Networks as Business Networks
Hans Hendrischke, UNSW Sydney
stChapter 7 in: Barbara Krug and Hans Hendrischke (eds.) China‟s Economy in the 21 century:
Enterprise and business behaviour. London: Edward Elgar (2006)
Hardly any company is set up or business deal made in China without the help of personal connections - guanxi - and the ubiquitous business networks. Yet, in China
and among China experts, the notion of business networks and of personal connections, which are the building blocks of business networks, remain influenced by the concept of traditional family networks in Taiwan, Hong Kong and the Overseas Chinese Diaspora (Weidenbaum and Murray 1996). The cultural explanation views trust, reciprocity and long-term commitment, which hold these networks together (Redding 1990; Tong and Yong 1998; Peng 2004; Luo 1997), as family commitments, much in the same way as for centuries religious and customary ties were underlying the trading networks of Maghribi traders in the Mediterranean (Greif 1993). The paradigm of traditional Overseas Chinese business networks still dominates the description and analysis of business networks in the PRC, even though it is unlikely that the private sector in the PRC could have achieved its size, complexity and level of international integration on the basis of family based structures. Annual field interviews with local entrepreneurs in Jiangsu and Zhejiang from 2000 to 2006 suggest that it might be time to take a fresh look at Chinese business networks and attempt an economic explanation for their role and operation in China‟s newly privatized economy. Three initial findings prompt this attempt.
First, business networks extend far beyond family structures and include seemingly unrelated businesses as well as local administrations. This raises the questions of how networks are established and expanded in China‟s new corporate environment. Have
traditional family structures been replaced by business networks able to expand beyond traditional loyalties and to create mutual commitments without previous history of personal connections? Can the governance of these networks be better explained by current network theories than by reference to Chinese traditions?
Second, business networks seem to operate as economic actors in their own right and to have the ability to create and control assets. This raises the issue of corporate ownership and of the dividing line between firms and networks. This in turn raises the question of the role of entrepreneurs versus firms as the primary drivers of corporate activity. If entrepreneurs have a choice between a commitment to networks and a
commitment to firms, the role of networks is much stronger than generally assumed, which has important business implications.
Third, local business networks, beyond facilitating business transactions, also play a role in the privatization process by linking local administrative and corporate interests and contributing to the coevolution of new business procedures and institutions at local level. This has implications for privatisation trajectories, local state support for enterprises, taxation and, more generally, the future development and formation of a unified national business system.
The following attempt to explore these issues is first of all an exercise in rethinking habitual concepts and moving from a cultural towards an economic explanation. There is a practical dimension as well. If Chinese business networks are based on cultural and family values, one has to be Chinese to be part of them; if they operate based on economic rationale, one needs to know the rules to participate.
The following account describes enterprise-level business networks in their local administrative environment from an institutional perspective and perceives individual entrepreneurs as embedded in their surrounding economic, social and political institutions. This local perspective departs from the grand unified narratives of „Confucianist China‟ or the „Authoritarian State‟ as well as from China‟s central
administration‟s view in Beijing that economic policies are being implemented in a controlled top-down process (e.g. Garnaut et al. 2001). The author‟s field research on
the emergence of private enterprise over the last five years produced a wealth of detailed observations which were not available to earlier studies (e.g. Qian 2003 or Peng and Zhou 2005) and which point to the crucial role of business networks in enabling nascent local businesses to operate in largely unregulated local business environments. The challenge facing this study is to sketch an overarching institutional architecture that links national policies and local diversity.
The following paper is based on interviews with approximately two hundred entrepreneurs in the rapidly expanding private sector in the Eastern Chinese provinces
1. Section 2 starts off with a conceptual description of Chinese around Shanghai
business networks that covers formation, membership, borders and cultural
embedding. Section 3 shifts the focus to the corporate role of networks, including their role as economic actors, their control over assets and their interaction with markets. Networks here are seen to operate at a deeper level than just in facilitating business transactions. Two case studies will be presented to better illustrate the functioning of networks. Section 4 extends this analysis to the coevolution between business networks and local governments and the institution-building capacity of networks in China‟s transition to a market economy. Section 5 proposes some general
There is general agreement on what constitutes the core elements of network structures. The main ones are entry and exit, the typology of ties, e.g. weak, strong, dyadic ties, density of the network, including structural holes, and boundaries of networks (Powell 1990; Granovetter 1993; Uzzi 1996; Nooteboom et al. 1997;
Borgatti and Foster 2003). For China, the description of networks is dominated by the cultural account which is based either narrowly on family structures and extensions thereof, such as the group loyalties found in the Overseas Chinese Diaspora, or more broadly on Confucianism (Tsang 1998; Lovett et al. 1999; Bian 1997). An alternative,
more politically oriented paradigm for describing and analysing networks originates from field studies in the PRC (Gold, Guthrie and Wank 2002). Both approaches find external reasons for the formation of business networks. In this sense both accounts are not satisfactory in explaining the dynamic business development in contemporary China and even less able to make any predictions. Family values and Confucianism are a-historical concepts that bear little relation to China‟s dynamic environment. The
political account catches some of the dynamism in the PRC, but there is general agreement that political change happens much more slowly than economic change and is therefore not helpful in analysing or predicting economic changes. One way to overcome these limitations is to use an institutional account that views networks as originating from an economic rationale. Such an account will have to incorporate elements of the cultural as well as of the political account, but put them on their economic feet, so to speak.
