Why Entrepreneurs Must Focus on Building Trust

New Book: Legal and social institutions that support entrepreneurs often aren't well established in developing countries. Tarun Khanna's new book explains how businesses can make up for that by building trust.
  • Author Interview

Why Trust Matters for Building Businesses in Developing Economies

Interview by Dina Gerdeman

Fear swept across China in 2008 as six babies died and about 300,000 others got sick from drinking infant formula that was sprinkled with melamine, an industrial chemical used in plastics and fertilizers that can cause kidney failure.

The tainted milk scandal spurred dairy farm entrepreneur Charles Shao to double down on quality control in the developing country. He harnessed technology to improve the processing of his herd’s milk, going far beyond what Chinese regulations required.

Today, all traces of melamine in baby formula may be gone, but still, cleaning up China’s milk hasn’t erased a broader problem: The scare made Chinese consumers so skittish that six years later, people are still paying significantly more for foreign milk they feel safer about drinking.

So Shao can’t focus merely on selling milk. Instead, he and other entrepreneurs must take steps toward rebuilding a broken bond of trust between the Chinese people and the country’s dairy industry, says Tarun Khanna, the Jorge Lemann Professor at Harvard Business School, in his book Trust: Creating the Foundation for Entrepreneurship in Developing Countries, which was released Tuesday.

“Systemwide change is needed,” writes Khanna, who has studied entrepreneurs in developing countries and launched ventures across Asia. “That will come from relentless experimentation, an understanding of the specific origins of mistrust in the Chinese food system, and, of course, plenty of time to sort out which experiments will have a truly lasting impact. It falls to entrepreneurs like Shao … to weave and maintain a web of trust between consumers, producers, regulators, and the public at large.”

"Pointing fingers and criticizing the government usually doesn’t solve anything"

In his book, Khanna chronicles the challenges Shao and other entrepreneurs face when trying to blaze a productive trail in places like Brazil, China, India, and Mexico. While consumer confidence in developed countries like the United States is bolstered by enforceable contracts, an impartial legal system, and strict regulations, none of that is a given in the developing world.

And entrepreneurs who don’t attempt to allay the mistrust that permeates these countries are doomed to fail, Khanna says. In this Q&A, Khanna shares advice on exactly how entrepreneurs should approach the delicate process of building trust in parts of the world where skepticism runs rampant.

Dina Gerdeman: You say entrepreneurs don’t have the luxury to be laser-focused only on the specific problem they want to solve in the developing world. Do you think many stumble because they don’t realize they need to build trust before diving into their product and service solutions?

Tarun Khanna: Certainly just having domain competence in where you want to be as an entrepreneur is insufficient. So many things can trip you up.

In the US, it’s a fair bet to say you can look at something like the engineering angle, or the analytics angle, or some specific secret sauce, and you can build a company around that. The other folks you need—the regulatory side, say, or the delivery side—can be cobbled together to collectively form a team.

Many of those pieces would be missing in Johannesburg or another developing country location. You don’t have the luxury of those supporting structures. So you have to work on building trust first that will entice others to join you.

Gerdeman: Why is it important for entrepreneurs to take ownership in weaving their own web of trust without waiting for others to solve problems related to their goals?

Khanna: Put simply, I feel that the approach I propose is the most practical. I have spent a lot of time as an entrepreneur in developing countries. You have to create the conditions to create. Rather than assuming a set of circumstances will materialize to solve your problems, you have to realize you’re the one who has to address this problem of pervasive mistrust. It’s not productive or sufficient to wait for the government or anyone else to get their act together. Pointing fingers and criticizing the government usually doesn’t solve anything.

A gut reflex is to say that these countries don’t work because of corruption. There’s some truth to that. But it may not be the main story. The main story is usually primarily a lack of understanding. It’s the practical thing to do to find people who are willing to work with you and co-create the conditions to create. You have to hold their hands as you go along.

Critics might say: You’re putting too much on the shoulder of the entrepreneur with this approach. They are right! It is harder than building an app in a Harvard dorm, surrounded by pools of expertise, relatively abundant risk capital, and so on. That’s why ‘development’ is hard. But the alternative is harder, to wait for the government, even a well-intentioned one, is a fool’s errand and could take generations.

