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The Most Important People in China

By Tim Hanson - Updated Apr 6, 2017 at 12:48PM

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In the world's most populous nation, guanxi is everything.

Tim Hanson is in China researching stocks with the Global Gains team. This column is one of the dispatches he wrote in Beijing and emailed back to international investors interested in China's growth story. To sign up for all of Tim's dispatches from China, visit china2010.fool.com.

In China, it's often not what you know, but who you know that counts. In the United States, you could describe that business concept with the dirty words "related-party transaction," but in China, the idea is known as guanxi, and it's generally considered a prerequisite for success.

What exactly is guanxi? It refers to the network of friends and business contacts that has underpinned Chinese commerce. Yet the economy here is changing rapidly. More and more multinational companies are entering the market, seeking to carve out a place for themselves. These developments have made guanxi more important than ever in some respects -- and totally irrelevant in others.

When guanxi still matters
If you read yesterday's dispatch, or you're a member of Motley Fool Global Gains, then you're aware of Chinese fertilizer company Yongye International (Nasdaq: YONG). You've probably also heard that some investors have questioned the company's decision to buy a customer list from one of its provincial distributors for more than $30 million. Why would Yongye simply buy a list from a distributor, rather than the trucks and warehouses used for the actual distribution?

For one thing, this distributor isn't a distributor in the conventional sense. Rather than adding value by moving products from a manufacturing plant to a store, this provincial-level distributor identified the county-level distributors and stores best suited to sell Yongye's products. You can think of it as more of a market-intelligence organization than a distributor -- and all of the value it created for Yongye lies in the approximately 2,700 points of sale it snagged for the company in Hebei province. 

As Larry Gilmore, Yongye's vice president of corporate strategy, told us, you can't just look up local distributors and retailers in rural China in a phone book. A resource like that doesn't even exist. But if it did, Yongye would have no idea whether the prospective partners have the financial strength and passion to succeed. Yongye's distributor was so much better than a phone book because it had close ties to the influential players in the province's agricultural sector.

And when it doesn't
As China becomes more modern, however, the role of guanxi may be reduced. We talked to several advertising brokers who had participated in China Central Television's (CCTV) recent auction for advertising time. Time used to be awarded based on brokers' connections, which benefited the advertising agencies run by former CCTV producers, for example. But CCTV's new leadership decided to change the sales model by auctioning off slots to -- gasp! -- the highest bidder.

This was frustrating for companies that had built their businesses on connections. In some cases, it was also frustrating for CCTV, which ended up with new, inexperienced partners. But these hiccups aside, both sides have concluded that a transparent, level playing field will attract more advertisers to CCTV -- which should end up benefiting all the players over the long run.

How to make good investments and influence people
Although relationships remain important in Chinese business, the key to investing in the country today is to steer clear of any company that relies too heavily on one person or relationship, at the expense of building a strong, sustainable core business.

Not only may guanxi's importance be waning in some sectors, but relationships can also disappear overnight. When we recommended that investors sell China Fire & Security (Nasdaq: CFSG) in June 2009, for example, the company's loss of a key government contact helped spur our decision.

So which companies do we think have strong, sustainable core businesses, capable of succeeding in rapidly changing China? We're just getting started over here, so keep reading these dispatches and visiting china2010.fool.com to find out.

Get Tim Hanson's "Global View" column every Thursday on Fool.com, or by following him on Twitter.

Tim Hanson owns shares of Yonge International. Yongye International is a Motley Fool Global Gains selection. The Fool owns shares of Yongye International. The Motley Fool has a disclosure policy.

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