RISK ASSESSMENT
FOR
CONSTRUCTION JOINT VENTURES
IN
CHINA
By L. Y. Shen,1 George W. C. Wu,2 and Catherine S. K. Ng3
ABSTRACT: The construction industry in China is developing toward the international procurement practice,
and such development has attracted many foreign firms into the Chinese construction market through the formation of Sino-foreign joint ventures. Joint venture has become an important sector in the Chinese construction
industry. However, the difference in management systems, technological practice, and cultural background among
the partners within joint ventures brings difficulties to the function of joint venture. A significant degree of risk
is involved in joint venture investments. Thus, foreign firms increasingly intend to spend more effort in studying
proper strategies of managing risks in their joint venture businesses. Based on a survey, this paper establishes
a risk significance index to show the relative significance among the risks associated with the joint ventures in
the Chinese construction procurement practice. Real cases are examined to show the risk environment faced by
joint ventures. The paper also investigates practical applications of risk management in the business of joint
ventures.
INTRODUCTION
Since the implementation of ‘‘open door’’ policy in China
in the early 1980s, a significant number of foreign construction
investors and contractors have entered into the Chinese construction industry through the formation of joint ventures with
local firms. While China is cautiously opening its construction
market to overseas, the report from the Ministry of Construction (MOC) shows that the number of foreign contractors who
have obtained the business certificate from the Chinese government has rapidly increased. There was none at the beginning of 1990s; by the end of 1996 there were 118, by the
middle of 1997 and there were 139. The Sino-foreign construction joint ventures has grown from 1,200 in 1994, to
1,600 in 1995, and over 2000 by the end of 1996 (MOC 1997,
1998). This development is in line with the reform programs
of the Chinese construction industry, which aim for changing
the project financing arrangement from traditionally governmental free allocation to commercial loan and changing the
project procurement system from governmental assignment to
competitive tendering. The application of competitive procurement has brought rapid development of other nonstate
owned construction sectors in the industry, including collective-owned firms, private firms, and Sino-foreign joint ventures. MOCs recent statistical report shows that, in 1998, the
total number of construction firms registered in the four-grade
grading system was 41,114, employing 19,427,428 working
staff. Still many small construction teams from rural areas
were not included in the grading system. These graded organizations include 8,702 state-owned firms employing 6,411,423
working staff, 28,304 collective-owned firms employing
11,231,744 workers, 4,108 other ownership employing
1,784,261 workers (MOC 1999). Other ownership mainly consists of Sino-foreign joint ventures, shareholding firms, and
private firms. Sino-foreign joint ventures will continue to grow
and play important roles in the Chinese construction. In a recent development, the government has considered housing and
infrastructure as two main sectors in the Chinese economy in
1
Assoc. Prof., Build. and Real Estate Dept., Hong Kong Polytechnic
Univ., Kowloon, Hong Kong.
2
Executive Dir., Henderson China Ltd., 5/F., Harcourt House, 39
Gloucester Rd., Hong Kong.
3
Sr. Contracts Mgr., Henderson China Ltd., 5/F., Harcourt House, 39
Gloucester Rd., Hong Kong.
Note. Discussion open until July 1, 2001. To extend the closing date
one month, a written request must be filed with the ASCE Manager of
Journals. The manuscript for this paper was submitted for review and
possible publication on April 13, 1998. This paper is part of the Journal
of Construction Engineering and Management, Vol. 127, No. 1, January/February, 2001. 䉷ASCE, ISSN 0733-9634/01/0001-0076–0081/
$8.00 ⫹ $.50 per page. Paper No. 18094.
the coming years. A significant proportion of the capital
needed is expected from overseas investment, and the majority
of these overseas investment works are expected to be implemented through joint ventures (Nian 1999).
