The company's source code is the secret of its success.

Photographer: Qian Daqun//ChinaFotoPress/Getty Images

IBM Should Hold Onto Its Code

Michael Schuman is a journalist based in Beijing and author of "Confucius: And the World He Created."
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For months, China has been asking U.S. technology companies to share proprietary information, ostensibly for security purposes. With the implicit threat of reduced market access in the air, IBM has complied, allowing officials to examine its source code and setting a dangerous precedent. 

IBM may preserve some sales in the short term. But at what cost? IBM’s source code contains the secrets to its software -- and its success. By revealing that vital know-how to China’s government, which also owns most of the country’s biggest companies, IBM is potentially aiding its rivals and undercutting its own competitiveness.

IBM says that it allows certain governments (which it hasn’t named) to inspect its products on a limited basis using methods that ensure its intellectual property is secure. China's government, though, has a long history of supporting domestic companies, both state-owned and private, to achieve national economic priorities. And China is clearly willing to break the rules to meet these goals, judging by its efforts to hack U.S. companies.

Granted, companies like IBM are caught in a tough spot. The Chinese market has become so big and important for everything from smartphones to automobiles that CEOs understandably feel compelled to appease Beijing to keep sales growing.

Yet being nice to China today won’t necessarily help U.S. companies tomorrow. Mark Zuckerberg may have tried to impress by delivering a speech at Beijing's Tsinghua University in Mandarin this past weekend, but that's unlikely to convince the government to lift its ban on Facebook in China, at least not in its current form. Rather than remaining dependent on critical technology from abroad, Beijing wants Chinese companies to create their own chips, systems and software to compete with, and ultimately replace, foreign rivals. In May, Beijing unveiled its “Made in China 2025” program, designed to boost Chinese manufacturing in IT, eco-friendly cars and other high-tech products. Foreign companies won’t dissuade China from pursuing these goals by caving in; in fact, they may only facilitate their own demise.

QuickTake China's Economic Data

What U.S. CEOs have to realize is that they currently have more leverage over China than they think. China’s economy is in terrible shape. GDP grew 6.9 percent in the third quarter -- the slowest since the depths of the last financial crisis -- and many economists believe even that rate is grossly overstated. Wages and other costs are rising, denting Chinese competitiveness compared to Vietnam and India. Corporate China badly requires an upgrade, to produce more advanced, better quality products.

All of this means China still badly needs foreign companies -- to create jobs, spur growth and, most of all, share critical expertise. No matter how insistently Beijing’s leaders want to promote local technology, the process is likely to be slow; very few developing nations have been able to transform themselves into truly advanced, innovative economies. Arguably, only Japan and South Korea have managed the feat over the past half century.

China’s leaders aren’t unaware of the challenge they face. President Xi Jinping admitted as much during a conference with U.S. CEOs in Seattle in September, when he encouraged them to cooperate more with Chinese companies.

Meanwhile, China’s economic slowdown and uncertain prospects have undercut its attractiveness as a market. A few years ago, foreign carmakers were scrambling to add capacity in China. More recently, Honda decided to mothball plans to build a new factory. Fast-food company Yum! Brands had once grown fat on its expanding KFC and Pizza Hut businesses in China; last week, it announced it was spinning off its sagging China unit. Taiwan’s Foxconn, famous for manufacturing iPhones in China, announced in July it would build as many as 12 factories in India, employing one million workers.

Foreign investors are souring on China. The European Union Chamber of Commerce in China discovered in a 2015 survey that only 58 percent of its members considered China a top three destination for investment, a sharp drop from 76 percent in 2012. Though 61 percent said China was increasingly important in their overall global strategies, that proportion represents a drastic decline from 79 percent in 2011. Meanwhile, foreign investors are looking elsewhere. In the first half of this year, India surpassed China in the amount of foreign investment it received for greenfield projects.

What all this means is that foreign companies have the power to press China into cooperating with them, too. Beijing must undertake serious reforms to attract the kind of foreign investment it needs most. Lax regulation and poor protection of intellectual property, for instance, make foreign companies wary of bringing new technology to China. The EU Chamber figures that more than two-thirds of the European companies that conduct R&D and operate in China don’t have a research center in the country.

U.S. companies should expand their businesses in China, engage in joint ventures, and keep peace with the government -- but not to the point of sacrificing their future. China needs them as badly as they need China. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Michael Schuman at contactschuman@gmail.com

To contact the editor responsible for this story:
Nisid Hajari at nhajari@bloomberg.net