Decoupling from China

Since 2020 the landscape for business globally has been redefined. Weaknesses on a global level have been exposed, from failures on the governance front to frailties in supply chains and human resource practices that needed to be adjusted. It has also provided a strong contrast in examples of what constitutes great partnerships, whether it be political or economic, and while these partnerships have empowered some, it has brought the shortcomings of others to the forefront. This is true especially for those who have any businesses or commercial prospects in China. In this article we take a look at whether more foreign companies will consider decoupling from their Chinese entity and the reasons for this becoming a more prominent reality.

The Mounting Challenges

While it has always been seen as a tough market to operate in, over the past decade it has been an extremely lucrative one, for those who got the criteria right. However, the Chinese economic environment, which had experienced a boom right after the early stages of the pandemic, is now also appearing to be impacted, with the effects looking to remain for the short to medium term.

With a sturdy political stance, a reduced growth rate, the property bubble crisis, travel restrictions and relentless COVID-19 restriction measures, doing business in China has become an uphill battle, especially for foreign owned enterprises in the region.

Regulatory Changes

In September 2021, China’s Data Security Law came into effect (read more about this), which had an unsettling effect on many of the foreign companies that operate in the country. Over the past 2 years we have seen more international companies decouple from the market due to what they call an increasingly challenging operating climate.

The background of the data security law and whether data can be sent out of China or whether Chinese authorities can have access to sensitive data from foreign companies is at the forefront of large-scale foreign companies decoupling from China. High-profile examples of this can be seen in cases with Microsoft’s LinkedIn and the Nike Running App, which have both exited the Chinese market and opted to leave behind a more localized version of their products, separate from their overseas entities.

The concern from foreign businesses around the changing regulatory environment, especially regarding intellectual property rights (IPR), is not a new one and over the next year we are likely to see more businesses opting to decouple and isolate their Chinese entity.

Re-configuring Supply Chains Outside of China

Another major reason companies are reducing their reliance on China is due to supply chains. Over the past 2 years we have seen the impact of the COVID-19 pandemic and other incidents such as the Suez Canal blockage, which have had major effects on global supply Chains. China’s reaction to the pandemic and subsequent implementation of the zero-COVID policy heavily impacted production and manufacturing, which was also accompanied by the backlog in logistics.

With travel restrictions still in effect and sporadic lockdowns still occuring across the country, companies with large parts of their supply chain based in China face the risk of their supply chain being affected.

However, while many companies may be considering moving parts of their manufacturing to other countries in the Asia-pacific region, this is not detrimental to the Chinese economy in the short term for 2 main reasons. The 1st is that even though companies are re-configuring their supply chains, it will be extremely difficult to move their entire manufacturing operations out of China, due to a lack of infrastructure in other countries and less familiar regulatory policies. The 2nd reason is that China is wants to change from a manufacturing-based economy to a consumer-based economy, therefore a gradual shift away from manufacturing is not unexpected.

Continual COVID Restrictions

In March of this year, we saw Shanghai and other cities across China go on city-wide lockdowns which affected the lives and businesses of all people in these cities. The effects extended beyond the cities and had also impacted global supply chains. Many businesses based in China have not made a full recovery, with some still feeling the effects of the on-going policies.

While more countries are learning to live alongside the Coronavirus and strive to adjust to the new conditions, China’s lockdown policy which aims to mitigate the risk of its citizens, continues to negatively impact businesses and the economy.

With the travel restrictions and quarantine periods still being enforced, travellers have been obstructed from visiting China for more than 2 years. With constant flight cancellations and less than ideal quarantine measures, companies have had trouble with a large number of executive level expatriates leaving and not being able to send willing replacements. This not only impacts on the interpersonal relationships that underpin good business partnerships but also creates an air of less visibility on the China-side of business operations.

Other Reasons Businesses are Moving Out

While the specific cases and reasoning for limiting activity in or decoupling from the Chinese economy will vary from company to company, foreign businesses across multiple sectors are reducing their reliance on China and the Chinese market.

The European Business in China Business Confidence Survey 2022 (BCS), which is conducted by the European Chamber of Commerce in China, showed that despite businesses achieving a revenue increase in 2021, 60% of respondents indicated that it is becoming more difficult to do business in China year-on-year.

Enhanced Focus on ESG

The focus of the Environmental, Social and Governance (ESG) framework both in Europe and North America will also impact on doing business with China. The focus of ESG on themes like reliable supply chains and stable employment has helped to address critical challenges related to the COVID-19 crisis and has shown the importance of resilient investment and management approaches. Organizations are being asked to report at executive and board level with regards to outcomes with regards to ESG implementation.

The challenges around a sustainable and stable supply chain are ones that many organizations are having to grapple with, with some interesting outcomes as a result. Companies are looking to diversify suppliers, finding alternate suppliers closer to home; or looking towards localization and innovation.

Lack of Transparency

Further challenges are highlighted by The European Commission on the EU-China trade agreement including the lack of transparency along with some tariffs and industrial policies, which make it difficult for foreign owned companies to compete in China. There is also the unfair advantage that state owned entities have over their foreign competitors, such as access to certain preferential policies and a less limited business scope, which has always been difficult for foreign enterprises to navigate.

As globally there is currently a negative outlook mainly due to geopolitical tensions, it has become increasingly important to safeguard financial recovery and revaluate operational strategies.

Final Thoughts

Looking for prospects outside traditional boundaries and leveraging all the knowledge and skills available to an organization has become essential. Making the best decision for the business, whether this is looking to other emerging economies or restructuring and  re-aligning with Chinese partners to sustain operations, businesses should act now to ensure stability.

MSA can guide your company through China’s complex regulatory business environment. With over a decade of experience supporting clients to set up, restructure or re-evaluate their business needs, our experts are well-trained in all aspects of doing business in China. Get in touch with us immediately so that we can provide aid for your business.