Nevertheless, the development of Sino-foreign joint ventures in the Chinese construction market has attracted foreign
partners’ attention to risk management. In the environment
where the market mechanism for protecting joint ventures is
still being established, joint ventures present themselves to
many uncertainties which can bring significant risks. In a typical Sino-foreign joint venture, the overseas party is usually
responsible for providing the majority of financing, and the
local partner provides facilities, land, and labor. Thus, overseas
party is usually in a more risky position, as they cannot easily
take with them the assets invested if they do not wish to continue or want to withdraw from cooperation. While a good
deal of the literature has presented the general business environment for joint ventures in China, there are few works focusing on the construction market. In the late 1980s, Walker
and Flanagan (1987) provided one of few typical works investigating the Chinese construction environment for joint
ventures. Flanagan and Li (1997) examined business conditions for overseas construction professionals in China. Shen et
al.’s works present the procedures for foreign firms to enter
into the Chinese construction market (Shen and Fan 1994;
Shen and Lee 1998). It appears that little research has been
conducted to investigate the risks associated with Sino-foreign
joint ventures in Chinese construction. Thus, it is the main
purpose of this paper to identify these risks and examine their
relative significance. The paper establishes a risk significance
index, from which the most significant risks are highlighted.
The data used are from a recent survey. Analysis is conducted
through discussing real examples. By presenting the facts of
risks, the paper presents references to overseas construction
professionals who are working or planning to enter the Chinese construction market.
CONDUCT OF SURVEY
The research team conducted a survey from August 1998 to
February 1999. The survey, distributed to 185 professionals,
received 54 effective replies from firms based in Hong Kong
or mainland China. The correspondents were from consultants,
designers, and project managers. They had good experience
working on behalf of a foreign partner in various joint ventures
in major cities in China including Beijing, Shanghai, Guangzhou, Chongqing, and Shenzhen. The majority of the respondents were working in leading construction and real estate
firms such as Henderson (China) Investment Co., Swire Properties, New World Development (China) Ltd., Hongkong Land
Ltd., China State Construction Engineering Co. (Hong Kong),
76 / JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001
Sun Hung Kai Properties Ltd., etc. Five in-depth interviews
were conducted in December 1998 and February 1999 that
supported the survey analysis.
It is widely accepted that construction activity is particularly
subject to more risks than other business activities because of
its complexity, and a wide range of risks associated with construction businesses have been previously identified. A typical
classification of risks includes technical risks, management
risks, market risks, legal risks, financial risks, and political
risks (Shen 1997). He (1995) presented some examples of
risks involved in foreign investment in China. Based on previous works, a list of 58 risk factors, as shown in Table 1,
were constructed and presented to respondents. The main purpose of the survey is not to develop a new list of risks but to
analyze the relative significance among the risks identified and
to highlight the major risks.
The respondents were requested to judge the significance or
‘‘expected loss’’ of each risk. There are many criteria that respondents may need to consider. One alternative approach
adopted by previous researchers is to consider two attributes
for each risk: the probability level of the risk occurrence, denoted by ␣; and the degree of impact or the level of loss if
the risk occurs, denoted by ␤ (He 1995; Li 1997). Therefore,
risk significance, denoted as RS, can be described as the function of the two attributes
RS = f (␣, ␤)
(1)
By applying this approach, the respondents were asked to respond to the two attributes for each risk. For considering ␣,
the respondents were required to judge the probability level of
risk occurrence by selecting one from among three levels,
namely, low possibility, normal possibility, and high possibility. For considering ␤, the respondents were required to judge
the degree of impact if the risk concerned occurs, by selecting
one from among three grades, namely, small impact, neutral
impact, and large impact.
ANALYSIS OF SURVEY RESULTS
To assess the relative significance among risks, this study
suggests to establish a risk significance index by calculating a
significance score for each risk. An alternative for calculating
the significance score is to multiply the probability of occurrence by the degree of impact. Thus, the significance score for
each risk assessed by each respondent can be obtained through
the model
S ij = ␣ij ␤ij
(2)
i
j
where S = significance score assessed by respondent j for risk
i; ␣ij = probability of occurrence of risk i, assessed by respondent j; and ␤ij = degree of impact of risk i, assessed by respondent j.
