Why It’s Challenging and Essential for Businesses to Sever Ties with China

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The news this week that a senior Nomura banker, Charles Wang Zhonghe, has been barred from leaving mainland China has sent shockwaves through foreign companies and investors in the country. The circumstances behind the ban remain unclear, although it may be related to an ongoing investigation into Bao Fan, China’s top tech sector dealmaker, who went missing in February. However, it serves as a reminder of the increasingly unpredictable environment for overseas businesses.

The ban comes in the wake of heightened scrutiny of foreign firms in China. In May, raids were conducted on US consultancies Capvision, Bain & Company, and Mintz, who were accused of disregarding national security risks and divulging sensitive information abroad.

The rising uncertainties of operating in China further compound the pressures on businesses from their respective governments to mitigate risks amid escalating geopolitical tensions and pandemic-induced vulnerabilities. Many companies are opting to relocate their operations overseas or spin off their Chinese operations into separate units.

However, de-risking is proving to be a challenging task, especially for manufacturers. China offers few viable alternatives, as multinational corporations rely on networks of suppliers in the country who can produce inputs at lower prices than anywhere else in the world. Scaling back manufacturing bases in China often leads to higher production costs and a loss of competitiveness.

One approach is to hedge bets through a “China plus one” strategy, which involves maintaining Chinese plants while directing new investments to countries like India or in Southeast Asia, such as Vietnam. Apple, for instance, is building its latest iPhone 15 in both China and India. However, Apple’s efforts to diversify manufacturing to India have encountered obstacles, including quality control and efficiency issues.

A recent growing trend, influenced by China’s treatment of foreign businesses as well as Western government pressure, is the adoption of “China for China” strategies. This entails reconfiguring Chinese operations to exclusively serve the domestic market, potentially insulating international groups from Chinese regulatory actions. Localizing supply chains can also reduce reliance on raw materials from outside China that may be disrupted by US sanctions. However, creating separate supply chains for Chinese and non-Chinese businesses is costly for manufacturers, even if it is feasible.

Service companies, particularly those that rely on data in fields such as finance, consulting, or IT, may have no choice but to embrace “China for China” strategies. Their situation became more challenging after Beijing implemented an expanded anti-espionage law this summer, which restricts international data sharing deemed sensitive. Venture firms Sequoia Capital and GGV Capital have already announced plans to split their China business into separate entities, citing US-China tensions. Likewise, IBM’s former IT services unit Kyndryl intends to separate its China business.

However, there is a risk that hived-off Chinese units may become detached from group oversight and more susceptible to official influence or opaque business practices in China.

Foreign businesses have limited straightforward options to reduce their exposure to China. While Beijing should be cautious about pushing out companies that have brought crucial investment and knowledge, US and European governments must understand that their rapidly shifting positions are causing significant stress to businesses. Boards require greater clarity on the future direction of China policy to effectively plan for the long term. “De-risking” may be inevitable, but it will not be a quick or easy process.