Chapter 4

Moral Decision-Making in Business

“If you analyze facts from different angles, you will discover the
benefits of fair play.” (Stephan Rothlin, Eighteen Rules for
Becoming a Top Notch Player, 2004)

4.1 Prelude

The complexity of a manager’s responsibilities to the firm’s various stakeholders

requires an approach to moral decision-making which respects that complexity. The
failure of the Pepsi Sichuan JV in China should open the readers’ eyes to the specific
complexities involved in attempting to manage cross-culturally. When an opportu-
nity for cross-cultural collaboration breaks down, as when Pepsi’s international
management discovered that their joint venture had been sabotaged by their partner
in order to achieve his own business goals, how should managers respond? In order
to learn all that one can from such disasters, a managerial decision-making model
derived from Peter Drucker’s early work is presented with some modifications that
allow the concerns of international business ethics to be well integrated into the
decision-making process. International business ethics, then, takes one further into
the heart of managerial responsibility and not away from it.

4.2 Case Study: Pepsi Sichuan, “A Marriage too Good

to be True”?

4.2.1 Abstract

When the joint venture (JV) between PepsiCo and its local partner in Sichuan broke
down, many observers compared their relationship to an ill-fated marriage passing
through various stages toward an inevitable failure. Initially described as a marriage
of convenience or an arranged marriage, it brought together two most unlikely
partners—with apparently asymmetrical ambitions. One was a major symbol of
American capitalism and globalization, the beverage giant Pepsi-Cola. The other
was the Sichuan Administration of Film, Radio and Television (SAFRT), a division

© Springer-Verlag Berlin Heidelberg 2016 65

S. Rothlin, D. McCann, International Business Ethics,
DOI 10.1007/978-3-662-47434-1_4
66 4 Moral Decision-Making in Business

of the provincial government that had previously sought to protect its local beverage
industry against foreign competition.
Unlikely as the partners were, the more remarkable was the venture’s early com-
mercial success: soon after the marriage was consummated, it must have seemed
like an ideal match, a marriage made in heaven. Nevertheless, a mere 8 years after
its founding, the JV had become a burden that allegedly hindered both partners’
businesses. By 2001, Pepsi China felt it had been “trapped in a painful marriage
with its local partner in Sichuan” (Liu 2006). The Sichuan partner, in turn, criticized
Pepsi for its polygamous attitude evident, it seems, in Pepsi’s intent to treat the JV
as merely one more addition to its list of more than 30 others all over China. In the
course of their increasingly bitter dispute, both parties appealed to the local govern-
ment not so much to counsel but more often to coerce the other side. Once it became
clear that the government would refuse to take sides against its Chinese partner,
Pepsi decided that it stood to lose more from being tied up in a dysfunctional
marriage than from obtaining a divorce, which it eventually did through the interna-
tional arbitration tribunal in Stockholm.
As we shall see, the ultimate collapse of Pepsi Sichuan was not a direct result of
poor economic performance, but increasing frustration on both sides with their part-
ners’ unrealistic expectations and indifference, if not contempt, toward each party’s
perceived grievances. In what follows, our focus must be on what can be learned to
avoid such an unhappy outcome. Could this marriage have been saved with a little
more forethought based on a greater commitment to common standards of business
ethics? In the 1990s and even today, many joint ventures in China have faced unex-
pected frustrations and challenges: what distinguishes the still successful JVs from
those where the foreign party has long left China is not necessarily a better initial
business plan but a better way of dealing with conflict once it erupts, as it almost
inevitably will.

4.2.2 Keywords

Joint venture (JV), Carbonated soft drink (CSD), Franchise businesses, Contracts,
Compromise.

