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 for-
mation 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 the coming years. A significant proportion of the capital

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 con-
struction 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 Construc-
tion (MOC) shows that the number of foreign contractors who
have obtained the business certificate from the Chinese gov-
ernment has rapidly increased. There was none at the begin-
ning of 1990s; by the end of 1996 there were 118, by the
middle of 1997 and there were 139. The Sino-foreign con-
struction 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 govern-
mental free allocation to commercial loan and changing the
project procurement system from governmental assignment to
competitive tendering. The application of competitive pro-
curement has brought rapid development of other nonstate
owned construction sectors in the industry, including collec-
tive-owned firms, private firms, and Sino-foreign joint ven-
tures. 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 organ-
izations 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 con-
sists 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 re-
cent development, the government has considered housing and
infrastructure as two main sectors in the Chinese economy in
needed is expected from overseas investment, and the majority
of these overseas investment works are expected to be imple-
mented through joint ventures (Nian 1999).
Nevertheless, the development of Sino-foreign joint ven-
tures 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 typ-
ical 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 con-
tinue or want to withdraw from cooperation. While a good
deal of the literature has presented the general business envi-
ronment for joint ventures in China, there are few works fo-
cusing on the construction market. In the late 1980s, Walker
and Flanagan (1987) provided one of few typical works in-
vestigating the Chinese construction environment for joint
ventures. Flanagan and Li (1997) examined business condi-
tions 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 Chi-
nese construction market.
CONDUCT OF SURVEY

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, Janu-
ary/February, 2001. ASCE, ISSN 0733-9634/01/0001-00760081/
$8.00 $.50 per page. Paper No. 18094.
76 / JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001
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, Guang-
zhou, Chongqing, and Shenzhen. The majority of the respon-
dents were working in leading construction and real estate
firms such as Henderson (China) Investment Co., Swire Prop-
erties, New World Development (China) Ltd., Hongkong Land
Ltd., China State Construction Engineering Co. (Hong Kong),
Sun Hung Kai Properties Ltd., etc. Five in-depth interviews TABLE 1. Risks Associated with Sino-Foreign Construction
were conducted in December 1998 and February 1999 that Joint Ventures
supported the survey analysis. Rick classification Index
It is widely accepted that construction activity is particularly (alphabetical order) score
subject to more risks than other business activities because of (1) (2)
its complexity, and a wide range of risks associated with con- (1) Financial risk
struction businesses have been previously identified. A typical Bankruptcy of project partner 0.2595
classification of risks includes technical risks, management Difficult convertibility of RMB 0.3091
risks, market risks, legal risks, financial risks, and political Loss due to fluctuation of inflation rate 0.3236
risks (Shen 1997). He (1995) presented some examples of Loss due to fluctuation of interest rate 0.3650
risks involved in foreign investment in China. Based on pre- Loss due to fluctuation of RMB exchange rate 0.2500
Low credibility of shareholders and lenders 0.4555
vious works, a list of 58 risk factors, as shown in Table 1, (2) Legal risk
were constructed and presented to respondents. The main pur- Breach of contracts by other participants 0.2223
pose of the survey is not to develop a new list of risks but to Breach of contracts by project partner 0.2336
analyze the relative significance among the risks identified and Lack of enforcement of legal judgment 0.3345
to highlight the major risks. Loss due to insufficient law for joint ventures 0.3505
The respondents were requested to judge the significance or Uncertainty and unfairness of court justice 0.4319
(3) Management risk
expected loss of each risk. There are many criteria that re- Change of organization within local partner 0.1641
spondents may need to consider. One alternative approach Improper project feasibility study 0.6386
adopted by previous researchers is to consider two attributes Improper project planning and budgeting 0.4591
for each risk: the probability level of the risk occurrence, de- Improper selection of project location 0.5796
noted by ; and the degree of impact or the level of loss if Improper selection of project type 0.5523
the risk occurs, denoted by (He 1995; Li 1997). Therefore, Inadequate choice of project partner 0.5229
Inadequate project organization structure 0.3163
risk significance, denoted as RS, can be described as the func- Incompetence of project management team 0.4023
tion of the two attributes Incomplete contract terms with partner 0.4933
Increase in project management overheads 0.3341
RS = f (, ) (1) Poor relation and disputes with partner 0.1932
Poor relation with government departments 0.3935
By applying this approach, the respondents were asked to re- Problems associated with culture difference 0.1791
spond to the two attributes for each risk. For considering , Project delay 0.6364
the respondents were required to judge the probability level of (4) Market risk
risk occurrence by selecting one from among three levels, Competition from other similar projects 0.4614
namely, low possibility, normal possibility, and high possibil- Fall short of expected income from project use 0.2827
Increase of accessory facilities price 0.1500
ity. For considering , the respondents were required to judge Increase of labor costs 0.0391
the degree of impact if the risk concerned occurs, by selecting Increase of materials price 0.1786
one from among three grades, namely, small impact, neutral Increase of resettlement costs 0.5500
impact, and large impact. Inadequate forecast about market demand 0.5819
Local protectionism 0.4941
Unfairness in tendering 0.1708
ANALYSIS OF SURVEY RESULTS (5) Policy and political risk
To assess the relative significance among risks, this study Cost increase due to changes of policies 0.6409
Loss incurred due to corruption and bribery 0.4595
suggests to establish a risk significance index by calculating a Loss incurred due to political changes 0.2509
significance score for each risk. An alternative for calculating Loss due to bureaucracy for late approvals 0.5141
the significance score is to multiply the probability of occur- (6) Technical risk
rence by the degree of impact. Thus, the significance score for Accidents on site 0.1214
each risk assessed by each respondent can be obtained through Design changes 0.4978
the model Equipment failure 0.1141
Errors in design drawings 0.2518
S ij = ij ij (2) Hazards of environmental regulations 0.1563
Incompetence of transportation facilities 0.0377
i
where S = significance score assessed by respondent j for risk Increase in site overheads 0.2714
j
Industrial disputes 0.0722
i; ij = probability of occurrence of risk i, assessed by respon- Local firms incompetence and low credibility 0.4664
dent j; and ij = degree of impact of risk i, assessed by re- Materials shortage 0.0518
spondent j. Obsoleteness of building equipment 0.1305
By averaging scores from all 54 responses, it is possible to Poor quality of procured accessory facilities 0.2234
get an average significance score for each risk, and this av- Poor quality of procured materials 0.2459
erage score is called the risk index score and is used to rank Problems due to partners different practice 0.3205
Shortage in accessory facilities 0.1450
among all risks. The model for the calculation of risk index Shortage in skillful workers 0.1527
score can be written Shortage in supply of water, gas, and electricity 0.2450

