on Direct Selling

At the Crossroads of Distribution Reform: China's Recent Ban on Direct Selling Ricky Y.K. Chan

he gradual liberalization of China's distribution system since the adoption of its open-door policy in late 1978 has introduced a new dynamism to the country and reshaped the channel structure of its domestic market. New players, particularly multinational companies, have been lured to invest feverishly in a multitude of direct and indirect modes of marketing activities in China. But this development encountered a major setback w h e n China's State Council issued a blanket ban on all forms of direct-selling activities on April 21, 1998. The edict ordered all the direct-selling firms in China to convert to standard retail distribution or go out of business by October 31 of that year. Although the ban was aimed only at eradicating the malpractices of unlicensed and mostly domestic multilevel marketers, it has greatly undermined investment efforts that had already been made by such multinational direct-selling giants as Amway, Avon, Mary Kay, and Tupperware. Before the ban, many analysts were optimistic about the development of direct selling in China. Since its introduction by Avon in the late 1980s, a total of 2,300 direct-selling firms had risen in China by 1997, employing as many as 20 million Chinese citizens and generating a sales volume of $2 billion. (All dollar amounts in this article are expressed as US$.) The investments of Awm. Amway, and Mary Kay alone totaled $200 million in China just before the ban. The consequences of the sudden ban on direct selling include a turnaround in the optimists' view and the emergence of a series of related problems. Salespeople from various affected multimarketing networks, unable to return merchandise to disreputable direct-selling firms for a proper refund, grew desperate and angry. Riots

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broke out in several central Chinese provinces and resulted in more than 10 deaths and 100 injuries. Some analysts maintain that the ban will further complicate China's oft-stymied efforts to join the World Trade Organization (WTO), and adversely affect the steadily improving Sino-U.S. economic relations. By reviewing the development of direct selling in China, we can explore the underlying rationales for China's imposition of the ban and examine its impact. It is hoped that some suggestions for both foreign direct sellers and the Chinese government can aid in improving understanding between each other. The G r o w t h o f D i r e c t Selling i n China Direct selling was first brought into China in the late 1980s, when Avon was permitted to establish its venture there. In practice, some equate direct selling with multilevel marketing, in which a direct-selling firm often uses some form of compensation to enable its distributors or sales personnel to make money on the sales of people they recruit, as well as on those recruited by the recruits. In Chinese, these recruited salespeople are often referred to as xia xian, or "downlines," in the sales network of their distributors. Attracted by Avon's early success, Amway, Mary Kay, and other U.S. direct sellers began to

At the Crossroads of Distribution Reform: China's Recent Ban on Direct Selling

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trickle into China in the early to mid-1990s. By promising riches in return for minimal investment, these pioneering direct sellers encouraged millions of poor, would-be entrepreneurs to join their sales schemes. Following these multinational giants, less renowned domestic directselling firms also emerged and flourished across the country, peddling everything from health products to urn slots (discussed later). In hindsight, several factors account for the rapid growth of direct selling in China. First, the country's logistical backwardness, particularly in rural areas, offered promising opportunities for the development of various modes of direct marketing. Among these modes, direct selling is often regarded as the most personalized because the product in question is generally endorsed and delivered by those with w h o m buyers are acquainted, such as relatives and friends. Second, when compared with most local brands, increasingly affluent Chinese consumers have been constantly impressed by foreign brands. For instance, Amway's low-priced home and health care products have long been widely accepted by the Chinese public because of their perceived value-for-money. In an SRG/AC Nielsen research report conducted in mid-1997 (Weeks 1998), 60 percent of Amway's Chinese users ranked its products as excellent or very good. Such strong domestic demand has, in turn, induced foreign direct-selling giants to increase their stake in China, thereby accelerating the growth of the industry. A third frequently cited factor in the growth of direct selling in China involves the Chinese people's cultural characteristics and the country's unique institutional settings. Some analysts credit the traditional mercantilism of the Chinese as an impetus for the high growth rate. They further maintain that in times of economic uncertainty, the presence of direct-selling firms can provide a viable means for business-minded Chinese to improve their financial position without forcing them out of their assigned work units (dan wei). Still others point to such factors as close-knit family ties, clan relations, and connections (guanxO as major contributors. According to Forney and Fang (1998), one anthropologist describes the development of direct selling in China as a p h e n o m e n o n of "Confucius-meetscapitalism" or "wringing profits from one's social 42