4.2.3 How and Why Pepsi First Came to China

In 1993, PepsiCo1 and SAFRT signed a contract of association creating a joint

venture named “Pepsi Sichuan.” The new enterprise was integrated into the global
Pepsi family and supply network through the trademark and concentrate contracts
signed in 1994. According to the original agreement, PepsiCo got a 27 % ownership

1
After 1995, PepsiCo is represented through Pepsi Investment (China) Limited (which will be
referred to hereafter as Pepsi China).
4.2 Case Study: Pepsi Sichuan, “A Marriage too Good to be True”? 67

stake and 17 % dividend [profit] rights (Hsu 2007). By mid-1995, Pepsi China’s
initial investments (including noninterest-bearing loans to Pepsi Sichuan) are esti-
mated to have totaled around USD $20 million. The contracts providing the concen-
trate supply also gave the JV access to the patents used in producing and bottling
Pepsi beverages and allowed it to use Pepsi’s global trademark. In return, the
Sichuan government agreed to invest two million RMB by mid-1995 and authorized
the newly formed Sichuan Radio and Television Co. to appoint Pepsi Sichuan’s
general manager, chairman of the board of directors, and three members of the
board (Liu 2006). The nature and terms of this deal were unprecedented in Pepsi’s
history in China and even highly unusual when compared to most JVs set up in
China at the time: for one, the Chinese partner was a government agency and had no
relevant expertise in the beverage industry. For another, although Pepsi China
contributed most of the equity (money, patents, brand, machinery), it only got a
minority share of ownership and dividend rights.
In order to understand the terms of this arranged marriage, it is important to
recognize the challenges Pepsi faced, as well as the interests of the Sichuan govern-
ment and the mei bo—the Chinese “aunt” who traditionally arranges marriages—who
became the big boss at Pepsi Sichuan, Mr. Hu Fengxian. Expanding in China was of
strategic importance for Pepsi, for it could be decisive in its global rivalry with
Coke. But even in China, Coke had the advantage of being the first mover and
already dominated the carbonated soft drink (CSD) market in the southern coastal
provinces that were the most advanced economically. Pepsi was thus forced to play
catch-up. Key to its strategy was to go where Coke had not yet been active and win
first-mover advantage for itself. Thus, when serendipity happened and a Sichuan
government official—Mr. Hu—approached Pepsi, it saw a great opportunity open-
ing. If Pepsi wanted to challenge Coke’s overall market dominance in China, it
couldn’t afford to let this one go by. Pepsi thus came to the negotiating table with an
urgent need to succeed and a willingness to pay a high price.
The CSD market in Sichuan, as well as the government that regulated it, proved
to be a hard nut for Pepsi to crack. Though clearly desiring economic development
and innovation, the Sichuan government was also keen to protect the small local
producers of soft drinks, as well as larger enterprises like Tianfu Cola. The govern-
ment then would let Pepsi in only if it could retain effective control over it. At this
point the services on offer from Mr. Hu seemed indispensable. He could bring
together both sides in a deal that would give Pepsi’s strategy a chance to succeed
while promoting local business development in unprecedented ways. Indeed, as a
gesture of goodwill, Pepsi promised to help the Sichuan government to develop
various unrelated industries—silk production, for example, printing and dyeing
industries, as well as farm products, processing, and trade, enterprises that had little
or no connection to CSD marketing and production. Pepsi China even agreed to let
the JV eventually develop a national soft drink brand of its own, though it stipulated
that any such product development could not be allowed to grow beyond 15 % of
the market share/sales volume of the leading Pepsi brands.
Commonly regarded as a major coup for both parties at the time, these
agreements would become the source of grievances that dogged the further course
68 4 Moral Decision-Making in Business

of the JV partners’ relationship. In order to understand what happened and whether

the grievances could have been addressed constructively, it is useful to distinguish
two threads as the conflict unfolds: first, the cultural, economic, and structural
issues involved in Pepsi Sichuan’s resistance to Pepsi China’s global business
model and, second, the specific actions and attitudes of Mr. Hu, whose responses
may be regarded as either a flagrant violation of universal standards of business
ethics or a heroic attempt to live by Chinese cultural values in an environment
increasingly dominated by globalizing MNCs.

