China’s economic boom has allowed the country to beef up its domestic industry through the launch of an “indigenous innovation” plan, which happens to contradict WTO anti-favoritism policy. Google may ultimately pay dearly for its recent pull out in response to Chinese censorship, while a more winning business strategy may be to work with, rather than against, this new giant. See the following article from Money Morning for more on this.
There’s no question about what kind of profit opportunities the Chinese market offers. Moreover, the willingness of U.S. companies to partner with China in the pursuit of profit is equally blatant.
So why is it that more U.S. businesses feel less welcome in China now than they did four years ago?
The fact is that in the past four years, China’s economy has continued to grow by leaps and bounds, while a humiliating financial collapse and soaring debt have tarnished much of the shine that once adorned the U.S. market.
Indeed, for the first time in perhaps more than a century China has the upper hand. How long that will last is a difficult question to answer, but right now, China wants to use its leverage to support domestic companies – and it’s doing so unapologetically.
“They want sophisticated international companies and they want to give them a leg up,” Brookings Institution senior fellow Kenneth Lieberthal told BusinessWeek.
To that end, Beijing recently unveiled its new “indigenous innovation” program, which demands that government procurement favor Chinese products. China never signed the World Trade Organization (WTO) government procurement agreement that prohibits such favoritism – although it promised when joining the organization in 2001 that it would do so “soon.”
Beijing has suggested that it would sign the agreement this year, but it has also asked for a 15-year phase in period.
Meanwhile, officials at every level of government across China have issued lists of products that can be purchased by their respective agencies, and virtually all of those items are made domestically. Shanghai, for example, released a list of more than 500 approved products, and just two of those items come from companies with foreign ties.
It’s policies like these that have U.S. companies feeling unwelcome. The proportion of U.S. businesses that feel increasingly unwelcome to participate and compete in the Chinese market rose to 38% in February, according to the American Chamber of Commerce in China (Amcham). That’s up from 26% just two months prior, and the largest number since Amcham began polling its members four years ago.
“For many multinational companies, China is a bright spot in the global picture right now but our survey shows member companies feel these [indigenous innovation] rules are a new kind of protectionism and will be used to exclude them from an increasingly important market,” Michael Barbalas, Amcham-China president, told the Financial Times. “Increasingly our member companies are talking about reciprocity and equal treatment in China as Chinese companies go global and benefit from access to other markets.”
Some 39% of U.S. companies responding to the Amcham survey said revenues from China fell in 2009 – the largest number since 1999. And a whopping 57% of U.S. technology companies said they expected to lose business in China as a result of the indigenous innovation rules.
European companies are feeling slighted as well. Just one-third of European companies operating in China say they are optimistic about future profits. That’s down from about half last year.
The findings of the Amcham survey will be presented to members of the Obama administration prior to the bilateral Sino-U.S. Strategic and Economic Dialogue in May.
Those talks will all most certainly cover China’s treatment of U.S. companies, particularly in light of Beijing’s recent dustup with Google Inc. (Nasdaq: GOOG).
China vs. Google
Google’s withdrawal from China last month was dramatic and emotional. It was spurred by the search giant’s claim that the Chinese government was behind a series of sophisticated cyber-attacks perpetrated against U.S. companies and human rights advocates.
But the truth is Google’s momentous decision to leave China was actually preceded by a series of smaller skirmishes between the two parties. The Mountain View, CA-based company had long chafed under Beijing’s strict censorship policies and was routinely pestered by government officials.
When China last year mandated that all computers sold in the country come with newly developed Green Dam Youth Escort filtering software preinstalled, it singled out Google as a major standards violator.
First, the China Internet Illegal Information Reporting Center (CIIRC), a government agency, accused Google of providing links to pornography, and then a slew of state-run media enterprises lined up to blast the company.
“Recently the CIIRC had received and verified public complaint against google.cn for spreading obscene and vulgar information in massive scale,” read the CIIRC report, titled “Strongly Condemn Google for Spreading Indecent and Obscene Information.”
“Such act has seriously violated the government’s relevant regulations. Moreover, it is against the society’s public morale and interest,” it said.
The official Xinhua news agency cited an unnamed Google official as admitting a “huge amount of porn and lewd information” had been disseminated via the search engine.
China Central Television (CCTV) in its evening news highlighted the CIIRC’s condemning notice and had a follow-up story in its “focus interview.” The news feature gathered various public opinions from teachers, parents, university students and youth experts against google.cn.
Google’s word association feature – a drop-down box that offers suggestions based on the terms typed into the search engine – was disabled after the report, which showed how typing the Chinese word for son could solicit terms that have lewd connotations. However, it was later revealed that a Chinese youth, depicted in the television segment as a university student who had started an anti-Google campaign, was actually an intern at the television station.
