Microsoft aspirations in China meets perilous climate

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Ralph Haupter, left, chief executive officer of Microsoft Corp.'s greater China region operations, and Steven Sinofsky, then president of Microsoft's Windows division, attend a promotion event of the new Windows 8 software in Shanghai in this Oct. 23, 201 Ralph Haupter, left, chief executive officer of Microsoft Corp.'s greater China region operations, and Steven Sinofsky, then president of Microsoft's Windows division, attend a promotion event of the new Windows 8 software in Shanghai in this Oct. 23, 201

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Microsoft Corp. joins a growing list of companies relying on growth in China yet crashing against the reality of a market still prone to protectionism, unpredictable laws and unreliable suppliers.
Just this month, Chinese regulators opened an anti-monopoly investigation into Microsoft and state media accused Apple Inc. (AAPL) of using its iPhone to steal state secrets. In May, Chinese authorities alleged GlaxoSmithKline Plc (GSK) sales people bribed doctors and hospitals to boost sales.
Foreign companies from many industries are increasingly encountering the challenges of doing business in China -- whether from efforts by Chinese officials to give homegrown businesses a leg up or in response to a U.S. crackdown on the country’s alleged theft of corporate secrets. As a result, China has dropped from the top investment priority for members of the U.S. Chamber of Commerce to the top 3 said Jeremie Waterman, the chamber’s executive director for greater China.
“Views of the market are clearly undergoing a transition,” said Waterman, who’s based in Washington. “The environment is arguably growing more difficult.”
Annual Chinese investment in the U.S. now exceeds American foreign direct investment flows to China, according to the Rhodium Group, a New York-based consultancy.
Through the first five months of the year, foreign enterprises invested $48.9 billion in China, up 2.8 percent from the same period one year earlier. Investment from the U.S. fell more than 9 percent while the European total dropped by 22 percent, according to the Chinese Ministry of Commerce.
Battling corruption
The worsening business environment coincides with efforts by President Xi Jinping to tighten his grip on power and show ordinary Chinese that he’s serious about battling official corruption. Yesterday, Beijing announced an official investigation into the nation’s former security czar, Zhou Yongkang, who is the loftiest official to be probed for graft since the Communist Party took power 65 years ago.
It’s not that U.S. companies have lost their appetite for the world’s second-largest economy. China is a $300 billion market for U.S. firms that will get even larger as the middle class doubles to 600 million in the next decade, according to the U.S.-China Business Council, which counts Wal-Mart Stores Inc. (WMT) and Apple among its more than 200 members.
And despite the worsening climate, most companies have no choice but to stay in a growing market of 1.4 billion people, said Robert Atkinson, president of the Information Technology and Innovation Foundation. For some, China is a production hub where products are assembled for the global market. For other companies, China’s growing consumer class represents the growth market of tomorrow -- however difficult it is to operate there.
‘Can’t walk’
“It’s hard for them to walk away,” Atkinson said. “They just can’t do that with China.”