The institutional account presented below is conceptually derived from the generalisation of case studies. The ideal type presentation of findings seems reasonable for this section, as the many observations concern informal structures which cannot easily be caught in formal interview processes or in anonymous questionnaires. On the other hand, they are open to any participant observer familiar with local institutions, culture and language. An institutional explanation will be proposed for each of the major elements of networks structures listed above.
Entry and commitment
In the cultural account, entry into Chinese business networks is based on family links or other forms of attachments, such as membership of the same cohort of students or the same dialect group or similar. Implied in the conditions of entry is the type of commitment that sustains the network. Commitment is hardly questioned in this account, as entry in a family network implies acceptance of family values, much the same way as being part of a network of a school cohort implies acceptance of the culturally defined norms related to this role.
While in the cultural account, membership of a group comes first and participation in the control of resources second, an economic account has to begin with control over resources and then add the social dimension. In other words, entry into business networks is governed by two conditions. One is acceptance of a social code of conduct; the other is control over resources of interest to the network. In family networks, these two conditions are met through family socialisation and inheritance rights to family assets.
In the institutional account, entry and form of commitment have to be separated and their order of importance reversed. This means that networks are constituted around assets and resources which are contributed by their members. It is control over assets rather than familiarity among people that makes an economic network and members are only join the network if they are able to contribute to the resource base of the network. Resources have to be understood in a wide sense, ranging from physical assets to intellectual resources as well as access to power structures, non-tradable information and social capital, in brief, everything that is required to constitute exploitable assets. Only when a resource base is established and assets can potentially
be put into operation, can the people who control these resources form networks which then need to rely on a set of social rules to assign members their share of control and benefits. We will now turn to these rules and return to assets in the following section. First, we propose a simple institutional model to explain the role of social rules and commitments of networks.
Acceptance of the social code of conduct commits entrants to some basic, unwritten rules intended to create trust that gives both stability and flexibility to the network. The first rule is that members have to be personally acquainted with other members of the network. This produces the one to one (dyadic) structure that is crucial for interpersonal trust among members (Chen and Chen 2004). The second rule is that members agree to establish personal acquaintance with potential new members. This way they avoid what is know in network literature as structural holes (Burt 1992). The third requirement for constant communication is often overlooked as a rule, because it is seen as part of natural social interaction rather than as a specific rule. This refers to the density of networks, i.e. frequency of contact (Boisot and Child 1996).
As a result, these networks are characterised by dyadic ties, strong interpersonal trust, few structural holes and high density. This concurs with the cultural account, according to which Chinese networks are characterised by high density, interconnectedness, stability and durability (Batjargal 2005). In contrast to the cultural account, however, the institutional account does not have to rely on vague notions such as „Confucian emphasis on social harmony[which] facilitates trust building among members of a guanxi cluster over time‟ or „the doctrine of the middle that
avoids extremes, and the balance between the yin and the yang‟ (Batjargal 2005: 20;
see also Luo 1997).
The weakness of the cultural account is that the density and Confucianist ideology are automatically interpreted as exclusionary devices. This is based on a limited understanding of how the creation of guanxi under business aspects actually works
and the fact that traditionally in Chinese representation family analogies and personal affective terms (old friendship) are used which in fact hide an underlying economic rationale. The best example of the economic rationality of an affective term is „old
friend‟ (lao pengyou) which is in popular usage often presented as a relationship akin to family membership.
Old friend as an informal agreement
At first sight it appears as if the social commitment within a network substitutes the emotional closeness of traditional family ties by a specific notion of friendship, thus confirming the cultural account that business ties grow out of personal links. However, this friendship with its fluid borderline between utilitarian and emotional aspects can be created nearly at will by activating cultural and social conventions. „Old friend‟
which reflects an ambivalent closeness that can be economically or personally motivated or preferably both, is an informal status between two or more people that is usually established after several personal meetings, often banquets and other forms of social entertainment which encourage a relaxed personal atmosphere. The procedure can be shortened in the case of urgent business demands. Usually it culminates in the mutual affirmation of now being „old friends‟, with the implication of now being open
to future business proposals on the basis of the newly formed trust (for a description of the process, see Yang 1994).
In institutional terms, „old friends‟ have established sufficient trust to make their
personal affinity strong enough to withstand surrounding formal institutions or to make up for the lack of formal structures in a weak institutional environment. „Old
friends‟ have established sufficient trust to jointly face the risks involved in overcoming or disregarding external institutional constraints. In the flexible institutional environment of China‟s transitional economy, „old friends‟ are able to
create their own procedures and institutions. Conversely, in areas of stronger institutional environments, these personal links can be used to circumvent formal institutional constraints, including laws and administrative regulations, and may become the source of illegal or corrupt conduct (see also Xin et al. 1996).
