Desperate market expansion and unreliable capital management led the company to fail
　　
　　On October 23, nine of the former senior management staff of PriceSmart Membership Shopping were summoned for interrogation at the First Intermediate People’s Court of Beijing.
　　The case, understandably, attracted attention from a large number of people. Zhao Kun, an alias due to his request for anonymity, from northeast China’s Harbin City, was among them. Zhao was one of the suppliers of PriceSmart, which had defaulted on a payment of goods for over 300,000 yuan. But this trial didn’t bring him any good news.
　　The court held a three-day trial involving alleged contract fraud and illegal capital withdrawal at PriceSmart, and looked into the criminal responsibility of its nine senior managers. But the court didn’t make a ruling on how to handle the large amount of money the company owed to suppliers.
　　Zhao’s woe is just the tip of the iceberg of PriceSmart’s failure to pay for goods. PriceSmart was in default on payments to suppliers of nearly 2 billion yuan, excluding its loans from banks-it owed more than 1 billion yuan to banks.
　　Meanwhile, the absent company founder, controller and chief suspect in the PriceSmart case, Liu Wuyi, had left the country, leaving behind a fragmented and heavily indebted PriceSmart.
　　The company’s case study serves as a lesson for the business community and government alike. Essentially, the moral of the story isn’t good, and neither is ill-considered growth.
　　
　　Becoming notorious
　　
　　NOT SO SMART: Due to illegal money management and expansion, PriceSmart won’t be courting any more members like this one
　　In 1995, Liu registered a company called PriceSmart Membership Superstore Enterprise Group (PM Group), which claimed to be derived from the trademark “PriceSmart” under U.S. Price Enterprises Inc.
　　It is notable that although the PriceSmart set up by Liu was the first membership-only supermarket in China and based on the U.S. model, the Chinese PM Group is actually a private company without any foreign capital. It adopted a kind of franchise store operation. Whenever a new PriceSmart supermarket opened in China, it would pay a sum of money to the U.S. side. Apart from the money, the PM Group China had no connections to the U.S. side.
　　In the next eight years, Liu expanded PriceSmart by starting membership stores nationwide, and in 2001, he also developed N-Mart to attract non-membership customers. By the end of 2004, he had opened altogether 48 stores in China and the nationwide sales once hit 4 billion yuan a year in its heyday. Liu was doing a good job targeting the wealthy demographic.
　　“Cars parked outside of PriceSmart were all imported, and those who drove homemade cars to a PriceSmart would be mocked at,” said Cheng Keneng, once a member himself.
　　“In the beginning, PriceSmart followed the rules and regulations docilely and was welcomed in local areas,” said Zhao. “When Liu Wuyi found it so easy to tap money by opening more stores, he became crazy about opening new stores and once ordered to open 70 more in three years. However, due to the lack of capital, talent and proper management, PriceSmart’s expansion was totally out of control.”
　　In 2004, banks tightened credit for PriceSmart, which put pressure on the company’s capital chain. In July 2004, the Changsha PriceSmart was accused by Nanfang Construction Material of owing its company a total of 28.09 million yuan in rent, water and electricity fees. As a result of the lawsuit, the Changsha PriceSmart was forced to close, creating a domino effect. Local banks and suppliers all urged PriceSmart to pay off its debts. Eventually, because of capital chain problems, all PriceSmart stores were closed by March 2005.
　　Dangerous pattern
　　The formerly resplendent private retailing enterprise came to a dead end with about 2 billion yuan in debt.
　　One question many inquiring minds want to know since the company’s downfall is this: What were the company’s fundamental problems?
　　“The root of the PriceSmart crisis is in its dangerous business pattern,” said Yang Qian, a professor of management at Beijing Commercial Management Cadre College. Yang stated that PriceSmart manipulated money from banks and suppliers in order to get more market share while its own capital was very limited. Once one link was in trouble, all the dominoes fell.
　　Yang said that the daily revenue of a 20,000-square-meter PriceSmart or N-Mart store was about 1 million yuan, and Liu could get 60 million in two months. But PriceSmart used to settle accounts with its suppliers only once in a period of more than three months. Then Liu could take the 60 million yuan in accounts payable and open a new store. In this manner, more and more stores were opened. Understandably, the capital chain built on suppliers’ money and bank loans was extremely fragile.
