Sunday, September 27, 2015

The Dilemma of China

Cisco's recently announced partnership with Chinese server maker Insur group illustrates the evolving challenges companies are facing as they attempt to thrive in China.  With slowing global growth, finding success in China's market is increasingly imperative for companies in every industry. However, China is taking advantage of this market power by favoring domestic companies and creating an environment where foreign companies are forced to partner with Chinese companies and thus risk losing their competitive advantage,

Why China?
Despite the recent volatility and underwhelming growth numbers, China's attractiveness as a market for a wide range of companies is obvious.  China's middle class continues to explode in size.  In 2001, the share of the Chinese population who were middle class was 1%. 10 years later, that share is 18%. Companies are eager to meet the demand created by these people with newly found purchasing power. In natural resources, China accounts for 49% of global coal consumption, recently became the largest importer of oil and is the second largest consumer of gold.  In 2010, China became the largest market for automobiles. Simply put, companies ignore the Chinese market at their own peril.

Increasing Difficulties
Sounds great right?  Problem is, with low growth elsewhere, companies are increasingly dependent on China for growth, and the Chinese government is well aware of this fact. The Chinese government is increasing its influence on the way foreign companies operate in the country, partially in an attempt to give its domestic companies a leg up.  The Chinese government is leveraging its power over domestic companies to encourage them to focus their business on domestic Chinese companies at the expense of internationals. Cisco is a prefect example.

Cisco's Chinese Experience
Cisco long resisted the partnership model in China, preferring to rely on its brand and expertise during its 20 years operating in the country.  Following this strategy led to impressive success. In 2014, Cisco controlled 21.2% of the Chinese server market.  However, this dominance is being challenged by domestic Chinese competitors, particularly Huawei, who are being steered business by the Chinese government.  In 2015, Cisco's share of the Chinese server market dropped to 9.4%.  Much of this decline can be attributed to the Chinese governments decision to remove Cisco (as well as other US companies such as Apple, Citrix and McAfee) from a government approved purchase list for small contracts amid concerns by the Chinese government that the US government had installed so-called backdoors into US made networking gear. Regardless of the reasoning behind the decision, this is a poignant example of the Chinese governments ability to determine winners and losers in its economy and its emphasis on supporting domestic companies.

What's Next
This trend has no end in sight. Companies will continue to struggle with the trade off of the massive financial potential of the Chinese market with the risk of sharing technological know how with Chinese partners who, with the assistance of the Chinese government, may soon become a competitor.

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