By averaging scores from all 54 responses, it is possible to
get an average significance score for each risk, and this average score is called the risk index score and is used to rank
among all risks. The model for the calculation of risk index
score can be written
冘
54
i
RS =
S ji
j=1
54
TABLE 1. Risks Associated with Sino-Foreign Construction
Joint Ventures
Rick classification
(alphabetical order)
(1)
(1) Financial risk
Bankruptcy of project partner
Difficult convertibility of RMB
Loss due to fluctuation of inflation rate
Loss due to fluctuation of interest rate
Loss due to fluctuation of RMB exchange rate
Low credibility of shareholders and lenders
(2) Legal risk
Breach of contracts by other participants
Breach of contracts by project partner
Lack of enforcement of legal judgment
Loss due to insufficient law for joint ventures
Uncertainty and unfairness of court justice
(3) Management risk
Change of organization within local partner
Improper project feasibility study
Improper project planning and budgeting
Improper selection of project location
Improper selection of project type
Inadequate choice of project partner
Inadequate project organization structure
Incompetence of project management team
Incomplete contract terms with partner
Increase in project management overheads
Poor relation and disputes with partner
Poor relation with government departments
Problems associated with culture difference
Project delay
(4) Market risk
Competition from other similar projects
Fall short of expected income from project use
Increase of accessory facilities price
Increase of labor costs
Increase of materials price
Increase of resettlement costs
Inadequate forecast about market demand
Local protectionism
Unfairness in tendering
(5) Policy and political risk
Cost increase due to changes of policies
Loss incurred due to corruption and bribery
Loss incurred due to political changes
Loss due to bureaucracy for late approvals
(6) Technical risk
Accidents on site
Design changes
Equipment failure
Errors in design drawings
Hazards of environmental regulations
Incompetence of transportation facilities
Increase in site overheads
Industrial disputes
Local firm’s incompetence and low credibility
Materials shortage
Obsoleteness of building equipment
Poor quality of procured accessory facilities
Poor quality of procured materials
Problems due to partners’ different practice
Shortage in accessory facilities
Shortage in skillful workers
Shortage in supply of water, gas, and electricity
Subcontractor’s low credibility
Unknown site physical conditions
Unusual weather and force majeure
Index
score
(2)
0.2595
0.3091
0.3236
0.3650
0.2500
0.4555
0.2223
0.2336
0.3345
0.3505
0.4319
0.1641
0.6386
0.4591
0.5796
0.5523
0.5229
0.3163
0.4023
0.4933
0.3341
0.1932
0.3935
0.1791
0.6364
0.4614
0.2827
0.1500
0.0391
0.1786
0.5500
0.5819
0.4941
0.1708
0.6409
0.4595
0.2509
0.5141
0.1214
0.4978
0.1141
0.2518
0.1563
0.0377
0.2714
0.0722
0.4664
0.0518
0.1305
0.2234
0.2459
0.3205
0.1450
0.1527
0.2450
0.3909
0.2345
0.1145
(3)
where RSi = index score for risk i; and S ij = significance score
assessed by respondent j for risk i.
To calculate S ij, the three-point scales for ␣ and ␤ (lownormal-high and small-neutral-large) need to be converted into
numerical scales. As an alternative method, it is suggested that
‘‘low’’ and ‘‘small’’ take a value of 0.1, that ‘‘normal’’ and
‘‘neutral’’ take a value of 0.5, and that ‘‘high’’ and ‘‘large’’
take a value of 1. By adopting these numerical scales, when
the 54 responses are applied to model 2 and 3, the index scores
for all risks are calculated, as shown in Table 1. Based on the
index scores, risk ranking is established, as shown in Fig. 1.
The risk ranking provides a useful reference to help joint ven-
JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001 / 77
FIG. 1.
Risk Ranking for Sino-Foreign Construction Joint Ventures in China
tures be aware of these major risks and plan proper ways of
controlling them.