networks." From another perspective, the growth "comes from a hunger born out of years of boring work at state-owned factories and 50 years without the freedom to choose jobs" ("Amway..." 1997). To some enthusiastic Chinese, direct selling holds out not just a job, but also an opportunity to develop and succeed in their careers. All the foregoing factors are probably of varying degrees of importance. But the true reason behind the growth of direct selling in China is probably a complex combination of all of them. The Blanket Ban Most people would agree that the rise of direct selling in China has been conducive to the country's economic development. But the rising number of fraud cases and pyramid schemes alerted Chinese policy makers to the potential problems that can derive from a rapidly expanding directselling industry. Indeed, the government had tried once before to crack down on such schemes by suspending direct-selling activities for seven months in late 1995 and early 1996, and by requiring all direct-selling firms to re-register. In January 1997, Chinese authorities also issued a decree to prohibit high school and university students, communist party members, and government officials from participating in any of the selling activities. Nevertheless, these measures were apparently too mild to fully rectify the situation. In 1997, the amount involved in major fraud cases related to direct selling exceeded $130 million, whereas the corresponding figure in 1996 was only $36 million. According to the Chinese government, the ban is aimed at "protecting interests of consumers, market order and social stability" (O'Neill and Miller 1998). It further maintains that because of China's weak regulatory system, many unscrupulous multilevel marketers have been able to resort to various selling tricks to lure relatively naive Chinese consumers into buying expensive yet inferior products. Take the case of Suzhou International Cemetery Company, which sold storage space for funeral urns in Shanghai. According to Smith and Johnson (1998), the company promised its distributors attractive returns by exaggerating the demand for the product in the city. By taking advantage of the ignorance and greed of the public, it was able to induce a large number of distributors and downlines to hurriedly purchase the urn slots in the hope of reselling them to others at the lower end of the sales network. Before its collapse at the beginning of 1998, Suzhou was able to generate a sales volume of 100,000 urn slots at a unit price of around $275-only a few hundred of which have been put to actual use. Business Horizons / September-October1999

Another case concerns a multilevel marketing scheme involving the sale of water purifiers. The scheme required a participant to buy a purifier at around $474. Each purchaser was then entitled to an "introduction fee" of $24 for each person he recommended to join the plan. These pyramid schemes only drove people to earn quick money by recruiting downlines instead of getting the product sold to the genuine final users. On the surface, the flourishing fraud cases and the consequent economic disorder constitute the main impetus for the ban on direct selling. Some observers, however, believe that a sound regulatory, framework could have counteracted the fraudulence without jeopardizing a lucrative business as such. They speculate that the true reason behind the ban is something more than just the rectification of economic disorder. The first noneconomic concern probably revolves around political ideology. As noted by the president of Asian Marketing Consultants Inc., "The Chinese consider companies such as Amway to be like a religion" (Ligos 1998). And the Chinese government is highly anxious about any forms of unorthodox religious sects sprouting up in the country. Specifically, the emotional intensit3" direct sellers elicit in their sales force seems to worry government authorities the most. To keep sales personnel inspired, direct sellers usually resort to motivational meetings and inspirational rallies at which people are encouraged to shout or cry. In the eyes of the Chinese Communist Party, these evangelical-style gatherings constitute a menace to social stability and represent something vaguely revolutionary. With their admirable sales records and sensational presentations, charismatic direct sellers are often perceived by their followers as heroes or even gods. The editor of Direct Selling Review, an internal Chinese official publication, also commented that "[direct selling] leaders are like religious leaders" IFc~rney and Fang 1998). It is the permeation of this religious flavor that has really annoyed the Chinese officials. In fact, their worry may not be totally unfounded. One direct-selling firm recently organized an inspirational rally on June 4, a date about which authorities are hypersensitive. It reminds the public of the Tiananmen Square incident, which happened on that day in 1989. Still another underlying concern relates to the erosion of Chinese cultural values. The Chinese have long been characterized as highly collective and relation-oriented. To maintain social harmony with members of their social networks, the Chinese are often willing to sacrifice their personal interests for the well-being of the group, trying hard not to jeopardize the interests of their acquaintances. If they are unable to refrain from doing so, they feel extremely ashamed and re-