This brings us back to our previous discussion. If „old friend‟ status is comparable to
an informal contractual agreement between parties to circumvent or disregard formal institutions and constraints should that be in their common interest, this has consequences for the density of the network and the strength of ties. The practical obligations under such an agreement include constant accessibility and responsiveness
to demands for cooperation from other members (whether these demands are accepted or not), and a commitment to loyalty and confidentiality within the network. The requirement of confidentiality is a consequence of the institutional borders that networks draw around themselves. The strength of ties is to be measured less in proximity of personal or social ties than in the commitment to consensual institution building, either in order to overcome the absence of formal institutions or to resist or undermine formal institutions that are deemed disadvantageous to the economic interests of the network. The borders of networks are defined by the ability to overcome external constraints, rather than by closed membership.
Weak and strong ties
Commitment to the network is not uniform across its membership. Anthropologists and management studies sometimes differentiate between strong and weak links (Granovetter 1993; Bian 1997). From an institutional perspective, networks are better divided in an active and a dormant sphere. The active sphere comprises those members who are linked to each other by joint economic activity, more specific, by joint exploitation of a resource base. Active links constituted by joint exploitation of assets form the core of networks. Dormant links form a periphery of unrealised cooperation and represent the potential of a network. The dormant sphere encompasses members who are joined by mutual acquaintance to members of the active network and who when required might be called upon to contribute their resources, but who are not currently engaged in joint exploitation. This is not the same as the differentiation between weak and strong ties. Weak and strong ties are based on personal and social ties, whereas the differentiation between active and dormant links rests on economic criteria, specifically on the involvement in the exploitation of assets. From this perspective, the degree of overlap between different networks, or between different cores, depends on the endowment of individual members with control over assets.
Dormant and active networks
Entry can be made into the active or the dormant sphere of the network. The former occurs when an entrant controls resources or assets which are immediately required by other network members. Entry into dormant membership occurs when someone has control over resources or assets which at the time cannot be configured into an
exploitable asset but are of potential interest to the members of the network. From this perspective, dormant membership serves to store social capital which can be activated for the mobilisation of resources. Membership in a network is therefore highly flexible and deliberately open to potential contributors, even allowing potential members to compete for access. Active membership, on the other hand, can revert to dormant status once resources are no longer required. This normally does not mean exit from the network.
Boundaries of networks
In institutional terms, the border of a network is defined by the social commitment to cooperate with the network members and the actual or potential contribution of resources. The size of networks is hard to pin down as there is no clear borderline for dormant membership. The active part of membership is more clearly defined as comprising those members who have pooled resources and assets for specific business purposes. Also, active membership in one network does not preclude membership in other networks as long as there is no conflict in the use of assets. Active and dormant members can belong to different and overlapping networks as long as there are no personal or economic conflicts of interest. Networks can include dormant members who at the same time may be dormant or active members of other networks. However, such links across networks do not constitute links between the original networks.
Exit from the network is as flexible as entry and happens through transition to dormant status and further cooling off once a member‟s resources have lost their
actual or potential usefulness for the network. Outgoing members move to the periphery of the network, which is defined by the distance from involvement in exploitation of assets. This fading out is more likely than explicit exit or expulsion. Expulsion would occur if trust is broken or if a member relied on formal institutions to exploit a network controlled asset in the form of individual profit-taking. The network would then employ formal or social sanctions.
Unlike families, business networks exist for economic purposes. This is not necessarily expressed in these terms when dormant networks are set up, because the social function tends to overshadow the economic purpose. The economic purpose
becomes obvious when dormant networks become activated around a business concern and when assets and resources are accumulated and assembled to form assets. The core function of business networks is to provide an environment enabling the formation and exploitation of business assets when existing institutions are lacking or dysfunctional. We will now take a closer look at how networks assemble and utilise assets.
There is a vast and detailed literature on what Peng and Zhou (2005) call the contents of Chinese business networks, such as their business to business economic role (e.g. Hamilton 1996; Schlevogt 2002) or their business to government social and political role (Boisot and Chila 1998; Wank 1995; Gold, Guthrie and Wank 2002). The underlying general assumption is that networks operate between firms. This assumption is questionable on the ground that in a transition economy like the Chinese in the last decade, assets are seldom given or static. Ownership and control rights may be contested and legal titles unenforceable (Krug and Polos 2004). To function in this dynamic environment, assets frequently require additional input or reconfiguration to bring them in line with the constantly changing regulatory and market environment (Stark 1996). The same is true for the ownership of assets. In China‟s gradual transition process, assets can have a stronger continuity than the property rights attached to them; put differently, informal ownership through networks can survive changing formal ownership. The reason for this is that assets are not privatised in a straightforward fashion, but instead come under the control of local governments in the wake of China‟s devolution policies (Qian 2000; Qian 2003). At
the local level, further privatisation happens in a step-wise process that is negotiated through networks between local governments and entrepreneurs (Krug and Hendrischke 2003). Correspondingly, assets change their formal status in this process, but not necessarily their informal status. This dynamism can be expressed by differentiating forms of network control.
Below, the terms network concern, network asset and private asset will be used to distinguish assets according to the way in which they are controlled by networks and