4.2.4 “The Hu Factor” in the JV’s Initial Success and Early

Signs of Trouble

The most controversial figure in this story is Hu Fengxian, whose initial role as a mei
bo was soon cast off in order to become the groom in this arranged marriage. In 1987,
while still a radio program manager at SAFRT, Mr. Hu first approached Pepsi about
its possible entry into the tightly regulated Sichuan market (Hsu 2007: 13). In Hu’s
estimation, the success of Pepsi Sichuan was largely his own, and later, he frequently
referred to the company as his son. In three short years after its launch, the JV had
achieved an average annual sales growth of 110 % while profits and taxable income
rose by 88.2 % (Liu 2006: 288). This growth reflected the JV’s market position—it
quickly earned a 47 % market share in Sichuan and was recognized as the top bever-
age brand by a clear majority of the local population (Du 2002). Pepsi was forging
ahead of Coke in Sichuan—a rare achievement that led one commentator to declare,
“Pepsi Sichuan … had created history” (Liu 2006: 288). While there’s no denying
that this success was largely “thanks to Hu and his team’s connections and business
acumen” (Fernandez and Liu 2011: 70), it is also important to recognize the synergy
between the product’s distinctive taste and the way it was marketed in Sichuan. Pepsi
earned a reputation for being more compatible than Coke with the hot pot dishes
preferred by the local population. Pepsi Sichuan thus made great strides by promot-
ing its drinks in hotels and restaurants. An A.C. Nielsen survey confirmed Pepsi’s
popularity among young Chinese consumers, who identified it as “the choice of a
new generation,” with a taste that stimulated their “spirit of limitless aspiration.”
With such initial success, why did the relationship between the partners sour so
quickly? Signs that something was wrong appeared as early as 1995—after the JV
had been operating for barely more than a year. At that point Hu Fengxian abruptly
reduced SAFRT’s pledged investment in the JV from RMB 2 million to a mere
RMB 11,000. Apart from provoking outrage within the Sichuan government when
it was discovered, this move left Pepsi significantly puzzled and wary. Though Hu
had been involved in the JV from the beginning, in Pepsi’s perspective, its partner
was the Sichuan government, not an individual entrepreneur. This incident alerted
Pepsi to be on guard for further irregularities, as they watched Hu seek to extend his
personal control over Pepsi Sichuan. During the following year when the provincial
government ordered Hu to restore SAFRT’s investment of RMB 2 million, Pepsi’s
4.2 Case Study: Pepsi Sichuan, “A Marriage too Good to be True”? 69

fears were calmed, since the government’s action encouraged them to think that it
would help them discipline Hu should the need arise in the future.
Pepsi soon had more serious reasons for worry. After committing another USD
$2.5 million to acquire another 5 % of the dividend rights in the JV, Pepsi demanded
a more rigorous scrutiny of Pepsi Sichuan’s accounting. According to Chinese law
and the JV contract, Pepsi Sichuan should have reported regularly on its financial
position to all of its investors. Nevertheless, Pepsi Sichuan’s management, headed
by Mr. Hu, blithely ignored this legal obligation, believing that his noteworthy
economic success, and the timely distribution of the profits he did claim, should
suffice to satisfy Pepsi. Left in the dark about the true financial results at Pepsi
Sichuan and lacking much insight into Chinese accounting practices, Pepsi sought
to enforce its presumed right to total transparency regarding the financial status of
its JV. Contrary to Hu’s expectations, due diligence and accurate accounting were
just as important to Pepsi as economic success.

4.2.5 The “Factory Gate” Incident

Eventually, the tensions over transparency and accounting practices erupted into the
first major clash between Pepsi and Hu: as stipulated in the JV contracts, Pepsi had
agreed to reimburse many of the JV’s expenses, especially for local marketing
campaigns. However, Pepsi’s standard procedure for reimbursements involved
having the JV partner submit receipts for expenses. In the normal course of reviewing
these, Pepsi accountants noticed major inconsistencies: the figures claimed by Pepsi
Sichuan for construction expenses were often not documented with real invoices, and
there seemed to be a suspicious pattern of double counting, that is, counting the same
expense twice in different expense bundles. Hoping to verify the overall financial
status of Pepsi Sichuan, as well as seeking documentation for the expense claims, in
1996, Pepsi’s board of directors sent a team of auditors to Pepsi Sichuan’s headquar-
ters in order to inspect bank accounts and to verify the expenses actually claimed.
Much to the auditors’ surprise, their visit marked a turning point in the relationship
between the JV partners: the auditors were refused entry at the factory gate and were
not given access to any of Pepsi Sichuan’s account books (Hsu 2007: 23).
Hu and his local managers simply refused to comply with the board’s instruc-
tions, with the apparent intent of showing Pepsi how little real control it had over the
JV. Such action, to be sure, only intensified Pepsi’s suspicions that the funds
allocated to Pepsi Sichuan had been misappropriated in order to pay for personal
expenses (e.g., luxury cars, travel to Europe and New York, etc.) incurred by Mr. Hu
and other members of his management team.2 Once alerted to these irregularities,
Pepsi made a further discovery about Hu’s conduct that eroded what was left of its
trust in him. Pepsi discovered that in 1996 Hu and his team had faked two board