gard themselves as having "lost face." This cultural characteristic has greatly helped the Chinese people to develop and strengthen mutual trust and connections with their clan members and friends. When this cultural value is considered in the context of the deception associated with various pyramid schemes, the problem of potential cultural erosion becomes apparent. As observed, the crux of successful multilevel marketing lies very much in the trustful relationship that has been established between the seller and buyer. One who lures one's relatives or friends to purchase some overpriced yet shoddy products for personal consumption is clearly an abuser of such a relationship. By the same token, it is also an abuse of trust if a distributor bilks his relatives and friends to become downlines of his sales network and to pay for some unmarketable inferior merchandise. As a centrally planned market economy, the Chinese government probably will not be too annoyed to see its citizens reaping profits from those with w h o m they are acquainted, provided that the deal is free from deceit and will not lead to social disharmony. What really bothers the parental Chinese government is that its citizens are no longer ashamed of trading mutual trust and human relationships for pure economic gain. In the eyes of Chinese policy makers, this is exactly the wicked side of capitalism that causes the serious spiritual pollution of human beings. They are also worried that social disharmony within numerous smaller social circles will eventually lead to the outbreak of large-scale social unrest across the whole country. All in all, because Chinese leaders are invariably proud of their country's cultural heritage, they are--perhaps justifiably--suspicious of any move that may lead to the demise of this heritage and increase the risk of social instability. This subtle sociocultural consideration is probably a neglected yet significant contributor to the imposition of the blanket ban on direct selling. Effects o f t h e B a n

Right before its wholesale proscription, an estimated 20 million Chinese were reportedly engaged in direct selling in China. With annual sales of $2 billion, the industry has been able to lessen the country's deteriorating unemployment


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problem in the course of its (state-owned) enterprise reforms. Recently, the total number of unemployed (xia gang) in China has reached 12 million. With the presence of direct selling, more opportunities were provided for those w h o were laid off to earn at least part of their own living-and in a few cases, to make a good fortune. Even for those still employed, direct selling has also given them an oppomanity to further improve their financial well-being. Miller (1998) reports that by working part-time for Amway, a middleaged school accountant was able to raise her monthly salary from the original $48 to as much as $286. Reduced unemployment and improved financial status are certainly some essential ingredients for advancing social stability. But ironically, concern over social stability has also driven the Chinese government to ban the industry. At an international level, Beijing's wholesale ban may have a chilling effect on foreign investment and make government pledges seem unreliable. Indeed, many bona fide foreign direct-selling firms did obtain all the necessary permits to run their businesses in China. The ban will thus make foreign investors suspicious of China's determination and sincerity to open its market. They may ask, "What's really permitted in China? And until when?" The government has long worked hard to uphold the principles of fair dealing and mutual trust, but its blanket ban greatly afflicts foreign investors' confidence in doing business in China and puts the country's gradually improving international reputation at risk. 44

When judged against the amount of investment multinational direct-selling firms have already made and the amount of sales they will likely forgo, the adverse impact of the ban on their confidence becomes even more obvious. Avon had invested more than $90 million in China and had recently attained annual sales of $75 million; Amway's corresponding investment and sales amounted to $100 million and $178 million, respectively. Indeed, Amway had recently committed itself to building a second factory worth $30 million in Shanghai. Hence, in the absence of any proper arrangement for these innocent foreign firms to recover their economic loss, it is hard to see how and when their confidence in the host government can be fully restored. S it has for more than a hundred years, China continues to attract, fascinate, confuse, and disappoint Western businesses. A population of 1.3 billion people does not guarantee that a sustainable lucrative market is readily available there. Although the Chinese government is eager to absorb foreign investment to accelerate its economic growth, it is invariably determined to preserve the political and social stability it considers indispensable for advancing the long-term survival of the whole nation. The implication is that the government is willing to sacrifice growth if such pursuit conflicts sharply with preserving stability. Such a ruling philosophy is reflected in the Chinese Communist Party's modernization model:

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Business Horizons/ September-October1999

tight political and ideological control along with economic liberalization. Chinese leaders' strong belief in the appropriateness of this model has been further reinforced by the experience of the USSR. In their eyes, the dissolution of this superpower was due to the simultaneous liberalization of its economic and political systems. The understanding of the pro-stability mindset of the Chinese leaders should warn foreign investors of the potential problems they may encounter in China if their activities are perceived to threaten the country's political and social order. Clearly, what bewilders and frustrates foreign direct-selling firms is that they were only the scapegoats for the wrongdoings of other, mostly domestic players. Even if they did their best to avoid being perceived as threatening the political and social stability of the host country, they could not prevent other unscrupulous copycats from doing devastating things. Along with infrastructural backwardness and red tape, this bewilderment and frustration is perhaps another nuisance foreign investors have to tolerate in order to do business in China. To Chinese leaders, an administrative command such as the blanket ban on direct selling is the quickest and most efficient prescription for order. For a government that has only limited experience in market economy practices, one should not be surprised by its reliance on central command to cope with crises. As a matter of fact, getting things done by central command rather than through market forces is commonly found in communist countries, echoing the Draconian governing practices of ancient Chinese kingdoms. No matter how unreasonable this pro-stability and pro-command mentality may be in the eyes of Westerners, there seems to be very little foreign investors can do if they still consider the Chinese market too big to ignore. The mentality of Chinese authorities is part of the operating reality foreign investors have to face in doing business in China, at least in the foreseeable future. Amway is one of the foreign investors fully aware of this reality, It has demonstrated a full understanding of the problems encountered by the Chinese government, and remains prepared to modify its mode of operations to comply with the new decree. Meanwhile, it continues its dialogue with Chinese authorities to see if the company will eventually be exempted from the ban. In the longer term, this pragmatic and empathetic approach will probably yield a better result than any other confrontational approaches in dealing with a nation characterized by a lack of trust in foreigners. As far as the Chinese government is concerned, there is little evidence that its wholesale proscription is aimed at legitimately invested foreign firms. Nevertheless, while foreign inves-

