Redherring: Special Report: China - When Fools Rush In

By Eric W. Pfeiffer

November 11, 2002

Rarely has the contrast been as stark. Just when you thought the U.S. tech sector couldn't sink any lower, a bellwether company like Sun Microsystems ends up knee-deep in Nasdaq's mud flats. Meanwhile, across the Pacific, China's tech sector is--wonder of wonders--doing just swimmingly. Thanks in part to its one-year-old membership in the World Trade Organization and the government's uncanny ability to balance capitalism and autocracy, China is expected to see healthy growth in nearly all sectors, with semiconductors, PCs, and software expanding 20 percent or more in 2002, according to the Information Network, a market research company.

For battered tech companies in the West, China is the land of milk and money. These companies are entering its markets at an unprecedented rate (U.S. direct investment in China increased 27-fold from 1990 to 2000), hoping to capture a part of what could quickly become the world's largest IT marketplace. China already is the largest market for mobile phones and cable subscriptions. If only Motorola--the reasoning goes--could capture in China the modest market share it has in the United States, it could sell ten times as many cell phones. AOL Time Warner could have a quarter-billion new customers.

But business isn't run on "ifs"--and China is one big "if." In software piracy, it ranks as one of the world's worst offenders. It is the eighth-most corrupt country in the world, according to Transparency International, a Germany-based organization devoted to fighting corruption. And it is a state wobbling on the brink of instability, where future massive unrest could make Tiananmen Square look like a side note.

Besides instability, tech companies face another daunting challenge: actually making money. Cutthroat competition means profit margins hang by a silken thread. Only a third of the 354,000 multinational corporations doing business there turn a profit, says Wang Zhile, a professor at the Chinese Academy of International Trade and Economic Cooperation.

But K.C. Fung, a professor of economics at the University of California at Santa Cruz, says profitability is heading up, thanks to multinationals learning how to do business in the country. Returns on foreign investment, he estimates, have climbed from 8.5 percent in 1995 to between 10 and 15 percent in 2000.

The message then is a bit paradoxical: don't do business in China, but get in quick because profits are heading up. As Orville Schell argues in his two stories [...], China will either be the tech titan of the 21st century, or it will tear itself apart. Coming to grips with this paradox is the first requirement for companies navigating this fast-growing market.

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