2
This was officially recognized in an auditing report from the Sichuan Auditing Bureau: Auditing
Report, Sichuan Auditing Bureau, 2002, Statement of Claim, exhibit 38, Pepsi Co (Hsu 2007: 44).
70 4 Moral Decision-Making in Business

meetings and produced corresponding minutes, in which they alleged that the board
had authorized Pepsi Sichuan to extend its sales and distribution region into
territories that had clearly been allocated to another JV partner. Faced with such
apparently egregious violations of basic business ethics, not to mention the terms of
the contracts that had founded the JV, Pepsi asked the provincial government to
conduct a thorough investigation.

4.2.6 Pepsi’s Response: What to Do with Mr. Hu?

During the next 2 years, Pepsi watched in horror as Mr. Hu tried to usurp all execu-
tive authority within its increasingly successful JV. How then should Pepsi have
responded? Given that Hu displayed what appeared to be astonishing ignorance of,
if not actual contempt for, standard Western management practices, he seemed more
and more ill suited for the position of general manager. Nevertheless, while such
arbitrary behavior may seem typical of a strong Chinese leader in the minds of
some, it hardly fits well within the worldview of today’s Western business corpora-
tions. From Pepsi’s perspective, the JV was much bigger than any one individual or
the relationship the firm had cultivated with any one individual. Pepsi followed the
conventional view according to which the JV was founded on a relationship between
two legal persons (i.e., companies), of which the managers appointed were to be
judged solely on the basis of their performance and thus were easily removable.
Judging Mr. Hu as primarily responsible for the irregularities now emerging in an
otherwise highly successful JV and considering any individual as replaceable for
the sake of the corporation’s greater good, Pepsi regarded what to do about “the Hu
factor” as both inevitable and straightforwardly obvious: Pepsi came to the conclu-
sion that it must ask the Sichuan government to remove Mr. Hu from his manage-
ment positions in Pepsi Sichuan.
However inevitable and obvious it may have seemed at Pepsi’s headquarters, this
decision was bound to be controversial in China. One observer, who was employed
by Pepsi Sichuan at the time, made this comment on how Mr. Hu and many other
Chinese viewed his situation:
Neither Pepsi Co people nor Mr. Hu were ready to work together culturally and ethically.
Mr. Hu privately commented that he and his team had [made] some errors in the manage-
ment including accounting keeping, however, they made profit and distributed the dividend
to Pepsi Co in time…. What he did not understand at the start was the fact that his outstand-
ing performance in terms of output and quality of Pepsi drinks could not offset the blunders
he had by faking some invoices and violating the financial rules. (Hsu 2007: 30)

Hu’s mistakes, in short, were relatively minor and should have been overlooked in
light of Pepsi Sichuan’s dramatic success under his personal leadership. Hu appar-
ently felt that both Chinese culture and common sense would support his preferred
self-understanding as a leader in the mold of the Great Helmsman—none other
than Chairman Mao himself—whose bold initiatives were designed primarily to
achieve China’s ambitious goals for economic and social development, while
4.2 Case Study: Pepsi Sichuan, “A Marriage too Good to be True”? 71

protecting the Chinese people from foreign domination. His success, in short, not
only gave a good “face” to all patriotic Chinese, but it also conformed to the post-
revolutionary model of leadership that would do whatever it takes to succeed, espe-
cially in dealings with foreign partners. However self-serving Hu’s reasoning may
have appeared to Pepsi’s executives, it clearly had significant appeal among Hu’s
former colleagues in the Sichuan provincial government for for whom there were
clear limits to what they would or could do in response to Pepsi’s grievances against
him.

