Netflix joins ranks of U.S. tech companies admitting they can’t conquer China
Netflix joins ranks of U.S. tech companies admitting they
can’t conquer China
Published: Oct 20, 2016 4:17 p.m. ET
China is a tricky market to navigate given its uncertain
legal and regulatory environment
By CIARA LINNANE CORPORATE NEWS EDITOR
Netflix Inc. is the latest U.S. technology company to
admit defeat in its ambition to conquer the Chinese market, joining a growing
list of companies to be stymied by a challenging regulatory, legal and
competitive environment.
The streaming giant said this week that it has decided
not to attempt a full-service offering in China, preferring to work with local
partners.
“The regulatory environment for foreign digital content
services in China has become challenging,” Netflix said in its third-quarter
letter to shareholders. “We now plan to license content to existing online
service providers in China rather than operate our own service in China in the
near term.”
Netflix is not alone. China is the biggest foreign market
for U.S. companies, which are eager to tap the potential of the world’s most
populous country and its second-biggest economy. But the nation of 1.38 billion
people is famously tricky to navigate, after a rapid period of transformation
that has changed it from a source of cheap goods and semifinished products to a
promising market with a burgeoning middle class that’s embracing consumer
goods.
The country’s regulatory and legal framework has failed
to keep pace with its economic boom, creating any number of road bumps for
foreign players. In its 2016 membership survey, the U.S.-China Business Council
found 67% of those polled citing the policy and regulatory environment as the
biggest issue impacting their five-year outlooks, ahead of domestic market
growth and the competitive environment.
“At the same time, market and policy headwinds have
slowed investment overall,” the report found. “Fewer companies are accelerating
investment in China—although the number reducing investment remains small.”
‘More and more we
see that China is developing separately from the rest of the world. In
internet, tech, media — there’s a separate ecosystem for what happens inside
China and what happens outside China.’
Amy Wendholt, Apco
Worldwide
The top 10 challenges cited by companies include the
exhausting red tape involved in acquiring licenses, the uneven enforcement of
rules, the difficulty of hiring and dealing with workers who are used to being
told exactly what to do, restrictions on foreign investment, competition with
local players, overcapacity and a lack of transparency.
“Three years after China announced significant reform
goals, most American companies are not seeing significant changes in the
business environment,” the report found.
Danielle Bailey, head of Asia-Pacific research and data
partnerships at research company L2 Inc., said U.S. companies need to show the
Chinese government they are bringing something it can capitalize on, such as
new technology or expertise.
“The government will be a large barrier to anyone
entering that market,” she said. “Unseating an established player is difficult,
and if there’s nothing in it for the Chinese there’s no reason for them to open
their doors.”
A step backward
Some high-profile companies have come a cropper in China
of late, including Yum Brands Inc., which had long enjoyed significant success.
The operator of the fast-food chains Pizza Hut and KFC is preparing to spin off
its China business after some strategic missteps that decimated sales. In one
instance, Yum introduced a premium steak product at Pizza Hut during the
Chinese currency devaluation of 2015. It was also battered by a food-safety
scandal when a prominent supplier was found to be selling meat that was out of
date.
Then there’s Caterpillar Inc., the maker of diggers and
dozers, which made a big bet on China that turned out to be badly mistimed, as
the Wall Street Journal reported this week. Caterpillar invested billions of
dollars in plants and equipment starting in 2010 to take advantage of a global
commodities boom, which quickly became a rout as oil prices fell and Chinese
growth slowed. The company is facing a fourth straight year of declining sales
— 24 straight quarters — the longest such period in its history.
Wood-flooring retailer Lumber Liquidators Holdings Inc.
was all but crushed when laminates sourced from China were found to contain
unacceptably high levels of formaldehyde, a known carcinogenic, after local
producers flouted U.S. rules on air quality.
Last month, ride-sharing service Uber Technologies Inc.
decided to sell its Chinese operation to Didi Chuxing, marking the end of its
costly and unprofitable effort to establish a foothold there. The move came
after regulators passed rules that would prevent companies from offering
competitive subsidies, which had been Uber’s main method of attracting drivers
to its service in China.