RISK ANALYSIS
While it is not practical to discuss the full implications of
all the risks identified in the survey, this section intends to
demonstrate the pattern of the risk environment by presenting
some practical examples discussed in the five in-depth interviews following the survey. Not all the risks addressed in this
section respond to the ‘‘most important risks’’ ranked in the
risk significance index as interviewees have different experiences, and their perception or judgment may not be fully in
harmony with the calculated average index scores.
Management Risk
The survey shows that there are five management-type risks
among the 10 top risks. When the in-depth interview was conducted, it seemed that ‘‘inadequate choice of project partner’’
is a typical risk to joint ventures. A wrongly selected partner
can lead to substantial losses. In a commercial building project
developed by a Sino-foreign joint venture in Shanghai, the
foreign partner suggested selecting the main contractor
through selective tendering, but the local partner insisted on
employing one of its subsidiary construction firms. Following
a number of discussions within the joint venture, the local
partner’s construction firm was eventually employed. However, due to the contractor’s inadequate building methods, differential settlement occurred at the foundation of the adjacent
factory building, and its production line was damaged during
the basement excavation of the project. The factory sued the
joint venture for damages. The contractor denied the liability
and refused to attend any meeting for negotiation and settlement. Finally, the case was settled through mediation, and the
joint venture had to reimburse the factory for all of the damages. Other adversities involved in this case include the difficulty to control the contractor’s performance particularly on
the cost aspect during construction. The negotiation on rates
for new items was almost always in favor of the contractor,
and the joint venture had to pay higher rates for many items.
In the end, the project was delayed, and substantial extra costs
occurred. The experience learned from this case demonstrates
one of many possibilities of making loss due to inadequate
choice of partner. Usually, overseas businesses tend to find
their partners from large state-owned companies. However,
many large state-owned companies may have huge registered
capital and assets, but little real cash flow. Furthermore, they
often have a complicated and bureaucratic system, and their
top managers are usually appointed by the government. Therefore, such a joint venture’s cooperation needs to be incorporated with the interests of the local partner’s superior.
Policy Risk
In the process of reforming the economy system, governmental policies are subject to reviews or changes or updated
as reform progresses. Therefore, many provisional policies and
regulations are issued by both the central and local governments. However, the variations in policies and regulations can
have significant impact on joint venture businesses. In the survey of this study, ‘‘cost increase due to policy changes’’ was
ranked as the top important risk. A joint venture project located
in an old city in Guangdong province was to redevelop a res-
78 / JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001
idential area into a high-class residential area. More than 1,600
families used to live in the area. The joint venture started the
project by signing the contract in July 1993. One of the critical
contractual terms concerned the resettlement of the residents.
According to the existing policy, those residents affected by
the redevelopment for commercial and high-class residential
buildings should be permanently resettled to an external location. The resettlement work started accordingly later that
year. However, after less than half of the families had been
resettled, the local government was requested by upper level
government to revise the resettlement policy. According to the
new policy, if the demolition of old buildings was caused by
the redevelopment for residential buildings, those residents
who were affected should be resettled into their original living
district. The new policy was in effect and applicable to all
projects irrespective of the date of contract signing. Due to the
sudden change of the policy, the joint venture had to change
the redevelopment plan, and the salable area from the development was dramatically reduced. As a result, it was reported
that the profit of this joint venture project dropped by over
50%.
Variation in tax composition is also a typical policy risk.
For the development of a construction project, there are many
tax/fee items applied against urban infrastructure facilities,
public facilities, roads, water, gas, treatment for waste water,
police station, school, kindergarten, and public toilets. According to the central government policy, there are 48 tax/fee
items to be charged by 14 governmental departments on construction project as follows: construction charging, 19; land
management, 10; electricity, 5; public security, 3; industrial
and commercial administration, 1; culture, 2; environmental
protection, 1; labor resource, 1; auditing, 1; statistics, 1; civil
administration, 1; education, 1; sports/physical culture, 1; and
post and telecommunications, 1 (SPC, 1997). However, this
regulation has been violated in local applications. The number
of tax/fee items varies widely in different regions. There were
107 tax items for the development of a construction project in
Wuhan and 102 items in Beijing (Hung 1997). Most of these
extra items are charged against administration expenditures in
local governments. Joint ventures may have to bear substantial
extra costs due to the variation in tax/fee items.
shortage of resources, injuries and accidents, etc. However, a
typical technical risk associated with joint venture in China is
considered due to the partners’ different practices, although it
does not appear among the most significant risks in the survey
index. In a commercial building project developed by a joint
venture in Beijing, significant extra costs were incurred due to
the difference in working procedures for constructing walls.