4.2.7 Pepsi’s Business Model at the Core of the Conflict

The conflict that sealed the fate of this “marriage of convenience,” however, cannot
be reduced to a clash of incompatible personalities. Equally important are the
accountability structures mandated by Pepsi’s universal business model and how
these were perceived in China. Though it had enabled Pepsi’s global success, many
including some of Pepsi’s Chinese partners felt that Pepsi’s so-called principles
gave it unfair, monopoly-like advantages which it exploited extensively—so they
feared—to control the operations of any one of its JVs and reserve the lion’s share
of the profits for itself. Thus, many of the challenges Pepsi saw arising as early as
1996 were directly linked to its business model—which, of course, provided the
ultimate standard by which Pepsi judged and responded to its Sichuan partner.
In essence, Pepsi is a franchise business that relies on highly localized partner-
ships in order to produce and market its global brands. While local collaboration is
indispensable for Pepsi’s global success, this leads to the immensely difficult chal-
lenge of maintaining discipline and retaining control over all of Pepsi’s global oper-
ations or licensed partners. If only one of its local partners fails to meet the high
quality standards (even producing an output just vaguely “different”), the repercus-
sions for Pepsi are not confined to the country where it occurred but are potentially
devastating on a global scale. Similarly, any local marketing strategy needs to
conform to the core Pepsi brand identity. Thus, when sharing its two core assets—
the ability to produce and bottle a beverage with the unique Pepsi taste and the use
of its global trademarks—with hundreds of organizations worldwide, Pepsi needs to
ensure that none of its partners can suddenly break away and start producing “Pepsi”
on its own.
The Pepsi business model is thus designed so that Pepsi’s control over its
independent and semi-independent partners increases wherever its business is most
vulnerable. Pepsi protects its secret formula, for example, by producing Pepsi con-
centrate in local factories that it wholly owns and exclusively controls. Local fran-
chisees bottling Pepsi products must buy the concentrate from Pepsi and mix it in a
standardized process designed to guarantee uniform quality and taste. Given the
need to ensure high quality and consistency in its products, Pepsi provides bottlers
with detailed instructions and technical specifications, mandating everything from
the proper water-sugar-concentrate mix, to the machines to be used in mixing and
72 4 Moral Decision-Making in Business

bottling operations, to the designs and specific suppliers of the bottles and cans. In
each of these areas, Pepsi understandably must maintain strict compliance among
all its franchisees. It is also important to note that as Pepsi generally sets up many
bottlers, it must prevent these different local partners from competing with each
other. Thus, Pepsi generally assigns specific sales regions in each country and
strictly enforces the agreements made by its local partners to refrain from encroach-
ing in territories assigned to others.
Given Pepsi’s business model, it should be clear why the unsettling events of
1996 seemed to require more than just Hu’s removal. Indeed, when first alerted to
the full extent of Hu’s misconduct, Pepsi not only complained to the local govern-
ment but also threatened to stop supplying concentrate to Pepsi Sichuan. That same
year, Hu ordered Pepsi Sichuan to expand beyond its designated sales region, a
violation of the JV contracts that could not be ignored by Pepsi’s other partners in
China. While none of them dared to be as openly defiant as Hu, there was a group
of four so-called rebellious bottlers (including Pepsi Sichuan) among the 14 Pepsi
bottlers in China. While Pepsi held a controlling stake of 50 % or more in each of
the three other “rebels” (Shanghai, Nanjing, and Wuhan), in none of them did it
exercise full and effective operational control (Liu 2006: 288). Even among the
remaining ten bottlers, clandestine efforts to encroach upon the other bottlers’ sales
regions began to surface. Over and above the challenge of finding a better way of
disciplining Hu (after withholding concentrate had proven ineffective), Pepsi had to
come up with a standardized response to various malpractices among its bottlers in
order to protect its business model.
Pepsi therefore set up a so-called Bottler’s Association (PCBA) in 1996, with all
14 bottlers joining voluntarily. These agreed—under Pepsi’s direction—not to
transship into each other’s territories. If such behavior occurred, it would be reported
to the Bottler’s Association, which would determine a compensation for the bottler
whose business was hurt, payable as punishment by the bottler who had broken the
agreement. Pepsi’s participation was crucial, since the payment balances between
bottlers were settled through increases and decreases in its concentrate prices. In the
following years, Pepsi Sichuan kept breaking the promises it had given Pepsi and
the other bottlers and thus saw the price it had to pay for the concentrate rise
accordingly.
Mr. Hu regarded the PCBA as an unwarranted interference into his and the other
bottlers’ operations. Soon, he was rallying the other “rebellious bottlers” within the
PCBA in opposition to the Pepsi business model. This may have come as a surprise
to Pepsi, since the PCBA was intended as a vehicle for “self-disciplining” the bot-
tlers. Pepsi believed it would relieve it of the vastly unpopular task of disciplining
each bottler individually. Mr. Hu, however, exploited the bottlers’ uneasiness about
the PCBA in order to denounce Pepsi’s “unfair monopoly advantages.” By resigning
unilaterally from the association on April 30, 1999, while continuing cooperation
with Pepsi in bottling and distributing its products, Hu showed the other bottlers that
Pepsi’s exploitation of its alleged monopoly position could be challenged. Later, in
2001, Hu and Pepsi Sichuan arranged a secret meeting attended by all 14 bottlers in
order to coordinate resistance against what he regarded as the unfair advantages of
4.2 Case Study: Pepsi Sichuan, “A Marriage too Good to be True”? 73

