What U.S. Businesses Should Consider Before Expanding In China

This week's announcement by the International Monetary Fund that China's yuan is "no longer undervalued" may shake up the political debate in Washington (where playing the China card is back in vogue), but this news is unlikely to make an impact on the short and medium-term forecasts of the Chinese market. China watchers have seen slowing growth on the mainland for months. Change is coming for Western companies operating in that market, including an increasingly hostile business climate. Multinationals may soon start voting with their feet.

Eamonn Fingleton, author of the book In the Jaws of the Dragon, gets it exactly right: in China, real power is based on the principle of "selective enforcement." Laws are strictly written, but are only enforced selectively by communist-controlled courts and party functionaries. Essentially, a law is enforced strictly if it suits the authorities, or casually if it does not.

Fingleton highlights China's selective enforcement vis-a-vis Qualcomm, the U.S. chip maker. In February, under selectively enforced antitrust laws, Qualcomm was fined $975 million -- a fine that whacks 58 cents a share off the company's earnings for this year. The tactic has been called "something awfully close to legal extortion" and is widely recognized as an ill-disguised play to open up market share for local competitors. Without a doubt, this move is a significant step in China's plan to be the chip industry's global leader by 2030.

Microsoft's pirated software is sold in stalls around Tiananmen Square for just three dollars per disk, and formal complaints by the company are frequently ignored. Last year, Microsoft was the victim of a similarly dubious antitrust crackdown; its offices were raided, and documents seized by Chinese officials. Intellectual property experts have exposed this as yet another example in the pattern of selective enforcement and IP theft, noting the "greater reliance of Chinese companies on the antitrust rules, particularly when bargaining for lower royalties and license fees." Annual losses caused by the theft of the intellectual property of American companies, 50-80 percent of which occurs in China, is estimated at more than $300 billion. As a cost of doing business, this may soon become too much to bear.

China's market aggression isn't limited to the IP-heavy software industry, however; selective enforcement and market-share appropriation spills over to other sectors as well. Perhaps the most egregious non-tech example is that of OSI Group, a major U.S. food processing company.

Last year, two reporters of government-owned Dragon TV were hired by Husi Foods, the Chinese subsidiary of OSI Group. Hiding their affiliation with Dragon TV, the reporters worked at Husi's Shanghai plant for two months, one ultimately filming the other dropping meat on the floor. The staged video was then aired on Dragon TV.

Based on Dragon TV's "investigative report," regulators raided the plant on July 20, 2014, arresting six Husi employees. The Shanghai Food and Drug Administration alleged that Husi sold expired meat to its Chinese customers, including food chains like McDonald's and YUM! Foods. The arrested Husi employees are still being interrogated -- incommunicado in an unnamed jail -- with no formal charges brought against them. The government-orchestrated incident cost OSI Group hundreds of millions of dollars.

The Chinese authorities make no bones about their objectives in such cases. China's Internet czar, Lu Wei, said that foreign companies should not expect to simply make money in China without being its "friend." That translates to making investments, contributing intellectual property, licenses, know-how, and politely toeing the party line.

U.S. companies considering expansion into China should begin strategic planning with the clear understanding that they risk explicit targeting of their intellectual property, business secrets, and market share. The enormous and growing Chinese consumer class is a tempting target for any Western company - but pursuing it while remaining profitable will become much more challenging in the evolving Sino-business climate. Meanwhile, Western companies already present on the mainland face the prospect of having their intellectual property looted, and of being slammed with fines and ruinous regulatory actions. They must take these mounting risks into account when evaluating the future viability of operating in China.