The incident concerned the procedures for laying conduits for
electrical and mechanical installations, which was undertaken
by a nominated E&M subcontractor. The main contract included the term ‘‘attendance for nominated subcontractor’s
works,’’ which stipulated the main contractor’s responsibility
for attending to the works carried out by the nominated subcontractor. However, during normal inspection, the joint venture’s work supervisor received a complaint from the E&M
contractor that the local masonry workers hired by the main
contractor were damaging the vertical conduits laid earlier by
the E&M contractor. The supervisor went to the site and found
that all vertical conduits were bent outward from structural
brick walls instead of being concealed in the walls as specified.
When questioned, the workers setting the walls revealed that
the local practice of finishing the works was in the sequence
of erecting structural brick walls, making chases for conduits,
laying conduits by the E&M contractor, and applying finishing
to conceal the conduits. When the masonry workers started to
work, they found that vertical conduits were installed and obstructed their operation. They therefore bent the conduits
(some conduits were even pulled out and set aside) in order
to make way for setting the brick wall. When the supervisor
discussed the case with the main contractor, the main contractor blamed the E&M contractor and asked for compensation
for abortive works. Because the different practice was not expected in the contract, the joint venture had to compensate the
main contractor. This case demonstrates that different technological practices can bring considerable losses if coordination is lacking among the parties within joint ventures. In fact,
it is said that a significant part of contractual disputes within
Sino-foreign joint ventures are due to poor communication and
misunderstanding between parties and that the difference in
technical practice is the major cause for the problem (Song
1999).
Technical Risk
Market Risk
Any construction work will be subject to some technical
risks, such as changes and errors in design, equipment failure,
The ‘‘inadequate forecast of market demand’’ was ranked
as one of the major risks in the survey. One typical example
FIG. 2.
Hierarchy of State-Owned Construction Enterprises
JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001 / 79
is the development of golf courses in China where some joint
ventures have invested a lot of money but with little income.
It seems that such demand is very limited in the current Chinese market. In the forecast of market demand, more consideration should be given to the number of players available
rather than the number of golf courses allowed to be built.
‘‘Local protectionism’’ is also presented as a major market
risk. A competitive tendering approach has not yet been fully
established in the Chinese construction. In fact, a significant
number of domestic construction organizations is state-owned,
belonging to either central or local governmental departments
that supervise and at the same time protect these organizations.
Fig. 2 shows the hierarchy of state-owned construction organizations. As many state-owned firms have little competitiveness in the market largely due to the management bureaucracy
and the overstaffing burden developed over the last several
decades under the planned economy, the government has to
help them to survive by assigning them certain jobs and limiting the entry of external competitors. Provincial localities
normally issue various regulations limiting the opportunities
for external organizations such as joint ventures to tender for
local projects. Joint ventures are still restricted to certain kinds
of projects such as the foreign-invested projects and the World
Bank projects. While this system is currently under reform, it
will take a significant period of time before a full competition
system is in place. The partial competition practice causes the
poor transparency in the tendering process, and a joint venture
can easily lose in such competition.
PRACTICAL RISK MANAGEMENT STRATEGIES
The principles of risk management have been well developed. Typical risk management strategies include risk transfer,
risk retention, and reduction. While these principles are applicable in general, the following discussions intend to provide
FIG. 3.
several practical examples in managing risks in the Chinese
environment.
