Finding the balance in changing global environment

IT companies must identify niches, focus on shifting consumer tastes

Last year was a tough one for foreign technology companies in China. Slower economic growth, rising regulatory and legal pressure and preferential treatment of domestic competitors were some of the factors that posed daunting challenges for tech companies.

Indeed, some top executives spoke openly of scaling back their China operations or even leaving.

But that would be a mistake. With an accurate view of the market and the right strategy, there is still an opportunity for foreign information technology companies to play a major role in a country where the high-tech sector is increasingly important.

Slower growth

First, the bad news.

With third-quarter growth at 7.4 percent, the economy is expanding at its slowest rate since the 2009 financial crisis. Exports are lower than forecast and imports are down. Property prices are slumping. Bad loans continue to plague the banking system. And predictions for 2015 are no rosier.

On top of all this, tech companies, along with a considerable number of other foreign companies, have been the target of regulatory or legal investigations by the Chinese authorities.

One reason for this is the fallout from revelations by former US intelligence analyst Edward Snowden that some tech companies were involved in passing data to the US National Security Agency. That triggered widespread and understandable suspicion on the part of the Chinese government.

This past spring, in a blow to Microsoft Corp, China banned the Windows 8 operating system from government computers, citing security concerns. The move followed claims in the Chinese media that Windows 8 was a tool the NSA was using to collect information on China.

Media reports also said that the Chinese authorities were concerned about the security implications of the reliance of Chinese banks on IBM Corp's servers. And during the summer, State broadcaster China Central Television described Apple Inc's iPhone as a threat to national security.

New direction

As all this was going on, Microsoft faced a probe into allegations of price-fixing. There was a surprise inspection by Chinese government officials of Microsoft's facilities, with mail and other material being seized.

Chip producer Qualcomm Inc has also been investigated over its pricing procedures, and other companies have faced probes.

Meanwhile, the central government has made clear its desire to see Chinese companies rely more on the products of domestic tech companies.

The appeal is obvious: greater perceived security and lower costs.

One result is that domestic companies such as Huawei Technologies Co are increasingly winning contracts from the IT departments of Chinese businesses. Meanwhile, Alibaba Group Holding Ltd has moved away from using IBM servers, EMC Corp's storage and Oracle Corp's databases by developing its own products.

Changing tastes

Many foreign IT companies have not kept up with Chinese consumer tastes and usage patterns. One example is the hugely popular and lucrative icons offered for sale by Tencent Holdings Ltd's WeChat, the type of product that other competing services, such as What's App, do not offer.

On the face of it, this is enough to make any foreign IT executive consider giving up on China. And yet, for all the problems, the potential of the China market is still so vast that it is foolish to think about heading for the exit.

Technology needed

For one thing, there is the sheer size of the China market. For examples:

Beijing's IT spending is greater than for all of Mexico, which has a population of 122 million and GDP of $374 billion.

Guangdong's IT spending exceeds that of Sweden, a small but advanced country with GDP of $192 billion.

These numbers are almost certain to increase, especially as China's 13th Five-year Plan, which starts in 2016, will put heavy emphasis on advanced technology.

In particular, the government has made the development of "smart cities"－using information technology to address key urban problems and issues－a top priority.

This involves, for example, developing database and network systems to manage traffic or electricity grids, coordinate public services and make more information available to city managers and the public.

More broadly, the new plan will also promote greater use of the Internet of Things, which refers to the interconnectivity of everyday devices to make daily life easier and more efficient. Chinese leaders have already identified the IoT as a key industry and are looking to Chinese companies to take the lead in developing new technologies and products.

Interconnections among devices will expand geometrically with the still unsaturated growth of devices into China.

Many analysts believe that with its strong technology manufacturing base, China is poised to set the global standard in this area. One example: 80 percent of the world's smartphones are made in Guangdong province. The factories that produce them are well-placed to turn to products for the IoT.

Expanding e-commerce

On top of this has been the stunning growth of e-commerce in China. Alibaba, for instance, had $9.14 billion worth of transactions on just one day, which was Singles' Day on Nov 11. It is now the world's third-largest Internet company, after Google Inc and Facebook Inc.

What is next?

With so many developments on so many fronts, there is certainly a role for foreign IT companies in China. The challenge is to determine what that role should be. This means recognizing that China is not the same as it was a decade ago, and a business model based on simply selling pre-existing products to the Chinese market is not necessarily going to work.

Rather, the companies that identify openings in the changing landscape for innovative new products will have the best chance of success.

For example, China plans to have 95 percent of the country connected to broadband. It is estimated that by 2018, there will be 1 billion smartphone users.

But such growth in users may result in the actual online experience not being such a happy one, with slow connections, difficulties in downloading and widespread consumer frustration. A company that can develop technology to boost network connectivity, or strengthen the signal, will find big demand in a steadily expanding market.

Consumer focus

Foreign companies need to focus more on China-oriented research and development, to identify areas such as those noted where there are openings to be exploited. Many foreign companies complain that Chinese tech companies get favors from the government. But both the central government and Chinese companies are putting almost all their resources into the China market.

To succeed, foreign companies will need to heighten their own focus on China, to better understand the changes underway and how to take advantage of them

Partnerships critical

Success will also require partnerships to be forged with Chinese companies. For example, there is Intel Corp's $1.5 billion deal signed in September with Chinese chip producer Spreadtrum Communications Inc to develop and market new smartphone chips.

Such ventures lead to the sharing of technological expertise and accelerate the development of new products. And by having a local partner, they help protect foreign companies from concerns that they might pose a security risk.

In the coming years, China will increasingly be at the center of global IT development, both as a market and a creator of new products. Whatever the challenges, foreign IT companies should not walk away from the business opportunities offered by these trends.

The author Kitty Fok is managing director, IDC China.