Pepsi’s business model, in particular its power to increase concentrate prices

unilaterally.
Confirming Hu’s success in rallying the different bottlers, in 2002, they com-
plained collectively to the government that the BA was an illegal, coercive organiza-
tion and successfully requested that it be outlawed. Although Pepsi China in
response set up an alternative, legal organization that same month, the potential
threat was considered serious. The bottlers’ dissatisfaction with Pepsi’s business
principles and practices focused on two main points: Pepsi’s power to interfere in
the operations of the bottlers and the perception that Pepsi, accordingly, could
unilaterally determine its own and the bottlers’ profits as well. An incident that
intensified both these grievances was Pepsi’s directive in 2000 that bottlers must use
bottles from the one supplier that it would designate for China as a whole. Pepsi
Sichuan claimed that not being able to use an alternative supplier increased its
production costs by RMB 7.7 million (Liu 2006: 48). Understandably, Pepsi’s deci-
sion reinforced the feeling that its bottlers had little freedom to make independent
entrepreneurial decisions in their own markets.

4.2.8 Hopes Dashed for Saving Pepsi Sichuan

In August 2000, Pepsi learned that the ownership of the Sichuan stake in the JV had
been changed once again. At that time the Sichuan State Asset Management Bureau
designated Sichuan Yunlv as the appropriate holding company for its ownership
stake. Far from diluting Mr. Hu’s control over Pepsi Sichuan, this move gave Hu
more independence to act (Liu 2006: 293). Any hopes that Pepsi harbored that the
Sichuan government might reign him in were dashed, when it realized that Hu
would not only not be removed but, now firmly entrenched in Sichuan Yunlv, was
likely to step up his resistance. Predictably, in 2001, Hu rejected out of hand Pepsi’s
proposal to acquire a 50 % ownership stake in the JV, giving it direct control over its
operations.
Hu’s own expectations centered primarily on one important promise that PepsiCo
had made in the initial agreement, namely, to assist Pepsi Sichuan in developing and
marketing a new drink, in addition to Pepsi’s existing brands. Hu’s ambition was
understandable—submitting himself to Pepsi’s principles only made sense to him in
order to acquire the technical expertise necessary to develop his own national brand.
Once the honeymoon was over between the JV partners, it became ever more
apparent why this project was unacceptable to Pepsi, even as it remained essential
for Hu. Enabling Pepsi Sichuan to develop its own brand would have required sig-
nificant trust, yet Pepsi had learned not to trust Hu. Given the many breaches in the
agreements establishing the JV, how could Pepsi make sure that he wouldn’t use—
without authorization—Pepsi’s proprietary designs and trademarks? It was already
clear that Hu intended to use the production facilities and infrastructure that had
been funded by Pepsi’s initial investment. So how could Pepsi be sure that Hu’s new
drink wouldn’t compete directly with the Pepsi brands?
74 4 Moral Decision-Making in Business

