Companies Try New Strategy to Stay in China: Siloing
As tensions rise between Washington and Beijing, firms seek to wall off China businesses
June 25, 2023
BEIJING—More Western companies are siloing parts of their businesses in China as they try to lower risks from tensions between Washington and Beijing.
is shifting to a model in which it relies on a local partner to operate some of its products and services there, effectively isolating its China business from its global operations.
Volkswagen VOW -0.56%decrease; red down pointing triangle
is planning to keep technology it is developing with a Chinese chip maker inside China, so that it won’t be badly affected if the technology ever comes under Western scrutiny or gets targeted by U.S. sanctions.
Lixil 5938 -2.13%decrease; red down pointing triangle
, a Japanese bathroom product maker whose brands include American Standard and Grohe, is reorganizing its supply chain to make products for China in China, and products for the U.S. largely in North America.
Such moves don’t go as far as venture-capital firm Sequoia Capital, which recently said it would fully separate its China and U.S. businesses by March 2024.
But they still help companies wall off China activities in ways that could keep problems from spilling over into their global operations if U.S.-China relations worsen.
“They are preparing for a long haul of U.S.-China tension,” said Xiaomeng Lu, a director at risk consulting firm Eurasia Group focusing on geopolitics and technology.
Some Western companies are seeking alternatives to China, including by shifting supply chains to places like India or Vietnam.
The move to silo operations in China is different. It lets companies stay present so they can keep selling into the country’s giant market, with less potential downside if the U.S. imposes more sanctions on China, or Beijing retaliates against Western businesses.
Some measures, such as setting up different supply chains for the U.S. and China markets, could be costly, and still not totally shield companies from losses if a more serious conflict erupts.
“The additional cost of trying to create two separate value chains could simply be unacceptably high,” especially for smaller firms, said Jens Eskelund, president of the European Union Chamber of Commerce in China.
Still, a survey by the Chamber released Wednesday found that 27% of 480 member companies experienced decoupling between headquarters and China operations over the past two years, up 7 percentage points from the previous year. Impacts from decoupling included developing separate information technology or data storage for China and the rest of the world, according to the survey, conducted in February and March.
Western companies have other reasons to localize or isolate their China businesses. Doing so can make companies more responsive to local markets and better able to fend off competition from homegrown Chinese rivals.
Companies also face tightening Chinese data-security requirements that are forcing them to ringfence data-storage in the country. While the rules have been getting stricter for years, some changes—such as a provision granting Chinese authorities power to review data transferred overseas—only fully kicked in recently.
Instead of running its own data centers in China, Salesforce, a business-software provider, decided to partner with Alibaba Cloud, China’s biggest cloud service operator and a unit of e-commerce giant Alibaba Group Holding, to provide the service.
The partnership, which officially began before the pandemic, has been expanding to include offering more localized products for China, hosted on Alibaba Cloud. That arrangement helps separate China from the rest of Salesforce’s global business.
Some of Salesforce’s global products aren’t available on the Alibaba Cloud platform, an omission that has led some customers to leave in search of local alternatives, people familiar with the matter said.
Last summer, Salesforce laid off staff in mainland China and Hong Kong, according to the people, and closed its Hong Kong office.
A Salesforce spokesperson said the company was restructuring its business to better serve the region, opening new roles while eliminating others, and would have more services available to customers later this year.
Other companies are siloing technology they use or develop in China.
Last year, Volkswagen’s software subsidiary invested $1 billion in Horizon Robotics, a Chinese automotive software and chip maker focused on autonomous driving. It spent another roughly $1.4 billion for a 60% stake in their new joint venture with goals including producing energy-efficient chips that could make Volkswagen’s cars more competitive in China.
Chip technologies are especially sensitive in the U.S.-China relationship, after the U.S. limited exports of advanced semiconductor technology to China, and Beijing banned certain firms from buying from Micron Technology, the largest U.S. memory-chip maker.
Any technology developed by Volkswagen’s joint venture will remain in China, the carmaker said. Keeping China-developed technology in China is part of its global strategy to build up more regional independence and limit fallout from geopolitical tensions, it said.
“We must not be naive,” said Ralf Brandstätter, who heads Volkswagen’s China business, in a message to employees earlier this year seen by The Wall Street Journal. Reducing dependencies wherever they may exist makes sense “politically, economically and entrepreneurially,” he said.
More manufacturers are trying to create parallel supply chains, with one focused on China, and one for other markets. While some of this was already under way in response to Trump administration-era tariffs and pandemic disruptions, it also makes companies less-exposed if political tensions deepen.
Lixil is shifting away from its traditional model of selling products made in China and Asia across the world.
It now aims to sell what it makes in China mainly in that country, while making 80% of the products it sells in the U.S. in Mexico, said Chief Executive Kinya Seto in an earnings briefing in April. In the past, most of its products sold in the U.S. came from Asia.
Merck, a German pharmaceutical and chemical company, said last month it is adjusting its supply chain so that the most of products it makes in China will be for the domestic market, “de-risking” those investments against geopolitical tensions.
“That means we are trying to limit, when it is reasonably possible, imports of important raw materials from other countries into China, especially from the U.S.,” said its chief financial officer, Marcus Kuhnert.
Russia’s war in Ukraine has pushed many boardrooms to discuss contingency plans for a potential China-Taiwan war, business advisers say. In a worst-case scenario, some executives fear they may have to write down or hive off their China business, as was the case with Russia.
Christopher K. Johnson, who heads political risk consulting firm China Strategies Group, said it was one thing for companies to give up on a relatively small portion of their global revenues coming from Russia and Ukraine. Walking away from China may be harder, given the market’s size.
The siloing strategy is “kind of a halfway house between completely leaving the market and remaining blind to worrying trends all around them,” Johnson said.
Some companies say it will be worth it. A Lixil spokesman said that expenses have risen as the company reorganizes its supply chain, but many are one-time costs that will put Lixil in a better position if global disruptions occur in the future.
Raffaele Huang and Tom Dotan contributed to this article.
Write to Elaine Yu at elaine.yu@wsj.com and Yoko Kubota at yoko.kubota@wsj.com