Employees work inside Microsoft Corp.'s China headquarters in Beijing, China.
Still, growing strains between Beijing and Washington are shadowing U.S. commercial interests. In May, American prosecutors indicted five Chinese military officers for allegedly stealing corporate secrets. Since then, Chinese state media have criticized Microsoft, Google Inc. and Apple for allegedly cooperating with a U.S. spying program; Qualcomm Inc. in November disclosed an anti-monopoly investigation.
China is also asserting itself economically while the U.S. is distracted by the Israeli-Palestinian conflict, instability in Iraq, tensions over Ukraine and other geopolitical hotspots, said Richard A. D’Aveni, a professor of strategy at the Tuck School of Business at Dartmouth College in Hanover, New Hampshire.
Pulling plug
Amid rising wages and growing barriers to doing business, some companies are doing the once unthinkable: pulling the plug. L’Oreal SA (OR), the world’s largest cosmetics company, said in January it will stop selling Garnier-brand products in China, eight years after it introduced the skincare and hair dye maker in that country. L’Oreal will focus on marketing the L’Oreal Paris and Maybelline brands there. Revlon Inc. will cease operations and eliminate about 1,100 positions in the country, the New York-based company said Dec. 31.
Actavis Plc, the second-biggest generic drugmaker by market capitalization, also has said it will end its presence in China because of the difficult business climate. The company has sold one operation there and is in talks to sell another.
“It is not a business-friendly environment,” Actavis Chief Executive Officer Paul Bisaro said in January at the JPMorgan Chase & Co. health-care conference in San Francisco. “If we’re going to allocate capital, we’re going to do so where we can get the most amount of return for the least amount of risk. And China is just too risky.”
Vietnam footwear
The beneficiaries will be countries like Vietnam for footware, India for soft goods and Mexico for manufactured hard goods such as metal assembly, said Foster Finley, head of the supply chain practice at AlixPartners LLP. By next year, the consulting firm estimates it will cost about the same for a U.S. firm to manufacture in America as in China.
Those that have elected to stay are facing an increasing barrage of officially sanctioned criticism. In October, China’s state-controlled media accused Starbucks Corp. (SBUX) of charging too much for coffee and said Samsung Electronics Co.’s smartphones don’t work properly. Samsung later apologized to Chinese customers and offered free maintenance. Starbucks received an outpouring of consumer support after the reports.
This month, Apple denied a report on China Central Television that iPhone software steals state secrets. Last month, a commentary on the microblog of the People’s Daily website said Apple, Microsoft, Google and Facebook Inc. (FB) cooperated in a secret U.S. program to monitor China.
Financial security
China is reviewing whether domestic banks’ reliance on high-end servers from International Business Machines Corp. (IBM) compromise the nation’s financial security, people familiar with the matter said in May. IBM said at the time it wasn’t aware of any official policy recommending against the use of its servers by banks.
This week, a Chinese TV station reported that a local subsidiary of OSI Group, a U.S. food-service company, was selling expired meat. OSI apologized and started an investigation but lost Yum! Brands Inc. (YUM), Starbucks and Burger King Worldwide Inc. as customers.
The Microsoft investigation took the Redmond, Washington-based company by surprise, according to a person familiar with the situation. Before the State Administration for Industry and Commerce raided the company’s offices, the two sides were holding productive conversations, said the person, who asked not to be identified because the talks were private.
Consumer economy
Many Western companies are clinging to the hope that new opportunities will materialize as China attempts a historic shift from an export-fueled economy to a more U.S.-style consumer economy. Yum Brands plans to open 700 new restaurants this year, including KFC and Pizza Hut outlets, as it expands into lesser-known cities in the Chinese interior.
“We’re still on the ground floor with constant, aggressive expansion ahead,” David Novak, Yum Brands’ CEO, told investors this month. “The macro trend we remain most enthusiastic about is the large and growing consuming class.”
U.S. automakers remain bullish on China. General Motors Co. said its second quarter sales in the country rose 8.1 percent to 812,170 vehicles, while Ford Motor Co. reported a 21 percent increase to about 362,000 autos. Tesla Motors Inc. started selling its Model S luxury electric car in China in April and, according to analysts, may have delivered as many as 1,000 on its way to a record quarterly volumes.
Indigenous innovation
All the sanguine pronouncements by Western companies are tempered by the knowledge that China is bent on supporting local industry. Since 2006, Beijing has pursued a policy of indigenous innovation, aimed at promoting home-grown technologies and eventually scrapping it reliance on foreign firms. Inspur Group Ltd. is building a server business to compete with IBM; Lenovo Group Ltd. has become the world’s biggest personal-computer maker; and Xiaomi Corp.’s smartphones attract devotion reminiscent of Apple product unveilings.
“Economics in China are tools of government power, it’s state capitalism, not free-market capitalism,” said D’Aveni of Tuck. “The Chinese understand the old joke that a capitalist will sell you the rope you plan to hang them with.”

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