When pressed for the expected reassurances, Hu openly admitted why Pepsi
would be put off by such a project: “Compared with Cola [that is, Pepsi Cola], the
new beverage can fully utilize local resources to reduce costs. It will be more profit-
able than Cola. However, Pepsi China will be unhappy in that we needn’t purchase
concentrate from Guangzhou Pepsi for the new beverage” (Liu 2006: 294).
Nevertheless, from Hu’s perspective, the new drink project would liberate Sichuan
Yunlv from its vulnerability to Pepsi’s alleged monopoly. As with the other griev-
ances, the parties continued to struggle without finding a mutually acceptable reso-
lution. Every year since 1997, Pepsi routinely turned down Hu’s proposals, claiming
it was inopportune for one reason or another. Understandably, Hu must have felt that
the marriage he had contracted with Pepsi had not only turned out to be painful, but
also unfruitful.3 From his perspective, Pepsi was consistently using the principles of
its business model to further its own narrow interests. Returning from a board meet-
ing with Pepsi executives on August 3, 2001, where he had for the fourth time been
told to wait for Pepsi’s approval, he told reporters that the Pepsi Sichuan would go
ahead with introducing its own national brand, pointing out that the objections raised
by Pepsi executives represented only the JV’s minority stakeholder’s opinion.
At this stage, Pepsi China was preparing to take unilateral action of its own,
entering an arbitration process that was the equivalent of filing for divorce. What
hindered Pepsi from seeking a divorce much earlier was its realization of the
dilemma it faced in Sichuan and China. Here is how one analyst described it:
A break-up with its partner was bound to undermine its advantage over Coke in Sichuan,
but a continuation of this relationship could have dire consequences. Not only that, the
internal conflict could also affect Pepsi’s overall image in China. Another concern was the
reaction of other bottlers. A new round of negotiations with the bottlers could create a dent
in Pepsi’s potential profits. Pepsi China had only two options: to terminate its cooperation
with Sichuan Yunlv and find another partner or go alone. However, neither of the options
seemed promising. It was quite challenging to find a trustworthy partner; a weak partner
could endanger Pepsi’s long-term advantage in Sichuan, while a strong partner could prove
to pose another problem. If Pepsi chose to go alone, it would definitely need to build the
sales networks from scratch and that will require huge investments. (Liu 2006: 298)

Sichuan Yunlv, on the other hand, apparently remained blind to the impact that its
actions would have upon its JV partner. It seems to have considered its escalating
quarrels with Pepsi as nothing more than a form of business bluffing that both sides
would ultimately set aside at the negotiation table. From Yunlv’s perspective, the
financial benefits of cooperation were too good to give up over matters of principle.
Indeed, after giving Pepsi every indication that Hu would not comply with Pepsi’s
business principles, Qu Zhidi, vice general manager of Sichuan Yunlv, announced,
“We [Sichuan Yunlv] hope the cooperation will survive and develop. We hope they

3
Hu’s frustrations were often well founded. Previously, he had correctly predicted the market
potential of a bottled water beverage. But with his proposals for exploiting this opportunity rou-
tinely rejected, he had to watch from the sidelines as such a product enjoyed explosive growth,
becoming by 2000 the best-selling beverage in China with a 37 % overall market share. By 2001,
the sales of bottled water had overtaken the combined market share of all CSDs in China (Liu
2006: 283).
4.2 Case Study: Pepsi Sichuan, “A Marriage too Good to be True”? 75

[PepsiCo] will come back to the negotiating table and help the joint venture sur-
vive” (Taipei Times 2002: 2).
Assuming that both parties would somehow muddle through, Hu continued to
take actions that could only provoke Pepsi China still further. In a final move dem-
onstrating that Pepsi had lost control over the JV’s operations entirely, Pepsi Sichuan
chose not to honor the original contractual agreement that called for its management
to resign on January 31, 2001, and the partners to reappoint jointly a new manage-
ment team. Pepsi insisted that this agreement be honored and, when it was not,
claimed that the incumbent management was illegal as of February 1. Pepsi’s pro-
test was simply ignored by Pepsi Sichuan and Yunlv.
Having long lost any trust in its JV partner and having little hope that the Sichuan
provincial government would protect its interests, in 2003, Pepsi filed for arbitration
with the intention of dissolving the joint venture. During November 2004, the two
sides met with arbitrators in Stockholm, bringing to light much of the “dirty laun-
dry” marring their 10-year marriage, while failing to acknowledge their own wrong-
doing and any legitimacy to the other partner’s grievances. Given the seemingly
irreparable state of the relationship, the arbitration committee granted Pepsi’s
request in 2005 for the corporate equivalent of divorce. This, however, was not to be
the last chapter in the Pepsi Sichuan story: the implementation in the Chinese courts
of the Stockholm arbitration settlement dragged on for a while longer, as Mr. Hu
sought to use his influence to extract more favorable terms. In the end, both partners
lost out financially. Coke achieved a higher market share in Chengdu than Pepsi and
seemed well on the way to winning the “Cola Wars” throughout China.