Gerdeman: In building his dairy farm in China, Shao offered to train other farmers in how to produce clean milk for free because he didn’t want to be lumped in with competitors who produced contaminated milk. Is this kind of sharing of information, even with competitors, necessary to building trust?

Khanna: With the melamine milk poisoning crisis, he found that as a lone actor trying to create clean milk in China, it was a very difficult problem to solve. It was hard as a solitary person to make that happen. It was like whistling in the wind.

But if there’s a critical mass of people doing things in a certain way, it allows people to look at dairy farming differently. If other people are providing complementary services, (the public) is much more likely to trust in it, rather than if it’s one solitary actor. So he thought, I have this asset and insight and it can be used by others, so he made it available to a larger group of people. Getting that critical mass allows it to become this viable option.

Shao’s alternative would have been to wait for an industry association to emerge that would then take on the task of educating others. But who would create that? Instead, he’s trying to create a constituency for change. It’s an example of an entrepreneur paying attention to public good creation more than they might have to in Boston.

Gerdeman: What role do you think technology can play in helping entrepreneurs build trust?

Khanna: The world’s biggest biometric program by far is in India. The FBI’s biometric database contains data on 60 to 70 million people. The Indian database has close to 1.3 billion. Prior to having this biometric database, there was no way to identify the vast majority of people in India accurately. When children are born, half of them don’t get a birth certificate even though it’s the law to do so. So with India’s massive welfare program, the government would provide assistance but had no way to trust that it would end up in the poor person’s pocket they intended it for. It might get stolen. The euphemism is ‘leakage.’

So technology was used to uniquely identify people and solve this problem. With biometrics working, the government is able to directly target the person who needs that aid. You don’t need a card or a fingerprint. You can get your money just by showing your eye.

That technology has leapfrogged everything else. It’s an example of technology being used to address a trust deficit between the government and its citizens. But that same technology creates other secondary issues that India is under-equipped to deal with, like privacy issues. So technology is an arrow in your quiver as an entrepreneur, but it’s not a panacea. When you have this new technology, it’s your responsibility and in your interest to co-create the infrastructure for that technology to be used responsibly and profitably.

Gerdeman: Why is it crucial for entrepreneurs to respect the norms of a society they are building a venture in, rather than fight against the rules?

Khanna: In these developing countries, you have a system that has been working for hundreds of years. We have a tendency to say that everything should be disruptive. I don’t know that that makes much sense to me. Sometimes going with existing practices may be the right way to do it. You can swim upstream on some dimensions of a problem, but not all for sure, and very likely you’re free-riding on some other foundational practices and norms that you’d rather not see change.

Instead, we should be looking for ways to build on top of existing practices. That’s better than a reflex approach that says, ‘I’m going to come in and shake things up.’

"Good entrepreneurs are judicious risk-takers and big dreamers. You can’t bet on lightning striking."

In microfinance today, the best firms in India, Mexico, and elsewhere are layering technology on top of social norms and practices that have existed for centuries, taking into account, for example, how poor women come together to pool capital and deploy it productively.

Gerdeman: It sounds like building trust in a developing country can take many years. I imagine entrepreneurs need to have a great deal of patience if they expect to see success, right?

Khanna: Some of the organizations I have contributed to building in the last decade have involved former students (at HBS). Their incoming assumption is often that we’re going to build this and exit in three or four years. They’re captivated by the “Facebook in a Harvard dorm room” phenomenon. They’re seduced by that.

You could always get lucky. But that doesn’t even happen in the US very often. That’s one in a million when the Gods are smiling.

Good entrepreneurs are judicious risk-takers and big dreamers. You can’t bet on lightning striking. It takes four or five years for a venture to get traction in the US, if it does. It’s going to take longer than that in a fast-growing developing country. So yes, in most cases, you are going to need patience. The payoff is the satisfaction of building a country’s soft infrastructure, providing much-needed services and, if you’re so inclined, of course financial success.

  • Book Excerpt

Why Many Chinese Don’t Trust the Dairy Industry

from: Trust: Creating the Foundation for Entrepreneurship in Developing Countries
by Tarun Khanna

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 causes 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 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, price sensitivity from 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 products 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.

Excerpted from Trust: Creating the Foundations for Entrepreneurs in Developing Countries by Tarun Khanna. Courtesy of Berrett-Koehler Publishers. Copyright © 2018.

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