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Answers must be supported with theoretical models and concepts from…
Answers must be supported with theoretical models and concepts from the recommended textbook, Lewicki, R. J., Saunders, D. M. & Barry, B. (2021). Essentials of Negotiation (7th ed). New York: McGraw-Hill International Edition.
It is important to support your answers with specific examples based on the scenario given in the case below, to demonstrate your understanding and application of the relevant concepts. You may make reasonable assumptions, as part of your analysis.
The case below is adapted from Harvard Business Case Study “Smart Health: Negotiate with a Social Purpose.” Jamie Zheng is Founder and CEO of Smart Health, a Shenzhen-based social enterprise specialising in developing intelligent health care products for the elderly. In particular, the Smart Health Medicine Watch which can remind the wearer to take medication, make emergency call and communicate with family members and healthcare professionals is its core product. Smart Health has five patents based on Jamie’s design of the Smart Health Medicine Watch for this market. Three months ago, this product was launched in the Chinese market with great success, generating average monthly revenue of RMB¥100,000[1]. However, Jamie thinks that this product can benefit from substantial modifications to make life easier for the elderly. The next step is for the company to continue spending on research and development in order to refine the product. To achieve this goal, Jamie is seeking a first-round investment of ¥5 million for a 20% share of the company.
Five different institutions and individuals have approached Jamie with offers. Two of them are being seriously considered by Jamie. One investment company is offering ¥4 million for 20% of the company but Jamie is concerned that this investor is mainly concerned with maximising profits and may abandon the social purpose of his enterprise, namely to help the elderly. The second offer is from an impact investor (such investors invest to address social or environmental issues). The impact investor is offering ¥3 million for 20% of the company. Jamie is not keen to accept this second offer as it is too low even though he appreciates the support of his social purpose.
Smart Health is registered as a social enterprise because its social purpose is important to Jamie on a personal level. While pursuing his master’s degree at Hong Kong University, he lived with his grandmother, who suffers from hypertension and diabetes for the past 20 years. On one occasion, Jamie’s grandmother fainted and almost died because she forgot to take her medicine. Luckily, a kind-hearted neighbour saved her life, but this experience changed Jamie’s outlook on what is important. As a result of this incident, Jamie made it his primary purpose in life to help the elderly live safely through increasing interactions with their family, friends and care-givers, and founded Smart Health with this purpose. With an initial innovation funding from 3M, Jamie invented the Smart Health Medicine Watch and started his social enterprise with the dual goals of helping as many elderly people as possible while running a sustainable and profitable business.
Based on these goals, Jamie designed a business model as follows. First, Smart Health sells its products to high-end customers to generate profits (currently about ¥100,000 per month in revenue) through both online and offline platforms. Second, the social enterprise spends a portion of revenue from sales to donate a simplified version of the Smart Health Medicine Watch to those low-income elderly who cannot afford it (currently, this costs the company about ¥20,000 per month). Third, Smart Health requires that its employees spend time volunteering at events for the elderly and also covers the cost of these events, which range from parties at nursing homes to community workshops for the elderly. Smart Health provides a demonstration of its products at these events but does not sell its product on these occasions (currently, this costs about ¥20,000 per month). The last two activities help Jamie achieve the social purpose of his enterprise but reduce the profitability of Smart Health. To maximise profits, many investors have suggested that Jamie should focus all his resources on high-end customers, but so far Jamie has refused. He believes that it is important to help all the elderly and he firmly believes that the company needs to devote sufficient resources to its social goals.
Jamie is recently approached by XYZ Capital, one of the largest venture capital funds in China. Jamie met its managing director, Chris Liu at an event held by Tencent[2] two months ago. In their conversation, Jamie shared the vision and unique nature of Smart Health as a social enterprise.
Chris seems to empathise and understand the social contributions of the company. Jamie feels an immediate connection after Chris shares that his mother is also suffering from health ailments. Chris recognises the benefits of Smart Health’s products, in particular, the Smart Health Medicine Watch and seems to also be passionate about helping the elderly. Due to Chris’s passion for the elderly, Jamie is optimistic that a deal can be made.
As managing director of XYZ Capital, Chris has full authority to decide which companies to invest in, as long as the investment can achieve a targeted return on investment (ROI) of at least 30%. After completing the due diligence, Chris sees high potential in Smart Health. However, this is the first time he is considering investing in a social enterprise.
Due to the market reception of the Smart Health Medicine Watch, Chris sees high potential for a return on investment that is acceptable to XYZ Capital because of the patent technology in the watch and the forecasted market growth of products for the elderly (see Note below on Chinese Aging Population). When assessing an initial investment, Chris also strongly considers founder characteristics and he finds Jamie to be charismatic, passionate and driven – all key traits of a successful entrepreneur. With his invention, Jamie believes Smart Health provides an innovative solution that fills an existing market gap for the elderly demographic and Chris agrees with this vision.