4.2.9 Conclusion

In retrospect, the breakdown of Pepsi Sichuan occurred because Pepsi’s business

model turned out to be completely contrary to Hu Fengxian’s ideas regarding what
it meant to own and operate a business. Hu was particularly irritated by the fact that
Pepsi could at any time enforce its intentions by withholding concentrate or with-
drawing trademarks, the lifelines of any franchisee. The mere possibility of such
retaliation Hu considered an act of blackmail, arguing that Pepsi’s monopoly over
its own products and trademark was contrary to fair competition laws and princi-
ples. According to Hu, Pepsi was “playing both athlete and judge” (Liu 2006: 297)
in what he came to regard as a game that had been rigged against him. In typical
producer-supplier relationships, he argued, the supplier has no privileged access to
its customer’s financial status and profit margins. Yet Pepsi demanded a full account-
ing of Pepsi Sichuan’s finances. Hu assumed that Pepsi would use this information
to extract as much revenue as possible from its JV partner. Beyond his seemingly
zero-sum attitude toward the distribution of the JV’s profits, Hu accused Pepsi of
acting unfairly, and contrary to their agreements, by seeking to undermine his mana-
gerial authority wherever possible.
76 4 Moral Decision-Making in Business

At the core of all of Mr. Hu’s grievances, then, was his feeling that Pepsi was
deliberately seeking to deprive him of the rewards of his extraordinarily successful
entrepreneurship. Once frustrated by Pepsi’s business model, he felt justified in
acting unilaterally—and in breach of his previous agreements—in order to achieve
his goals. Pepsi, on the other hand, had made many promises to Hu and the Sichuan
government that it could not fulfill—it should have realized—without jeopardizing
its global business model. Even if the necessities of running a global franchise
business did not allow room for modifying its business model, could Pepsi have
done a better job of explaining its business model and honestly disclosing its many
practical implications, positive as well as negative?
The failure to establish and maintain transparency and mutual trust in the man-
agement of their JV eventually led to corporate divorce and the negative economic
consequences that usually follow a divorce. In order to learn from their failure as it
unfolded, we investigated the terms of their association and each side’s interpreta-
tion of what had been promised by the other. Their mutual regret over a marriage
“too good to be true” could only have been avoided had both parties been able to
understand their cultural differences and the resulting differences in their ambitions
and ideas about how to do business. Apparently unwilling or unable to reflect on
such matters, both partners silently and surreptitiously reached for greater control
over both the decision-making and the profits from the JV. Both partners became
increasingly strident in asserting their claims to what they considered their fair
share, culminating finally in serious accusations that could only be resolved through
a bitter divorce. As with all such marital breakdowns, we are left to wonder: could
it have been different? What can we learn from the failure of the Pepsi Sichuan JV?

4.3 Case Study Discussion

Characterizing Pepsi Sichuan as an “arranged marriage” or “marriage of conve-

nience” may help to shed light on the cultural differences that separated the expecta-
tions of its two partners. But since such descriptions may not resonate very well
with romantic Western notions about marriage—as an exclusive, monogamous rela-
tionship of virtually eternal significance, based on mutual love—it may be useful to
recall that Pepsi Sichuan was just a business. As one observer tersely summarized
the situation, “The joint venture owned by Pepsi Co and the Sichuan TV Bureau,
seemingly very different organizations in nature, was set up in Chengdu, as an
exchange of interest” (Hsu 2007: 12). It wasn’t really a marriage in any sense of the
word. Nevertheless, the marriage metaphor allows us to explore the emotional
intensity that informed their responses to each other’s actions. The clash of cultures
that was played out in their relationship apparently reveals very different attitudes
toward honoring moral and contractual obligations, toward anticipating the needs of
one’s partner and responding to them on a good faith basis, and finally toward the
vexing question of what one or the other partner should or shouldn’t do when these
expectations are either ignored or unilaterally repudiated. We are left to consider