54 Subcontractors low credibility 0.3909
Unknown site physical conditions 0.2345
S ji Unusual weather and force majeure 0.1145
i j=1
RS = (3)
54
where RSi = index score for risk i; and S ij = significance score neutral take a value of 0.5, and that high and large
assessed by respondent j for risk i. take a value of 1. By adopting these numerical scales, when
To calculate S ij, the three-point scales for and (low- the 54 responses are applied to model 2 and 3, the index scores
normal-high and small-neutral-large) need to be converted into for all risks are calculated, as shown in Table 1. Based on the
numerical scales. As an alternative method, it is suggested that index scores, risk ranking is established, as shown in Fig. 1.
low and small take a value of 0.1, that normal and 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 inter-
views 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 experi-
ences, 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 con-
ducted, 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
partners construction firm was eventually employed. How-
ever, due to the contractors inadequate building methods, dif-
ferential 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
78 / JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001
joint venture for damages. The contractor denied the liability
and refused to attend any meeting for negotiation and settle-
ment. Finally, the case was settled through mediation, and the
joint venture had to reimburse the factory for all of the dam-
ages. Other adversities involved in this case include the dif-
ficulty to control the contractors 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. There-
fore, such a joint ventures cooperation needs to be incorpo-
rated with the interests of the local partners superior.
Policy Risk
In the process of reforming the economy system, govern-
mental 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 govern-
ments. However, the variations in policies and regulations can
have significant impact on joint venture businesses. In the sur-
vey 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-
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 lo-
cation. 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 devel-
opment 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. Ac-
cording to the central government policy, there are 48 tax/fee
items to be charged by 14 governmental departments on con-
struction 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.
Technical Risk
Any construction work will be subject to some technical
risks, such as changes and errors in design, equipment failure,
FIG. 2. Hierarchy of State-Owned Construction Enterprises
JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001 / 79
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 in-
cluded the term attendance for nominated subcontractors
works, which stipulated the main contractors responsibility
for attending to the works carried out by the nominated sub-
contractor. However, during normal inspection, the joint ven-
tures 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 ob-
structed 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 contrac-
tor blamed the E&M contractor and asked for compensation
for abortive works. Because the different practice was not ex-
pected in the contract, the joint venture had to compensate the
main contractor. This case demonstrates that different tech-
nological practices can bring considerable losses if coordina-
tion 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).
Market Risk
The inadequate forecast of market demand was ranked
as one of the major risks in the survey. One typical example
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 Chi-
nese market. In the forecast of market demand, more consid-
eration 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 organ-
izations. As many state-owned firms have little competitive-
ness 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 lim-
iting 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 devel-
oped. Typical risk management strategies include risk transfer,
risk retention, and reduction. While these principles are appli-
cable in general, the following discussions intend to provide
FIG. 3. Structure of Contractual Relationships in Joint Venture
80 / JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001
several practical examples in managing risks in the Chinese
environment.
Cooperation with Government Offices
To operate a Sino-foreign joint venture in the Chinese con-
struction 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 ne-
gotiation 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 ca-
pable 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 le-
gal 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.
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% shareholders loan; equity internal rate of re-
turn 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 re- findings in this paper also present valuable data for the Chi-
sponsible for the extra costs due to the construction risks in-
cluding delayed time, poor quality; and local partner assum-
ing 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 contrac-
tual 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 project-
based 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 com-
mercial 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 state-
owned firm recommended by the local partner who, by agree-
ment, was responsible for the quality of construction and tech-
nical program. Nominated subcontracts were made through
selective tendering mostly to local construction firms. On the
foreign partys recommendation, the cost control consultant
was from Hong Kong. The foreign party in such an arrange-
ment assumed the role of project manager, and the local part-
ner assumed the role of construction manager responsible for
all technical risks. The entire project was successfully com-
pleted.
CONCLUSIONS
With assistance of a practical survey, this paper has syste-
matically examined major risks affecting the Sino-foreign con-
struction 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 in-
volved in the joint venture businesses in Chinese construction.
JOURNAL OF CONSTRUCTION ENGINEERING AND MANAGEMENT / JANUARY/FEBRUARY 2001 / 81
The proper understanding of this risk profile is essential in
order for joint venture to take proper risk management strat-
egies. The investigation of several practical risk management
strategies demonstrates effective examples of adopting risk
management principles properly. They provide useful refer-
ences to other joint ventures or those overseas firms who are
planning to operate their businesses in China. The analysis and
nese government and local partners to have an in-depth un-
derstanding of the risk environment to the operation of Sino-
foreign 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.
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