Entrepreneurial ventures often fail in the developing world because of the lack of something taken for granted in the developed world: trust. Over centuries, the developed world has built customs and institutions such as enforceable contracts, an impartial legal system, and credible regulatory bodiesand even unofficial but respected sources of information such as Yelp and Consumer Reportsthat have created a high level of what scholar and entrepreneur Tarun Khanna calls "ambient trust."
This is not the case in the developing world. But Khanna shows that rather than become casualties of mistrust, smart entrepreneurs can adopt the mindset that, like it or not, it's up to them to weave their own independent web of trustwith their employees, their partners, their clients, their customers, and society as a whole. This can be challenging, and it requires innovative approaches in places where the level of societal mistrust is so high that an official certification of quality simply arouses suspicionand lowers sales! Using vivid examples from Brazil, China, India, Mexico, and elsewhere, Khanna's stories show how entrepreneurs can build on existing customs and practices instead of trying to push against them. He highlights the role new technologies can play (but cautions that these are not panaceas) and explains how entrepreneurs can find dependable partners in national and local governments to create impact at scale.
As far back as the 18th century, Adam Smith recognized trust as what Khanna calls "the hidden engine of economic progress." "Frankness and openness conciliate confidence," Smith wrote. "We trust the man who seems willing to trust us." That kind of confidence is critical to entrepreneurial success, but in the developing world entrepreneurs have to establish it through their own efforts. As Khanna puts it, "The entrepreneur must not just create, she must create the conditions to create."
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The Why's and How's of Trust
Comparing the dairy industries of China and India reveals the why's and how's of trust. Why? Because trust weaves together in a web all those needed for productive enterprise — and because, when this web is torn, there's a dramatic fall from grace. How? There are many ways to weave this web of trust, even in the same prosaic context — the production of milk. The Chinese solution emphasizes speed and high technology. In this chapter, I profile an entrepreneur borrowing tricks from California's technology industry to make his cows "happy" — while the Indian solution is a slow-but-rock-solid, community-based solution developed over decades and anchoring the future. The disparate entrepreneurial paths to the same high-productivity goal share the emphasis on trust that cocoons everyone, from dairy farmer to end consumer.
Rebuilding Lost Trust
In 2008, anxious parents in Gansu Province, deep in the Chinese mainland, began visiting hospitals with their ailing infants. Tests found that several domestic brands of dairy-based infant formula powders they were consuming contained melamine, an industrial chemical used in plastics and fertilizers that can cause kidney failure in small children. Ultimately six babies died and approximately 300,000 were affected during what became known as "the Chinese milk scandal."
Somewhere along the supply chain, intermediaries had been diluting raw milk with water and then adding melamine to fool quality tests (melamine is high in nitrogen, and most tests only look at nitrogen levels as a proxy for protein levels). In some cases, dairy farmers themselves engaged in this practice, with the tacit approval of big dairy companies like Sanlu, to squeeze out some extra profits in an industry with very low margins.
Despite government efforts to restrict negative media coverage during that summer's Beijing Olympics, the scandal caused international outrage. Protests and lawsuits followed. The government eventually tried the chairwoman of Sanlu and sentenced her to life in prison. Two wholesalers were convicted of overseeing the dilution and contamination and then selling the contaminated products with full knowledge of the health risks — and they were actually executed in November 2009. These were unusual moves, since the government rarely cracks down so hard on bad actors in the food industry.
Indeed, this milk crisis was hardly the first instance in which food contamination threatened the health of the Chinese. There was the episode a few years back when farmers' use of chemicals to accelerate growth resulted in a rash of watermelon explosions. Earlier in 2015, authorities found so-called "zombie beef" in the supply chain. Certain vendors had somehow gotten access to forty-year-old beef that had been thawed and refrozen many times over and were selling it across China.
And then there was the discovery in March 2013 of more than 16,000 dead pigs floating in a tributary of the Huangpu River, a significant source of Shanghai's drinking water. China Central Television reported that pig farmers in Zhejiang Province were selling pigs that had died of disease or natural causes to black market dealers, who then butchered them and illegally sold the pork. After a few of these malfeasants were sentenced to life in prison, the lucrative illegal trade in dead pigs plummeted, and farmers started dumping them in rivers in droves, instead of paying to discard them in pits. The images of masked and suited sanitation workers hauling the bloated carcasses out of the river with poles and nets repulsed the residents of Shanghai.
Even so, the tainted milk crisis was different. It struck a deeper chord. Why?
That crisis affected mostly young children and infants. Due to China's long-standing one-child policy, there is an entire generation of parents who have invested all their hopes and energy into their single child. They are thus willing to go to greater lengths and expense to protect him or her: After the news broke, many parents undertook shelf-clearing expeditions to buy and bring back expensive foreign-brand infant formula from New Zealand, Singapore, and Hong Kong. Years later, this pattern continues.
This response neatly captures the net result of the scandal: Many Chinese simply don't trust their domestic private food sector anymore. A trust vacuum exists.
This trust vacuum creates a vicious cycle, one that's difficult to break. The problem stems from all sides in the dairy industry.
