Ominous clouds on China’s tech horizons

Chinese companies as varied as Tencent, Huawei, Baidu, Alibaba, and Xiaomi not only dominate China’s internet, e-commerce, telecommunications, and smart device industries but have become major players on the global stage. With the pandemic now ebbing in China, there is hope in some quarters that its tech industry will lead the nation in a swift recovery.

But not so fast.

Like the mythical ouroboros or ancient dragon that in a circular depiction eats itself tail-first, the state-enterprise model that is central to China’s 40 years of economic growth is at risk of self-destruction.

While Chinese tech companies should be credited for hard work and smart strategies, their decades-long success is largely a function of their unique governance model. Whereas most Western business and government policy makers view China’s companies as independent, multi-billion-dollar enterprise, they fail to appreciate that what they see is only the nose of a  multi-trillion-dollar beast. As we describe in our just-released book, “Enterprise China,” Chinese companies are part of an entire ecosystem of companies tied together by the largest entity on the planet (by employment — the second-largest by revenues): the Chinese State.

Although Beijing no doubt plays a prominent role, the central government is only part of the state picture, capturing 45 percent of total state revenues in 2021. Often overlooked are the powerful provincial and municipal governments, which took in 55 percent of all fiscal revenues ($1.74 trillion in total) in 2021. As an example of the weight that municipalities can bring to the party, consider the city of Shanghai’s $1.5 billion fund to “nurture” tech companies, which includes taking equity positions in start-ups.

Enterprise China consists of the roughly 150,000 state-owned enterprises. Collectively, these bring in over $9.8 trillion in revenue, and constitute 61 percent of all Chinese firms on the Fortune Global 500 list. Their economic production is about the same as the nominal GDP of Germany and larger than the economies of India and France.

But the observant reader might note that many of the companies we listed at the beginning of this article — such as Alibaba — are not technically state-owned. While not state-owned, the state nonetheless often has small ownership holding, through which they gain owner’s rights. Over the last eight years, Beijing has been actively acquiring minor — often limited to 1 percent — shares, through “special management shares,” of Chinese tech giants like Alibaba, Tencent and ByteDance. However, even when the state owns none of the entity’s shares that does not mean that the company is independent and free of state influence.

One unique mechanism of influence is that all Chinese companies with more than 50 employees must have a Communist Party representative on site. This oversight does little to foster experimentation, the lifeblood of innovation. The fact that most of Huawei’s impressive advances in 5G have come from its tech centers outside China underscores the challenge of innovating inside China.

The willingness and ability of the Chinese state to exercise influence over private technology companies is illustrated through two high-profile cases. The first is Alibaba. In 2020, Alibaba’s market capitalization peaked at $665 billion. Its founder, Jack Ma, had an estimated net worth of $50 billion. As part of Alibaba’s ecosystem, Ma developed ANT Financial, which was set for an IPO that would have brought in $35 billion. This would have made it the largest IPO in history, valuing ANT at $315 billion, more than Société Générale, Deutsche Bank, Credit Suisse, Barclays, ING, Santander, and Goldman Sachs combined.

Then Ma made fateful comments about the government stifling innovation and needing to reform the country’s financial system. He was called in for questioning and subsequently disappeared for many months; the IPO was halted, Alibaba fined, and its share price plummeted by two-thirds.

A similar disappearing act is playing out today with tech king-pin Bao Fan, the founder and chairman of investment bank China Renaissance. Boa was behind the start-ups and public listings of many of China’s most successful tech companies. Then, he too went “missing,” as reported by his company. Chinese media reported that he was summoned for questioning by investigators looking into the behavior of one of his senior executives. He hasn’t been seen since.

Perhaps Boa was too slow in reading the tea leaves. Others, including Colin Huang, chairman of e-commerce company Pinduoduo, and Zhang Yiming, founder of TikTok, got out early, both separately announcing in 2021 that they would be stepping down to “try new things.”

China’s crackdown has sent shivers through its tech companies, resulting in an estimated decline of $1.2 trillion in market cap. The message is clear: Even though the state may not own you, it will play a central role in your strategic decisions … and in the tradeoff between political exigence and economic benefit, politics will prevail.

Two decades of research has well documented that the organizational culture changes and the new leadership capabilities required to successfully transform a company from imitation and expropriation to creation and innovation are staggering. To be clear, the question goes not

to the intelligence of Chinese businessmen or their innate ability to innovate. This is not in doubt. The question goes to the culture and systems needed to bring out, foster, and support the transfer of that intelligence and creativity into market-ready innovations.

Under the Enterprise China model, the state and business co-exist in a symbiotic partnership. Xi Jinping’s crackdowns on tech companies has shifted the balance strongly in favor of the state and risks choking the engine of the country’s long term economic ambitions. As a consequence, China’s much-anticipated return after the pandemic slump will likely be short-lived at best.

Those preoccupied with Chinese state interference in elections should take note. When the state oversteps its bounds, the story rarely ends well. Such will certainly be the case for Chinese technology companies. 

Dr. Allen J. Morrison is a Professor of Global Management at Thunderbird School of Global Management at Arizona State University and former professor and associate dean at the Ivey Business School at Western University. He has authored over 60 articles and case studies, and 13 books. He has also served on the board of directors of a NASDAQ-listed Chinese technology company.

Dr. J. StewartBlack is the chief strategy officer at Squire Patton Boggs and adjunct professor of Global Leadership at INSEAD. He is also a keynote speaker, consultant, researcher, and author of 20 books. He has published many articles for executives in Harvard Business Review, Sloan Management Review, and Business Horizons.

They are co-authors of the new book “Enterprise China: Adopting a Competitive Strategy for Business Success”