Forbes, Asia, May 22, 2018, Alex Capri, Contributor
Washington and Beijing recently concluded days of fraught negotiations and have announced that there will be no “trade war.” This is no surprise. The real news, however, is what the negotiators failed to mention. Conspicuously absent from official news briefings were any references to ZTE, China’s largest manufacturer of telecommunications devices—which, as it turns out, represents a microcosm of the bigger challenges confronting U.S.-China relations.
ZTE a symbol of China Inc.
ZTE has benefited hugely from China’s economic policies. As a tech company, ZTE has been on the receiving end of generous funding via Beijing’s “Made in China 2025” master plan, which has become a major stumbling block for U.S.-Sino relations. The plan, which is dedicated to subsidizing Chinese innovation in ten key technology sectors, including AI, robotics and telecommunications, has incited a backlash within the U.S. political establishment and resulted in a flurry of countermeasures, including U.S. sanctions, blocked acquisitions and export controls.
The ZTE story is now well documented. So far, the company has paid U.S. governmental agencies $890 million dollars in penalties—out of a $1.19 billion assessment—for violating U.S. sanctions and export control laws. Recently, after ZTE failed to meet the conditions of its negotiated settlement, the U.S. Bureau of Industry and Security (“BIS”) announced a seven-year ban on the sale of U.S. parts and components to ZTE.
ZTE is now on the verge of collapse. But Liu He, the lead Chinese negotiator and chief economic adviser to president Xi Jinping, appears to have left Washington with no resolution to the debacle.
Lessons for global business
There are both general and very specific lessons to be learned from ZTE’s predicament.
In general, U.S. sanctions are an economic weapon of mass destruction: they detonate suddenly and spread collateral damage quickly to the farthest reaches of a business ecosystem, impacting suppliers and manufacturers, logistics companies and many other third parties. Given the complexity and interdependence of global value chains in the tech sector, this makes regulatory compliance a matter of life or death.
More specifically, the ZTE case highlights three important issues for global business: First, the importance of corporate good governance; second, the need for end-to-end supply chain traceability, and, third, an awareness that global supply chains are being re-shaped by divergent U.S.-China business practices and policies.
The importance of corporate governance
ZTE’s predicament can be tied to a massive failure of good governance and ethics. Chinese firms are notoriously opaque, which promotes a culture of secrecy, distrust and managerial uncertainty. After negotiating with the U.S. government to reinstate its business license in 2017, ZTE agreed to discipline 39 employees that had actively engaged in the destruction of evidence and the obstruction of justice. Instead, it was learned that none of these employees were disciplined and some were actually rewarded with bonuses. The ZTE sales ban swiftly followed.
If Chinese firms are to become bona fide global players, they will need to adopt better governance practices.
Supply chain traceability
U.S. law requires that if any foreign made item—fabricated by any foreign company—uses more than 10% (by value) U.S. “controlled items” or technology, the entire product is subject to U.S. laws. That means that a product that is 90% Chinese origin still needs to be traced all the way to its end user, and can’t be sold to any “denied parties” if there is U.S. technology inside. The problem is that there are thousands of denied parties on export control lists, and new names are added every day.
Managing this process is a daily nightmare. Imagine trying to track hundreds of thousands of sub-components and partially assembled gadgets as they are move around a global supply chain and end up in finished products around the world.
Technology will eventually solve this problem. The next generation of smart digital tracking devices will rely on the internet of things (IoT) and the cloud will enable tracking of even the tiniest components—including where they originate, who had contact with them and where they end up.
Re-organization of global value chains
In order to ring-fence business operations that are subject to export controls, new ecosystems will emerge that include firms that have been vetted for transparency, traceability and good internal controls. According to Greg Nichols, a principal at Tradewin Asia–a global supply chain advisory firm–many of the world’s top multinationals are reevaluating how to move critical operations into safer environments. “Multinationals are actively looking for ways to reduce over-exposure to high-risk business environments with poorly enforced corporate governance standards.” said Nichols.
Global supply chains that have taken decades to evolve are now fragmenting and re-organizing around new clusters of firms, increasing the likelihood of some Chinese companies being left out in the cold or forced to form their own ecosystems.
Alex Capri is a senior fellow at the National University of Singapore, where he teaches in the business school and in the Lee Kuan Yew School of Public Policy.