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US Tech Firms Face Chinese Hurdles

by | July 29th, 2014 | 01:11 pm
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Edward Snowden’s revelations, along with cyber-espionage cases and China’s IT protectionist tendencies have combined to create a storm for US tech firms.  Chinese investigations and sanctions directed at foreign IT firms started more than a year ago and have grown more frequent in recent months. Following the US government’s indictmentsof five PLA officers for cybercrimes on May 19, 2014, the Financial Times reported that state-owned enterprises (SOEs) in China were instructed not to hire US consulting firms such as McKinsey and Boston Consulting Group, claiming that they have been spying on behalf of the US government.  As well, other major US companies were added to the Chinese target list, including Microsoft, Apple and Oracle.

Since the May indictments, China required SOEs to ban Microsoft’s Windows 8.  And on July 27 Microsoft revealed that representatives from the State Administration for Industry & Commerce (SAIC) made simultaneous visits to Microsoft’s office in 4 cities in China for apparent antitrust investigation. Citing national security concerns, Chinese banks were asked to remove IBM servers and Oracle software and replace them with a local brand.  Apple’s iPhone was criticized by China’s state-run broadcaster CCTV, which claimed that national security is threatened by an iPhone feature that tracks a user’s location.  Apple denies a security risk, pointing out that the tracking function can be turned off.  One expert observed that tracking features are standard across many smartphones. In June 2014, state-run People’s Daily called for “severe punishment” of US tech firms, adding Google, Facebook, Yahoo, and Cisco to the culpable list, again citing the Snowden revelations.

Qualcomm and InterDigital came under investigation in February 2014 for a different reason: charging high royalties for patent licenses, despite evidence that their rates were in line with market practice.  The InterDigital probe was suspended after the firm agreed to change its pricing structure.  The Qualcomm investigation seems likely to end with a fine by the National Development Reform Commission (NDRC), one of the bodies that implements China’s anti-monopoly law. Reports published on July 24, 2014, stated that the NDRC deemed Qualcomm to be a monopoly, and CEO Steven Mollenkopf said “some loss would be probable.”

Beyond these immediate problems, Chinese government directives foretell more hurdles for American firms. Days after the PLA indictments, the State Internet Information Office announced that it would establish new methods of determining whether foreign tech firms pose national security risks in China.  Moreover, China continues to classify cloud computing as a value-added telecom service, meaning that the servers must be based in China, and that foreign firms must team up with local companies to enter the market (a process known as forced localization). Microsoft, IBM, Amazon, and SAP have all joined with local firms to provide cloud computing services, along the way conveying valuable technical information to their local partners.

Obstacles facing foreign IT firms appear to have been inspired by a mixture of Snowden revelations, the US campaign against cyber-espionage, and China’s desire to protect SOEs and national champion firms.  In addition, China could be retaliating against US policies. The United States blocks NASA, the Justice Department, and the Commerce Department from purchasing Chinese IT equipment. However, the scale of US protective measures is much smaller than the scale of Chinese protective measures.

These restrictive actions are starting to take a toll.Qualcomm recently announced that, because of the NDRC investigation, it may miss out on collecting licensing fees on as many as 250 million smartphones and tablets being assembled in China this year. Nearly half of Qualcomm’s revenue comes from China. IBM’s operating revenue in China was down 21 percent in the first quarter of 2014, compared with the last quarter of 2013.  Cisco has reportedly seen a drop in Chinese demand.  A few years ago, former Microsoft CEO Steve Ballmer said that revenue from China was only 5 percent of what the firms earns in the United States.  With a ban on SOE purchases of Windows 8, this year will be no different. Apple’s revenue from China, by contrast, is doing better, despite the iPhone controversy.

Confronted with Chinese hurdles, US policy options are limited. The United States might use the bilateral investment treaty (BIT) negotiations to press China to scale back its measures.  The United States could also continue its push for inclusion of a significant number of provincial governments and SOEs under the terms of the Government Procurement Agreement.

But perhaps the best defense for US tech firms is a good offense.  In June 2014, IBM won a contract to build software systems for state-owned Shanghai Airport Authority, to help manage operations like airplane taxiway protocols and passenger waiting times, “dramatically” improving on-time flight performance. Following IBM’s example, perhaps the most effective answer for other US firms is to continue doing what they do best: leading edge innovation. If American firms remain leaders in their industries, China may not be able to live without them.