For example, the price-sensitivity of consumers who are mostly not wealthy drives down prices for companies trying to win the market. This dynamic means that dairy farmers get low prices for their raw milk. If they are to make any profit at all, they have to lower their costs. For a small farmer wrapped up in the myriad daily challenges of running a dairy operation, the most expedient thing to do is to cut corners. Even if a farmer tries to take the high road — by investing in higher-quality feed for his cows, for example — and to recoup his costs by selling milk at a higher premium, it won't pay off easily. Most consumers wouldn't place any faith in his efforts, at least not for a while. This lack of trust persists because the level of trust in all dairy producers has become so vanishingly small.
In reality, many different players and methods can be involved with rebuilding trust. But rather than waiting for others to solve the problem, the entrepreneur can be the change agent herself. Her solution may be a tech solution. Or it might harness the community. Or both. She will almost certainly have to reimagine the role of talent, to attract it to an industry now perceived as staid and boring.
Filling the Trust Vacuum
Even when the government does try to solve the trust problem through new regulations and consoling announcements, these initiatives do not always work quickly enough. Entrepreneurs waiting for others to provide solutions to the trust vacuum are likely to be waiting quite a while.
For example, in China, when the melamine milk scandal surfaced in 2008 the government sought to contain the mounting outrage from parents of sick children. Wen Jiabao, then the nation's premier, who cultivates a studiedly avuncular image, tried to apologize publicly. This is rare, since Chinese leaders are usually obsessed with projecting strength. However, despite their infrequent deployment, these apologies are a key part of Chinese political theater — a technique for managing the "optics" of delicate situations, a pressure valve to let off some steam without conceding too much.
"As the head of the government, I feel extremely guilty," Wen said in September of that year. "I sincerely apologize to all of you. What we are doing now is to ensure that nothing like this will ever happen again, and we are not only talking about milk. We will never let the same situation repeat with any kind of food product. Please trust us. We will strengthen quality control on new products to ensure that there will not be any more issues. Public confidence can only be rebuilt on merciless punishment."
Yet today these pledges still ring hollow to many ordinary Chinese. After all, senior Chinese political figures had made similar promises in response to other food safety scandals. Critics asked how new regulations could be effective, as there weren't enough food safety inspectors to enforce them. Consumers signaled what they thought of these steps by purchasing imported milk powder products whenever they could.
The combination of tighter regulations and harsh sentences doled out to accused perpetrators (including the execution of the head of China's Food and Drug Administration in 2007) seemed to have improved the situation. The government's new rules have had the effect of driving many smaller, "backyard" dairy producers out of business, encouraging consolidation into larger farms. This has made testing and rejection of low-quality milk much easier.
Still, ordinary Chinese continue to distrust their food as being unsafe. Beyond the dairy sector, food contamination problems continue to this day. The public's trust in its food remains broken.
* * *
So much for government remedies. Another set of attempts may emanate from activists.
In 2011, Wu Heng launched a website called "Throw It Out the Window," featuring an interactive map based on crowd-sourced information about food scandals around the country. It soon went viral — and quickly crashed from too much traffic. Give Wu credit for showing initiative.
Wu's website has to contend with two powerful forces. One is the Communist Party, which is intent on maintaining order and has often intervened swiftly to curtail activists protesting such issues as pollution or human rights violations. If Wu oversteps, he will be similarly sanctioned; if he underreports, his enterprise lacks credibility. It is a tenuous existence.
The other obstacle, perhaps even more daunting, is what Wu has called food safety fatigue. He thinks people have learned to just live with the risk and worries that his website has simply had the effect of desensitizing consumers to the dangers of contaminated food. He cites the high prices of certified organic alternatives. Furthermore, the cumulative health effects of eating polluted or contaminated food could take years to materialize in the average person. This combination, indeed, is the magic recipe for resignation.
Resignation is an adaptive strategy present in many communities around the developing world. In India, for example, the Hindi phrase chalta hai is a pervasive response to such problems. Functionally meaning "it's okay, let's carry on," it is often used to condone cutting corners, breaking rules, looking the other way. This resignation holds a certain logic for the poor, or even for the middle classes living in societies plagued by corruption or hampered by dysfunctional institutions. When the vicissitudes of life are so random and often cruel, the only choice left is to simply decide not to be bothered by them.
In other words, outrage is a luxury many low-income consumers feel they can ill afford. So they throw up their hands, and say, Mei ban fa — "Nothing can be done."
Wu Heng's website showed pervasive mistrust. It was a good step in the direction of finding a solution, though it was not remotely enough.
* * *
Of course, many solutions have been tried, and many have failed to rebuild trust in China's dairy industry. But the mei ban fa attitude, while completely understandable, does not help, either. There is plenty to be done.
In an unlikely move to fill the trust vacuum, an entrepreneur named Charles Shao has brought his education as an engineer from California's elite universities, and his experience building a tech company — ultimately sold to Google for a handsome sum — to the "Wild East" of the dairy industry in China. Shao is compact and stocky, with an informal, laid-back manner that — along with the top two buttons left open on his shirt — evokes his youth spent in California. He speaks with a kind of soft-spoken bluntness. When asked about his core challenges, he smiles and shrugs in a way that suggests he has indeed assessed the height of the mountain he's trying to climb as a dairy farmer in China, and he has come away impressed yet undaunted.
