parents were more likely to hold our institution in high esteem. Most important, the head of our Chinese partner was trustworthy, had solid relations with key government officials, and would be looking for work after he retired in two years. We assured him that there would be room for him on the staff of the new school, giving him an added incentiv e to make sure the project was successful.

New Negotiating Techniques

Joint-venture schools require a dual-approval process. The first approval is the harder one and can take more than a year, if it comes at all. A careful reading of the relevant regulation, the Joint Venture Cooperative Schools Temporary Regulations, shows that a letter of intent can substitute for a contract when applying for the first approval. So we applied with a letter of intent before signing a contract and eliminated the most contentious part of the process. We purposely made sure that the feasibility study did not lock us into any potentially difficult commitments and carefully crafted the school by-laws, which were required submissions as part of the approval application. Throughout, we conveyed modest long-term ambitions for the joint venture to avoid arousing jealousy among government officials who might have blocked our application.

We also worded our approval documents to indicate that the JV was only a first round of investment and that, if everything went well, we would invest more later. This reduced the required up-front capital to a manageable level. We structured our broad goals to match exactly those of the Chinese partner, but made sure we had control of both the board of directors and daily operations. (In China, control on paper does not always guarantee control of a ventur e's staff, funds, daily operations, and connections, so this by itself would not be enough to protect us in the long term.)

The first approval came about four-and-a-half months from the time we first approached the Chinese party. The Chinese partner did much of the work, and we could not have been happier with the result. The y were not only powerful enough to push everything through quickly, they were eager and motivated to do so.

Once we had the key initial approval, we finalized the contract. Always receptive and friendly, we tried to write whatever the Chinese requested into the contract–as long as it did not affect our basic principles of control. Then we transferred the necessary funds and began renovating our space. The final approval came in a mere two months. The wording of this final document was especially important as it established our status and rights as a school. The document gave us among the best terms for such documents in the whole country. We are the first foreign school to have the right to open schools throughout a province without further approvals–other joint-venture schools only have approvals valid for one city–and do not need to register new companies (usually an expensive proposition).

We are also among the first foreign technical schools to offer students a four-year bachelor's degree, recognized at the province level, which enables all of our students to enter local job-placement markets (rencai shichang). Such markets are usually limited to students with state-backed college (2- or 3-year) or university (4-year) degrees. Those without such degrees are relegated to second-rate job markets.

Don't Let Your Guard Down

After our approvals came through, our very capable consultant turned greedy. He decided that a long-term relationship and more work from us or others to whom we might introduce him were worth less than the chance to make some quick money. He tried to convince our Chinese partner to help him hijack our school and its funds. But by this time, we were armed with experience and prepared for anything. We sent our previously chosen general manager to run the school at the appropriate moment, equipped with the right titles and authority–making it clear that she represented us and had our full support. We also emphasized to our Chinese partner her importance in running our school. Her actions over the next two months to counter the machinations of the increasingly desperate consultant proved again that the most valuable assets in China are capable and loyal employees.

My company now has one successful university running in China and is setting up a second one. Classes began in late September after an opening ceremony, which was attended by several top provincial officials, including a vice governor. In the first year, all students must study English intensively: 35 hours a week for 11 months. Then they must choose one of four majors leading to a bachelor's degree in a business or computer-related field.

This term the school has 100 students, and has already surpassed its e nrollment projections by 25 percent. Revenue is 37.5 percent higher than expected. Next year, we hope to have 200 students in this school and to open two more schools with 100 students enrolled in each. Within two years, we aim to have a presence in every city in eastern China, eventually establishing 20-30 schools. Our ultimate goal is to become the leading supplier and trainer–we also offer part-time and corporate training–for multinationals across the region. Our greatest chances for success lie in the excellent people working for us and in the fact that we now know how to manage both our operations, and relations with the government, well.

Seth Kaplan is managing director of Informatics East China, Inc.