Many analysts saw the assault on Google as a way for the Chinese government to justify the implementation of its hugely unpopular Green Dam software. But many others interpreted it as a way of undermining Google and advancing the interests of domestic search giant Baidu Inc. (NYSE ADR: BIDU).
“Chinese search engines are the obvious beneficiaries of [the criticism of Google] and that suits the authorities fine,” an industry insider speaking on the condition of anonymity told TIME magazine. “They all take care of the political censorship themselves and obviously have to do exactly what the bureaucrats tell them. A foreign company like Google is that much harder to control.”
Pacifying the Panda
Of course, it’s probably not in the best interest of most companies to pull out of the Chinese market entirely.
Google’s decision to flee China was principled, but it was also costly. The search giant stands to lose anywhere from $400 million to $600 million in annual revenue, as well as a considerable foothold in the world’s largest and fastest growing Internet community.
So while Chinese companies have clearly taken home field advantage, it’s probably better for U.S. companies so take a different approach.
“The current business climate is similar to the one we saw after Tianamen Square in 1989,” said Money Morning Chief Investment Strategist and Editor of the New China Trader Keith Fitz-Gerald. “But the companies that pulled out of China, that abandoned and gave up on it have since been penalized and never recovered. Meanwhile, those that stuck with it and went with the flow are better off. I think this will eventually blow over and the major international players operating in China won’t be affected.”
According to Fitz-Gerald, U.S. companies around the world, not just in China, are guilty of taking an America-centric approach to business.
“One mistake I see all the time around the world is American businesses going into a foreign country expecting to do business on American terms,” said Fitz-Gerald. “It demonstrates arrogance and a way of life that most foreign representatives find distasteful. If companies really want to succeed in China they’re going to take off their American hats and do business the Chinese way.”
“That doesn’t mean they have to give up any of the principles we cling to at home but there is definitely a different way of doing things over there,” he added.
China’s private sector could be one arena where U.S. businesses could find sympathetic partners. Privately owned Chinese companies are often denied the cheap financing that is readily offered to state-owned enterprises.
The fact that China is attempting to rein in lending to cool its red hot economy will make these private companies even more vulnerable. Chinese banks extended 700.1 billion yuan in new loans in February, according to the People’s Daily. That’s just half the value of loans extended in January and 371.4 billion yuan less than total loans furnished in the same month in 2009.
Chinese entrepreneurs say state-owned enterprises are eating them alive, swallowing up private competitors at fire-sale prices or just plain squeezing them out.
“Now the big brothers are trying to grab all the food and enjoy it by themselves,” Bao Yujun, president of the China Private Enterprises Association and former vice chairman of the All-China Federation of Industry & Commerce, complained to Forbes. “They don’t want to leave any to the little brothers.”
U.S. businesses could also look for more partnership opportunities in India, Taiwan, Japan, and Korea. By leaving China and using their technology, innovation, and experience to bolster regional competitors, U.S. business could send a powerful message to Beijing.
There also are foreign companies that are less affected by Beijing’s bias. One example is Yum Brands (NYSE: YUM) – owner of the Pizza Hut, KFC, and Taco Bell food franchises.
Yum has 1,100 restaurants operating in China today and plans to have 2,000 units running by the end of 2013. In fact, the company opened more than 500 new KFC outlets in China last year, reporting a 23% increase in operating profits in the region. Revenues were up 18% year-over-year, to $3.68 billion. There are now more than three times as many KFC locations in China as there are McDonald’s Corp. (NYSE: MCD) restaurants.
In fact, KFC has augmented its menu with items that cater to local tastes – like egg cakes and rice porridge – hires 99.9% of its staff locally, and sources 90% of its ingredients from Chinese suppliers.
John Frisbie, president of the US-China Business Council, told Minyanville that Yum is “very unlikely to be touched by the recent policy concerns other U.S. companies have had.”
“By and large, the indigenous innovation rules will affect Yum less than it will companies like Microsoft [Corp. (Nasdaq: MSFT)], Boeing [Co. (NYSE: BA)], Caterpillar [Inc. (NYSE: CAT)], and Motorola [Inc. (NYSE: MOT)] — companies based in the U.S. that export to China, which is trying to incentivize domestic innovation using methods that don’t conform to worldwide best practices, like tax incentives and R&D programs,” says Frisbie.
Ultimately, the companies that don’t give up will come out ahead, says Fitz-Gerald.
“It was difficult for foreign companies to break into the U.S. market 200 years ago. U.S. firms did everything they could to keep them out,” he said. “But the ones that stayed were handsomely rewarded for their efforts.”
This article has been republished from Money Morning. You can also view this article at Money Morning, an investment news and analysis site.