US Tech Companies Raked Over The Coals In China

China is the promised land for our revenue-challenged American tech heroes: 1.2 billion consumers, economic growth several times that of the US – if we could believe the GDP numbers – and companies splurging on IT equipment and services.

Layer on top of that the “cloud,” the vast high-growth segment with its thousands of datacenters around the globe connected by fiber-optic cables, and managed, searched, and analyzed by ever more powerful software products. Much of our personal data resides in the cloud. It got there via Facebook, Twitter, photo-sharing apps, online backups, email, smartphone apps, license-plate scanners, and the like. More and more corporate and government data resides in the cloud. Increasingly, software is sold as a service and is based in the cloud. American tech companies dominate it and expect to retain that dominance in the future.

The cloud business in China is corporate nirvana: a high-growth sector in a high-growth country. Or rather, it was nirvana, now that Edward Snowden’s revelations about the NSA’s hyperactive surveillance practices have spilled out. Core element of his revelations: prodigious hand-in-glove cooperation of American tech companies, from giants down to startups, with a munificent “customer,” the Intelligence Community [my take… NSA Pricked The “Cloud” Bubble For US Tech Companies].

Now IBM, Oracle, and EMC have become targets of China’s Ministry of Public Security and the cabinet-level Development Research Centre. That’s what an anonymous source told the Shanghai Securities News, a branch of the state-owned Xinhua News Agency, which reports to the Propaganda and Public Information Departments of the Communist Party. “Anonymous sources” on these issues aren’t quoted in the Shanghai Securities News by accident.

“At present, thanks to their technological superiority, many of our core information technology systems are basically dominated by foreign hardware and software firms, but the Prism scandal implies security problems,” the source said, according to Reuters. So the government would launch an investigation into these security problems.

Total stonewalling followed. IBM told Reuters that it was unable to comment. Neither Oracle nor EMC were available for comment. The Ministry of Public Security refused to comment. The State Council’s Development Research Centre claimed it wasn’t involved any such investigation. The Ministry of Industry and Information Technology told Reuters that it “could not confirm anything because of the matter’s sensitivity.” Another MIIT official wasn’t aware of anything.

Accusations of hacking into sensitive systems have been ping-ponged between the US and China for years. As evidence piled up that a lot of hacking from the Chinese side originated in facilities associated with the People’s Liberation Army, denials fell on deaf ears in the US where the government claimed the improbable moral high ground.

So Snowden’s revelations about the NSA hacking into Chinese systems proved to be, among other things, embarrassing. Now all plausible deniability was out the window. And China is counterattacking. Losing its secret commercial and governmental crown jewels would certainly be on top of its worry list. Hence a new leeriness about American IT equipment, software, and services – a boon for Chinese IT companies, which, like their beleaguered American brethren, have faced stagnating revenues.

Last October, the US House of Representatives Intelligence Committee – the very entity that had been briefed about and had condoned the now leaked NSA surveillance programs – determined that Huawei, China’s dominant telecom and networking equipment maker whose largest customer is the Chinese government via its state-owned enterprises, posed a threat to US national security. The Committee then curtailed Huawei’s ambitions to gobble up US companies and hawk equipment to US carriers.

Now China is turning the tables – to benefit its own tech companies. Huawei could certainly use some help. Growth for the erstwhile high-growth company has stalled. In 2012, revenues of 220.2 billion yuan ($36 billion) were up a measly 3.3% from 2011. Its smaller sibling, ZTE, with revenues of 84 billion yuan in 2012, lost 4.2 billion yuan that year.

So the Chinese government is going to make life harder for US tech companies. There will be “investigations” and plenty of rhetoric in the media to add to the revelations Snowden has offered. Reluctance by Chinese companies to buy US tech products is already showing up in the numbers. During Cisco’s earnings call last week, when the company lowered its revenue forecast, CEO John Chambers revealed that product orders in China, instead of growing rapidly, had skidded 3%! And that was just the beginning.

In China, being such a new market, the smaller issue in dollar terms is losing existing customers – in Cisco’s case, only 5% of its business is currently in China. The larger issue: China was precisely where a big part of the growth was supposed to come from. Now it won’t. IBM, which reported falling revenues, and Oracle which reported stagnating revenues, are counting on China. EMC reported growing revenues in the region, though it didn’t break out China, where it isn’t a big player. Dell, which made the headlines last week in the Snowden scandal, reported stagnating revenues in China and declining revenues in its cloud business. And going forward, it will be harder for them to compete in China.

As has been the case with pharmaceutical companies in China, investigations, after they take off, tend to entangle more and more foreign companies – in tech’s case, to crack down on data security and to give Chinese companies a leg up. For our already revenue-challenged tech companies, the hoped-for growth opportunities in China are fizzling.

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