Apple, Qualcomm and Microsoft learn the new cost of doing business in China

Phil Goldstein

China is the world's largest smartphone market by volume according to many research firms, including IDC, and tens of millions more Chinese consumers are likely to buy smartphones in the years ahead as both the middle class and LTE coverage there expands. That makes it an alluring target for companies like Google (NASDAQ: GOOG), Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), Qualcomm (NASDAQ:QCOM) and others.

Yet over the past month or so all of those companies has either acknowledged or has had to deal with pushback from Chinese regulators or Chinese state-run media. To me, it's clear that the cost of doing business in China is going up--but the cost of missing out on a growing smartphone market as large as China is even higher.

Here's a quick primer on some of the latest developments:

  • On June 25 Google unveiled its Android One initiative at its I/O developer conference. The program is designed to provide a software and hardware reference design to smartphone makers that Google said will help lower the cost of developing and making Android phones. Google will unveil Android One hardware made by Micromax, Karbonn and Spice in India later this year. Perhaps just as importantly, Google is also making sure Android One phones will run stock Android software and get automatic updates and access Google's Play Store for apps and media content. That's a marked contrast to Google's strategy in China, where it does not promote is Play Store. Google largely gave up on controlling the Chinese Android experience when it decided not to operate its search engine in mainland China. That has opened the door for Android device makers to use Chinese search engines and third-party app stores. With Android One, Google is working to avoid this scenario in India and other emerging markets.
  • On July 11, Chinese state media said Apple's iPhone posed a threat to national security because of the smartphone's ability to track and record user locations. A report by broadcaster CCTV on Friday criticized the iPhone's "Frequent Locations" feature for allowing users to be tracked and potentially to have their private information compromised. Apple responded immediately to defuse the situation and maintain its China business. The company said in a statement that it is committed to protecting the privacy of its users, and that no unique user or device information is transmitted when using the location functions, according to Reuters. Despite the dustup, Apple CEO Tim Cook said he is bullish on China, and called this year's FDD-LTE rollouts there "another big opportunity."
  • On July 24, the state-run Securities Times newspaper reported that China's antitrust regulator concluded that Qualcomm (NASDAQ:QCOM) commands a monopoly in the Chinese chipset market. However, it's unclear whether the regulator has decided that Qualcomm has abused that position for its own gain. The allegations could eventually lead to record fines against Qualcomm of more than $1 billion. The probe has also made it tougher for Qualcomm to strike new LTE licensing terms with Chinese manufacturers, just as Chinese operators are rolling out TD-LTE and FDD-LTE services. The investigation could give carriers and device makers leverage in those negotiations.
  • Earlier this week Chinese regulators raided Microsoft's offices in four cities and confirmed an investigation into whether Microsoft has violated the country's anti-monopoly laws. "Microsoft complies with the laws and regulations of every market in which we operate around the world," the company said in a statement Tuesday. "Our business practices in China are designed to be compliant with Chinese law." Even before the probe, Microsoft CFO Amy Hood said earlier this month the company was seeing "challenging conditions in China or like many other multinationals we're experiencing a weak business environment which we do not expect to change in the near term."

So what's behind all of this? It's difficult to say, but the flurry of action against U.S. tech companies does not appear to be coincidental. In 2012, the U.S. government effectively blocked Huawei and ZTE from the U.S. network equipment market over espionage concerns, which the companies have consistently called baseless. Then, earlier this year, Edward Snowden helped expose attempts by the U.S. National Security Agency to hack into Huawei's servers, and its efforts to monitor the Chinese vendor. And then in May of this year, the U.S. government indicted five members of the Chinese People's Liberation Army and charged them with hacking into the networks of U.S. companies.

Some believe China's recent moves against U.S. technology companies is part of a larger strategy by the country to counter the U.S. government's actions. China is "playing a long game," said Duncan Clark, the Beijing-based chairman of BDA China Ltd., which advises technology companies, according to Bloomberg. He said China is working in part to promote its domestic competitors.

"Whether or not it's concerted, it certainly has that appearance," IDC analyst John Jackson said of China's recent actions. "It's safe to assume in diplomatic back channels the causality is well known."

However, Jackson said if this is an attempt by China to get its domestic wireless and tech companies--Alibaba, Huawei, Spreadtrum, Xiaomi, etc.--to expand more internationally and step up their game, it "would seem to be a strange way to go about animating that."

Ultimately, both sides should realize that a trade war benefits no one in the long run. "We have this tension, and that tension never goes away," Jackson said. "The resolution is going to lie somewhere between mutual advocacy or lobbying on the part of Chinese and Western multinationals with the recognition that more open access to each other's markets is a good thing. And [there needs to be] a political resolution as well."

Based figures from IDC and China's Ministry of Industry and Information Technology, China accounted for close to 35 percent of all smartphone shipments worldwide during the first half. With that huge potential market, U.S. companies are going to have to endure slights and investigations. There's simply too much money on the table. For now, this is the cost of doing business in China. --Phil