“There were already two competitors, both of which have
venture-capital backing,” said L2’s Bailey.
The deal has brought together a strange group of rivals.
Didi had a partnership with Lyft Inc., a rival of Uber, as part of a global
ride-hailing coalition. Lyft said it would be re-evaluating that partnership
after Didi’s investment in Uber. It also draws in Apple Inc., which had
invested $1 billion in Didi, as a kind of partner with both Uber and Lyft.
Censorship challenge
Apple’s troubles in China run the gamut, from patent
disputes to a crackdown on its iBooks and iTunes movie service on the grounds
that it doesn't have the correct licenses. Most big U.S. tech companies have
fallen foul of China’s ever-changing rules and its censorship restrictions;
Alphabet Inc. quit the country in 2010 after its search, Gmail, Google maps,
YouTube and Google Play services were blocked and attacked by government-backed
hackers.
‘You can’t have a
mission to want to connect everyone in the world and leave out the biggest
country.’
Mark Zuckerberg,
Facebook
Facebook Inc. has been blocked in China since 2009, and
its photo-sharing service Instagram was cut off in 2014. Founder and Chief
Executive Mark Zuckerberg has made clear his ambition to get into China, even
hosting a Q&A with students in Mandarin in 2014. On the company’s
third-quarter 2015 earnings call, Zuckerberg said: “You can’t have a mission to
want to connect everyone in the world and leave out the biggest country.”
With U.S. companies locked out of internet services,
local companies have rushed to fill the void, encouraged by a government that
is eager to build domestic champions.
“More and more we see that China is developing separately
from the rest of the world,” said Amy Wendholt, Hong Kong managing director for
the public-relations firm Apco Worldwide. “In internet, tech, media — there’s a
separate ecosystem for what happens inside China and what happens outside
China.”
The government has been trying to create its own
semiconductor industry, for example, since the 1990s, according to the
consultant McKinsey & Co., initiatives that failed because they were more
focused on academia and research.
China still represents an important market for U.S. chip
makers. China’s biggest tech companies are consumers of chips in products like
computers and notebooks made by giants like Lenovo Group Ltd. and networking
gear and smartphones developed by Huawei Technologies.
“Most if not all of high-end and midrange Chinese phones,
computers and servers contain U.S.-designed silicon,” said Patrick Moorhead,
principal analyst at Moor Insights & Strategy, in an email.
Moorhead cited an unusual joint venture that Intel Corp.
INTC announced in January, to work with Tsinghua University and Montage
Technology Global Holdings on the development of a special programmable chip
that would be used right along with one of Intel’s Xeon processors in servers
in data centers, which would act to “preserve the intellectual property of both
parties.”
That kind of partnership may prove a sound approach to
gaining entry to China, where domestic companies can provide the network of
contacts and approvals needed to get things done. Above all, companies need to
do the research to understand the Chinese consumer and adapt to local
customers.
Finding a partner
One company that has succeeded in China is Nike Inc.,
which is riding a number of global trends to success, including China’s gradual
embrace of sports and athleticism and the popularity of the NBA.
“It’s a stand-alone global brand with premium positioning
that the Chinese recognize,” said Bailey. “It’s something that the Chinese
can’t readily replicate.”
Netflix has clearly understood the need for a partner if
it wants to overcome its main obstacle since it embarked on a global expansion
earlier this year. There are now a number of streaming competitors in China,
starting with Tmall Box Office, an Alibaba Group Holding Inc. business with a
model that is very close to that of Netflix.
“In addition, there’s Youku Tudou (owned by Alibaba),
PPTV, iQiyi, PPS.tv, Sohu Video, LeTV, Tencent TV, M1905.com, Sina Video, CBox,
and Funshion,” Deutsche Bank analysts wrote in a recent note. China, the
analysts noted, requires SVOD, or streaming video-on-demand, services to source
70% of content in China. “We think Netflix would need a partner to enter China
successfully,” they wrote.
Netflix shares were up another 1.1% Thursday, and have
gained 8% in the year so far, while the S&P SPX, -0.14% has gained about 5%.
Additional reporting by Tonya Garcia, Therese Poletti,
Claudia Assis and Tomi Kilgore.
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