"It's a basic consumer education problem," he says. "If you can afford it, you buy the international brand of infant formula. It's a no-brainer. It's something you can trust. The melamine scandal turned things upside down." Shao noted that the melamine crisis galvanized the government, and its harsh penalties had some effect on cleaning up the supply chain: "Melamine is gone; it's a lot better now." But he points out that a much larger problem persists, seven years later. "Consumer confidence in milk in China is so low today that there is a lot of foreign milk in China that is two or three times — one is even ten times — the average price. But people will pay money for it."
How can a lone entrepreneur overcome the suspicions of a billion cost-conscious food shoppers and inspire trust, despite being in this vacuum, devoid of confidence? His mind naturally gravitates to his strong suit, technology. This is what he's relied on from the time he started Huaxia Dairy Farm just outside Beijing in 2004, well before the onset of the melamine crisis.
The Beginnings of a High-Tech, Happy-Cow Solution in Chinese Dairy
At Huaxia's inception, Shao had the sense that China lagged decades behind the United States, in terms of its dairy productivity. He saw an opportunity to bring U.S. standards into the industry. But he had no background in farming or food. So why agribusiness?
"No one is into agriculture in a serious way here," he responds.
By "serious," Shao means there is no competitor who is serious about innovation, particularly about reimagining the use of technology in this otherwise staid setting. For example, from the outset, Shao worked to improve the gene pool of China's dairy herd. Cows in China produce relatively low quantities of milk. So Shao started by building a herd of high-quality imported and crossbred cows. He used new data management systems to construct advanced facilities, sourced high-quality feed, and installed the latest equipment. He went way beyond what Chinese regulations required, meeting U.S. Food and Drug Administration standards for processing.
Although these decisions raised Shao's costs 15 percent over those of his competitors, he felt that the investment would pay off quickly: He would produce more and better milk per head, lose fewer cows to sickness, cut down labor costs, and have to replace equipment less often. The goal was to emphasize quality, a strategy that would be well worth the higher costs.
"When I first came [back to China], these people were thinking the cow was just a machine to produce milk," he says. This attitude led to low output. Good dairy farmers will tell you that happy cows produce more milk. "I did a lot of research and development on cow comfort," he remarks.
At the farm he built outside Beijing in 2013, these efforts show. A specially engineered "water curtain" circulates cool air throughout the barn. Some cows move freely around their barn enclosures; most lie on their sides and happily munch on feed. They are basically lounging around, completely relaxed. "How do you tell a cow is happy?" Shao asks. "She sits down and chews her cud, then regurgitates it." Electric golf carts drive up and down, moving the feed closer so the herd can eat without getting up.
"If a cow moves from my 2004 farm to this one," Shao points out, referring to the first facility that he built without these amenities, "I get five liters more milk [daily] per cow. She eats more, relaxes more, and gives more milk."
The facility doesn't have the stench one conventionally encounters on dairy farms, either. Cows amble out of the milking barn, and mechanical sweepers and flowing water continuously Technology applied at a Chinese dairy: multiple cows being milked simultaneously. remove the manure they drop. The manure is then piped to another building, where it will be processed into organic fertilizer to be sold to other farms.
Charles Shao views his role as one focused not solely on his own business but on the health of the industry as a whole. In the same way that he improved on the dirty, unventilated barns he found on arrival back in his home country, Shao sees a key part of his role as an entrepreneur as improving the entire ecosystem of dairy farming in China. He also did something unusual: He started partnerships with U.S. veterinary colleges to train Chinese dairy professionals. He worked with other dairies, helping them import better feed from the United States, effectively training employees of competitors for free. "Without research and development, my business will not survive. But I can't do all the R&D on my own."
Some critics were puzzled, even angered by these moves. How, they wondered, could Shao expect to make money with higher costs? Chinese consumers would not be able to afford the more expensive milk, these critics argued. Moreover, why was Shao not protecting his innovations and ideas? "My investors worry that if I train my competitors I'll go out of business," he says. They plead with him, saying he's basically giving his intellectual property away. How dare he share these ideas with others — with competitors — encouraging competition that could doom his business and possibly further hurt an industry already on the ropes?
This idea of sharing information with the competition — even valuable information — did not originate with Charles Shao, however. It borrows from the technology industry's "open-source" movement, in which everyone in the industry freely accesses the knowledge of others and contributes to enhancing it. In other words, people "pay it forward," trusting that others will do likewise. It's hard for the Chinese dairy entrepreneurs to appreciate this, however, stuck in a low-trust environment as they are.(Continues…)
Excerpted from "Trust"
Copyright © 2018 Tarun Khanna.
Excerpted by permission of Berrett-Koehler Publishers, Inc..
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Table of Contents
Introduction: Trust, Entrepreneurship, and the Developing World 1
1 The Why's and How's of Trust 27
2 The Mindset Change 63
3 Building on Existing Social Norms 89
4 Working as a Team with the State 125
Trust: A Coda 161
About the Author 183