From a purely financial perspective, Chris’s market research indicates that Smart Health can make an above-average market return on investment (compared to similar companies that XYZ Capital has invested in). Current projections estimate that the Smart Health Medicine Watch has a profit margin of a very healthy 40%, and there is great potential for Smart Health to produce more products, due to the extensive investment and effort that Smart Health has devoted to research and development. Smart Health is requesting an investment of ¥5 million for 20% of the company. If Smart Health were a normal for-profit enterprise, Chris would have no problem with these terms, since his due diligence indicates that the investment is likely to yield a sufficient ROI for XYZ Capital.
However, Smart Health is a social enterprise. It dedicates a significant amount of company time and financial resources to organising social functions at community events for the elderly, as well as donating simplified versions of the watch to lowincome elderly. These efforts have the potential to benefit the company in the future, but currently they have an adverse impact on the financial resources, as Smart Health has been spending much of its existing profits on donations to the elderly (by donating the simplified version of its products to the low-income elderly and organising events to enhance their lives). This significantly reduces Smart Health’s profits, which is certainly not acceptable to XYZ’s investors. Though Chris is sympathetic to helping the elderly on a personal note, he still needs sufficient financial returns in order to invest in Smart Health.
If Jamie insists on continuing with the social activities that reduce profits, Chris is not sure how to properly value the company and is afraid that he will not reach the ROI that is acceptable to XYZ Capital. In fact, if Jamie continues to use the profits from sales of the Medicine Watch to help the elderly, Chris is sure that the ROI will not meet XYZ Capital’s standards. XYZ Capital is after all, not involved in venture philanthropy or impact investing. As a traditional investment institution, ROI has always been most important to XYZ Capital. Therefore, controlling the flow of funds (i.e., placing financial conditions on how funds are accessed) or controlling the board may be a key tool to enable Chris to control how Smart Health makes financial decisions in the future, to ensure it achieves an acceptable ROI.
Jamie and Chris agree to meet in two weeks’ time to explore:
1. The amount that XYZ Capital will invest in Smart Health and the percentage of share that Smart Health will sell for this amount.
2. The number of board seats that XYZ Capital will receive. Currently, there are five seats on Smart Health’s board of directors, including Jamie. If XYZ receives more than two seats, this will mean Jamie giving up decision-making control over the company to XYZ.
3. Any financial conditions as to when and how much money is given (i.e., whether in instalments) and under what conditions (i.e., meeting certain profit or revenue targets).
China’s Aging Population[3] China’s population is aging faster than in the past. It is expected that the number of people aged over 60 in China will exceed 350 million by 2030. Due to the one-child policy, which was implemented since the 1980s, most families face the problem of “four seniors, one young couple, and one child”[4]. Therefore, with the increasing dependency ratio, traditional family-supported elderly care can no longer satisfy people’s needs. As a result, since China’s 11th Five-Year Plan period, the government has proposed developing the elderly care industry and has started introducing a series of policies to encourage private capital to help improve it. Public data shows that China’s elderly care industry will reach ¥13 trillion by 2030. Given the huge market potential, more and more players – from various sectors including real estate, insurance, pharmaceuticals, and elderly care service – are emerging in the market.
Since 2013, the State Council and other departments have issued policies and guiding principles to develop integrated elderly care and medical services. In 2017, in a report delivered at the 19th CPC National Congress, a section on carrying out the Healthy China 2030 initiative said: “As we respond proactively to population aging, we will adopt policies and foster a social environment in which senior citizens are respected, cared for, and live happily in their later years. We will provide integrated elderly care and medical services, and accelerate the development of old-age programs and industries.” The integration of medical services and elderly care service is a clear development priority for the elderly care sector in China.
Question
Due to the conflict between Smart Health’s social goals and its subsequent profitability and ROI, it will be iin XYZ Capital’s interest to have majority of the board seats. This will control how Smart Health makes financial decisions in the future including scaling down of donations to the elderly. One option is for Chris to orally assure Jamie that Smart Health can continue to pursue its social mission even if XYZ Capital controls the board majority. Once the majority is in their hands, there is nothing Jamie can do even if Chris does not prioritise or pursue the social mission, until profitability is acceptable.
Chris feels slightly uneasy initially but decides that making the oral assurance to Jamie is the right thing for him to do. Defend Chris’s decision using two (2) ethical frameworks. Support your answer with relevant examples.
