China’s Tech Industry: Why So Bleak?

A close look at China’s tech sector shows that it might be facing a bleak future ahead. (Image via  pixabay  /  CC0 1.0)
A close look at China’s tech sector shows that it might be facing a bleak future ahead. (Image via pixabay / CC0 1.0)

When China announced its ambitious Made in China 2025 plan, President Xi must have envisioned a future where Chinese companies would dominate the global tech industry the same way U.S. firms have done for the past several decades. But a close look at China’s tech sector shows that it might be facing a bleak future ahead.

Increasing costs

Tech companies in China are battling with a big financial problem — rising costs. And unfortunately, the revenues are not keeping up to maintain profitability in the industry. This one-sided increase in costs means that companies will have fewer profits for reinvestment and will have to resort to external funds to support operations, a move that will plunge businesses deeper into debt.

One of the biggest companies in China, Alibaba, released its second-quarter earnings recently, declaring a 61 percent growth in revenues. However, the company had bought other businesses in a bid to show increased revenues. And this investment of large funds to acquire other businesses resulted in sharply lower operating margins for the company. While the operating margin for December 2017 stood at around 31 percent, the operating margin for June 2018 fell to a dismal 3.2 percent.

One of the biggest companies in China, Alibaba, recently reported operating margins were sharply lower. (Image: Rico Shen via wikimedia CC BY-SA 4.0)

One of the biggest companies in China, Alibaba, recently reported operating margins were sharply lower. (Image: Rico Shen via CC BY-SA 4.0)

The same problem was seen with the Internet portal Sina. Though the business declared a growth rate of 50 percent in the recent quarter, the hard fact is that sales and marketing expenditures in the same period climbed by 120 percent. And anyone with a basic understanding of finance will get that those numbers are not at all good, especially considering that the marketing budget of the company has already exceeded revenues for several previous quarters.

Companies like Tencent, NetEase, and so on are also facing the same issue of uncontrollable costs. And the U.S. crackdown on Chinese companies is definitely not helping to bolster the spirit of economists in Beijing.

U.S. crackdown

The U.S. is coming down heavily on several Chinese companies after intelligence reports suggested that they pose a security risk. While some firms have been permanently banned from operating in the U.S., a few others have had to pay heavy fines to compensate for illegal activities.

Telecommunication firm ZTE had to pay a hefty amount in fines to avoid being barred from selling in the U.S. after an investigation showed that the company had circumvented U.S. sanctions on Iran and North Korea. President Trump had prevented Qualcomm’s takeover to avoid China getting an advantage in developing and deploying 5G technology. The U.S. also warned its citizens to avoid using Huawei phones because of security risks.

Even Lenovo, which has an excellent global reputation, had to offer a settlement to the U.S. for shipping laptops that had malware installed in them. The company had released a statement promising to adhere to the high quality of business expected from them.

However, Lenovo has also been linked to espionage efforts on behalf of the Chinese government. As such, the firm is closely monitored by U.S. intelligence agencies just like all other high profile Chinese companies, which makes the future prospects unclear for the company.

Lenovo has also been linked to espionage efforts on behalf of the Chinese government. (Image via pixabay / CC0 1.0)

Lenovo has also been linked to espionage efforts on behalf of the Chinese government. (Image: via pixabay / CC0 1.0)

Unless Beijing is able to convince the U.S. to trust them and allow its businesses to operate freely in the United States, the increasing crackdown on Chinese tech firms will definitely impact profitability and even threaten the existence of many businesses.

But this will require the Chinese Communist Party to relax its authoritarian functioning and to become more transparent on the international stage. Unfortunately, that is something that won’t happen, as it is against the nature of the Chinese Communist Party. So, considering the declining operating margins and the U.S. crackdown on technology companies, the future of the Chinese tech industry certainly looks murky.

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