　　Beginning in 2002, PriceSmart was frequently accused of delaying payment. In the middle of 2004, suppliers united to boycott PriceSmart, causing a complete break in its chain.
　　“From then on, the capital black hole had been revealed,” Yang said.
　　As a matter of fact, it was not just PriceSmart that was running this dangerous operating pattern. Many retailers are still expanding their business in this way. Chen Ji, a professor at Beijing Technology and Business University, pointed out that U.S. supermarkets attach great importance to credibility and stick to the terms of contracts. There, it is much less possible to delay suppliers’ payments.
　　However, a considerable number of domestic retailers still dream of maintaining business operations and expanding via bank loans and suppliers’ money. Once the banks and suppliers withdraw their money, the retailers are hit hard and even collapse. They eventually get themselves in trouble.
　　The blind worship of foreign brands was another factor in the dangerous operation of PriceSmart.
　　“Many local areas worship imported brands blindly and the governments are keen on attracting investment to boost GDP,” said Zhang Yulin, assistant researcher of the Chinese Academy of International Trade and Economic Cooperation under the Ministry of Commerce. Zhang noted that local governments shouldn’t spoil retailers in the name of achieving good performance, increasing employment and taxation.
　　“The insufficient information disclosure and irresponsible investigation and approval system naturally give rise to over-competition, leading to a disordered market,” Zhang said. He noted that PriceSmart’s shops took bank loans by guaranteeing one another, which is the least reliable practice and is dangerous.
　　It was later proved that this kind of guarantee actually offered a convenient way to manipulate capital, leading to a large amount of bad debt in banks. To some degree, banks were also responsible as they didn’t have a comprehensive approval and investigation system for debtors. The banks’ carelessness essentially helped spoil PriceSmart.
　　
　　Alarm bells for all
　　
　　Zhao said from his perspective, the government and business world now should be more aware of the importance of strengthening legislation in the market and preventing retailers from illegally tapping money through unbridled expansion.
　　“If the legislation and supervision is not strong enough, such cases like PriceSmart will still occur,” Zhao said.
　　Zhao’s prayer is now being answered.
　　On November 15, the Administrative Measures for Fair Transaction Between Retailers and Suppliers was jointly issued by the Ministry of Commerce, National Development and Reform Commission, Ministry of Public Security, and State Administration of Taxation. These measures state that the retailers should pay for goods in less than 60 days.
　　Huang Hai, assistant to the Minister of Commerce, said that some retailers in China adopt a similar operating pattern as PriceSmart, delaying payment to suppliers for three or four months with the excuse of opening new stores. In this way, the retailers can expand their business rapidly, but also, dangerously.
　　“In China, there is much more supply than demand, and also due to the lack of restrictive laws, many retailers are integrated to form retailer giants and abuse their market advantages, which gives rise to unfair and unjust transactions,” Huang said.
　　Retailers’ default on payment has frequently caused business crises.
　　“Private retailers generally lack capital; hence they have the inclination to stall payment to suppliers and bank loans to open more shops,” said Huang. He pointed out that this operating pattern was dangerous and could easily cause a break in the capital chain. It also offers a convenient way for retailers to run away with the money.
　　Meanwhile, the newly enacted government measures also have special regulations for foreign enterprises. First, foreign enterprises will be subject to business network investigation if intending to open a business in China.
　　“Although we remove geographic and quantitative restrictions on shops, we will still carry out an examination and approval system,” Huang said. “Foreign enterprises should act in line with the commercial network planning of local governments. If they don’t, they are not allowed to open.”
　　Furthermore, according to the Law of the People’s Republic of China on Foreign-funded Enterprises and Law of the People’s Republic of China on Chinese-Foreign Equity Joint Venture, “If the foreign-funded enterprises are going to open new stores and expand their operating scale, they must increase investment, without which they won’t be allowed to open new stores,” said Huang.
　　Zhao said the implementation of the new measures is without doubt good news. However, Zhao also worried that some retailers are simply too aggressive and leave a doubt as to whether the measures can be properly enforced.
　　Zhao said that before the implementation of the new measures, there were other similar regulations on retailers. However, the enforcement departments didn’t punish enough.
　　“We are unsatisfied with the exploitation of retailers, but because of competition, we suppliers must enter the big shopping centers,” Zhao said. “If we lose one big retailer, it means we are going to lose dozens of its networks. It also means we send the market share to our competitors.”
　　

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