Cooperation with Government Offices
To operate a Sino-foreign joint venture in the Chinese construction industry, it is important to cooperate and maintain
good relationships with local government. A large contractor
from Hong Kong formed a cooperative joint venture with a
local state-owned company for developing a multifunction
building in Shanghai. Upon the completion of two-thirds of
the project, the government proposed to extend a ramp for an
existing bridge that was adjacent to the project. This proposal
would result in blocking the entire shop-front of the building
facing the ramp extension. However, because the joint venture
established a good relation with the local government, the negotiation led to a relocation of the ramp. Consequently, not
only would the shop-front of the building not be blocked, but
the value of the building also would be enhanced because the
new ramp improved the traffic flow of the location.
Proper Risk Allocation in Contract
Proper contractual arrangements determine who is more capable of controlling various specific risks. Generally, the local
partner in a joint venture has all the knowledge about the local
environment including resources, technology, policies, and legal practice. It has proven effective to allocate risks at the
operational level to the local partner. A joint venture project
was a power plant with a capacity of 2 ⫻ 150 MW located in
Southwest China. The project included the main cooperative
contract power purchase agreement (PPA), supplemented by
three other contracts signed respectively with the Equipment,
Procurement, and Construction (EPC) contractor; the operation
and maintenance (O&M) contractor; and the fuel supplier. The
organization structure of the joint venture is shown in Fig. 3.
Structure of Contractual Relationships in Joint Venture
80 / JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001
The US$290,000,000 project was offered to a Sino-foreign
joint venture with 20 years of cooperation period. The foreign
party controlled over 50% of the shares. The major terms in
the cooperation contract included ‘‘investment amount: 35%
equity, 65% shareholder’s loan’’; ‘‘equity internal rate of return not less than 15%, interest rate for loan not less than
10%’’; ‘‘preemptive amortization for the investment by foreign
party’’; ‘‘10 years payback period’’; ‘‘local partner being responsible for the extra costs due to the construction risks including delayed time, poor quality’’; and ‘‘local partner assuming all operation and maintenance risks to ensure that the
operation hours of 5,000 per year minimum.’’
The joint venture also bought insurance against the risk of
breaching the contract by either party. Through such contractual arrangement, the local partner, who was in severe shortage
of capital, secured the capital needed, and the overseas party
secured its interests as well.
Controlling Technical Risk
Most Sino-foreign cooperative joint ventures are projectbased ventures. Project management procurement system has
proven to be an effective approach for controlling technical
risks in such joint ventures. A real estate project located in the
central commercial district in Beijing was developed by a
Sino-foreign cooperative joint venture. The project involved
the development of a 20-story residential building, three commercial office towers over a three-story podium on top of a
three-level basement, and an eight-story hotel. The project had
a site area of 30,070 m2, and the total gross completion floor
area was 280,000 m2. The foreign party assumed the duty of
overall project management and spent major efforts on cost
control. The main construction contract was offered to a stateowned firm recommended by the local partner who, by agreement, was responsible for the quality of construction and technical program. Nominated subcontracts were made through
selective tendering mostly to local construction firms. On the
foreign party’s recommendation, the cost control consultant
was from Hong Kong. The foreign party in such an arrangement assumed the role of project manager, and the local partner assumed the role of construction manager responsible for
all technical risks. The entire project was successfully completed.
CONCLUSIONS
With assistance of a practical survey, this paper has systematically examined major risks affecting the Sino-foreign construction joint ventures. The risk significance index developed
in this paper, supported by examining real risk cases, provides
an effective insight and clear picture of the risk profile involved in the joint venture businesses in Chinese construction.
The proper understanding of this risk profile is essential in
order for joint venture to take proper risk management strategies. The investigation of several practical risk management
strategies demonstrates effective examples of adopting risk
management principles properly. They provide useful references to other joint ventures or those overseas firms who are
planning to operate their businesses in China. The analysis and
findings in this paper also present valuable data for the Chinese government and local partners to have an in-depth understanding of the risk environment to the operation of Sinoforeign joint ventures. Such understanding is very important
for implementing further effective measures to ensure the right
direction of future development and create a more attractive
market to overseas construction professionals.
APPENDIX.
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