tors should be sympathetic to China's problems, Chinese leaders should also take note of international practices in the course of integrating with the global economy. These practices, among other things, include showing due respect to agreements with investors, to their property rights, and to the market mechanism. Indeed, most of China's concerns about direct selling can be addressed through some fine-tuned regulations. Such regulations should comprise a more stringent set of requirements for granting license and the prohibition of licensed firms from engaging in pyramid sales. To attain a win-win situation, the government should listen carefully to the opinions of genuine foreign and local direct sellers to derive a mutually agreed-upon set of regulations for the industry. If officials at various levels of the country can closely observe these regulations and monitor their implementation effectively, China will not need to maintain a blanket ban on direct selling to eradicate pyramid scares. From another perspective, labor-intensive direct selling complements China's current enterprise reforms well; banning it is likely to induce more unemployment or even social unrest. Certainly, the Chinese government does not want to ban business activities that can provide jobs and enhance social stability for long. In China, there is an old saying, "Don't give up eating for fear of choking." Perhaps what the Chinese government needs to tackle the abuses of direct selling is more effective regulations and supervision, not a blanket ban. References

"Amway: Born-Again Marketers," Business China, August 18, 1997, p. 12. "Ban Fails to Sway US Firms," South China Morning Post, May 2, 1998, p. 3. Beijing Foreign Languages Institute, The Pinyin Chinese-English Dictionary (Hong Kong: Commercial Press, 1979). "Can Beijing Cope with Rising Unemployment?" Asiaweek, October 9, 1998, pp. 46-49. "China Should Regulate Direct Marketing, Not Ban It," Asiaweek, May 8, 1998, p. 1. D.A. Davis, "China Game," Drug and Cosmetic Industry, June 1998, p. 8. M. Forney and B. Fang, "Selling Salvation," FarEastern Economic Review, January 8, 1998, pp. 68-72. "Great Impacts of the Direct Selling Ban Cause Regional Governments' Refusal to its Full Execution," Apple Daily, May 1, 1998, p. A24.


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M. Ligos, "Direct Sales Dies in China," Sales andMarketing Management, August 1998, p. 14. S.T.K. Luk, "Structural Changes in China's Distribution System," International Journal of Physical Distribution and Logistics Management, 28, 1 (1998): 46-67. "Mainland's Ban on Direct Selling Shocks Washington," Apple Daily, March 18, 1998, p. A24. WJ. McDonald, "The Ban in China: How Direct Marketing Is Affected," Direct Marketing, 61, 2 (1998): 1619.

C.S. Smith and I. Johnson, "China Implements Direct Marketing Ban," Asian Wall Street Journal, April 23, 1998, p. 1. "Thousands of Direct Sellers' Dream for Fortune Is Over," Asiaweek (Chinese ed.), May 4-10, 1998, pp. 18-20. A.M. Weeks, "Network Building," China Business Review, 25, 1 (1998): 49. O.H.M. Yau, Consumer Behavior in China: Customer Satisfaction and Cultural Values (London: Routledge, 1994).

M. Miller, "Distributors Rush to Rescue Fortunes Before Selling Ban," Money, April 26, 1998, p. 2. M. O'Neill, "US Begins Challenge on Marketing Ban," South China Morning Post.. Business Post, April 25, 1998, p. 1. M. O'Neill and M. Miller, "Mainland Bans Direct Marketing," South China Morning Post, April 23, 1998, p. 1.

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Ricky Y.K. Chan is an associate professor of business studies at the Hong Kong Polytechnic University. The work described in this article was supported by a research grant from the Hong Kong Polytechnic University.

Business Horizons / September-October 1999