New China internet law signals fresh troubles for US technology firms-and future internet governance

A new law from China tightening internet controls could spell formidable new headaches for US technology firms in an already difficult environment, and also alter the landscape for how they do business there in subtle but major ways.

China has long enforced various constraints on internet use within the country-censoring online information, especially in times of political turmoil; manipulating search mechanisms to prevent sensitive material from emerging; and even blocking sites completely. But formally encoding internet restrictions into a national edict imposes an entirely different order of scrutiny on US and other foreign firms, compared with mere local-government or low-level compliance. Moreover, controlling the flow of online information will be the Cyberspace Administration of China-a governing body at the country's highest levels of management-indicating the seriousness of the new law.

While the new law affects all foreign technology entities, American firms are subject to closer probing by Chinese officials when doing business in the country, and the new law is not likely to let up on such scrutiny. The United States and China have clashed on many cyberspace-related issues-including Washington's charges of alleged Chinese hacking and cybertheft of American assets-fueling acrimony between the two powers.

A direct implication of the new China internet law is that every American technology firm doing business in China will be affected. Even though many lament the new statute as adding another layer of burden for operating in the country, not complying with China's demands-and risk being left out altogether-is unthinkable. China's market is simply too big to ignore, and US technology companies that chose to withdraw or were banned for perceived offenses against Beijing-Google, Facebook, and Twitter, for example-have forfeited billions of dollars in potential revenue.

Baidu, a Chinese search company that can be said to be Google's equivalent in China, reported paid search revenue in 2014 of 48.5 billion renminbi, or a hefty $7.6 billion. Sina Weibo, a popular microblogging site in China described as something of a Twitter-Facebook hybrid, posted display advertising revenue of 2.1 billion renminbi, or $334 million, for the same time period.

Of concern, too, is a particular clause in the draft law about "safeguarding critical information infrastructure." What this means is not yet entirely clear, but it puts on notice any US technology firm providing IT hardware, software, and services. It could mean that new conditions make compliance with the law more difficult for US players-for instance, unpalatable terms such as turning over customer data or sharing valuable intellectual property with Chinese counterparts. Firms unable or unwilling to stomach the stipulations could either exit the field or be exiled from participation, enabling Chinese companies to step in to fill the vacuum.

A look at some figures bears out China's enormous size and pull in technology markets. For instance, China accounts for 21-22% of global revenue for microcontrollers-tiny computers on an integrated circuit used in practically all modern-day devices featuring automated control mechanisms, present in gear ranging from automobile engine control systems to office machines and implantable medical devices. Meanwhile, in the area of industrial electronics for semiconductors such as memory integrated circuits, optical chips in light-emitting diodes, and sensors and actuators, China's share stands at 15-16%.

A not-so-obvious effect of the new internet law would be to shut out US and other foreign firms from the booming online shopping business in China. Just as Amazon has upended the commercial model and consumer experience for shopping in the United States, Chinese firms are also innovating on their home front, creating their own "must-shop" events. One example, the 1111 event held every November 11 encouraging single men and women to buy for themselves, has become a sort of "Christmas in China" day. With China able to shift huge amounts of merchandise to its billion-and-a-quarter population, and with the internet itself able to facilitate promotions of all sorts regardless of seasonality, US firms unable to take part risk losing out in this financial bonanza and becoming altogether irrelevant in light of diminished influence and power.

Winners and losers

To be sure, American technology firms have been working to protect their own business interests in China even before the new law. IBM, Qualcomm, Intel, HP, and Dell, for instance, have formed partnerships with Chinese domestic companies, hoping that local tie-ups would improve their prospects for doing business in the world's second-largest economy. Dell is investing $125 billion in China over the next five years to revive its faltering business in the country. Intel plowed as much as $1.5 billion in September last year for a 20% stake in Tsinghua Unigroup, the owner of Spreadtrum Communications and RDA Microelectronics-two Chinese chipmakers with ties to the Beijing government. The new law is likely to ratchet up the pace of American partnerships with Chinese entities while accelerating localized operations for US players.

For other foreign players besides the United States, the law's impact will likely be more muted. Similar to what US firms are doing, foreign technology players also partnered with Chinese firms-French telecom colossus Alcatel-Lucent with Shanghai Bell; and Finland-based giant Nokia with China Huaxin. The difference, however, is that the foreign non-US players have ended up establishing Chinese companies and are expanding their presence even more. For instance, Ericsson (China) Co. Ltd.-established in 1994 as a subsidiary of Ericsson of Sweden-acquired Chinese IT services provider Sunrise Technology in May 2015. Meanwhile, Nokia's agreement with China Huaxin will enable it to merge Nokia China with Alcatel-Lucent Shanghai Bell to create a new joint venture: Nokia Shanghai Bell, with Nokia holding 50% plus one share. Perhaps more important, China's attention isn't riveted on European and other non-US actors to the same degree, which could allow them to emerge relatively untouched in the wake of the new law.

The biggest beneficiaries of the new China internet law will be Chinese domestic technology companies, as Beijing is wholeheartedly supporting a homegrown effort to dislodge foreign expertise from Chinese shores. Huawei Technologies and ZTE Corp., China's two biggest telecom equipment vendors, already rank among the world's top five mobile infrastructure vendors in terms of revenue, with a combined share last year amounting to 35% of the world's total. No US firms are in this charmed circle, and the new law is not going to help American players break new ground.

By IHS estimates, California-based Cisco Systems may be missing out on as much as $2.0 billion every year in China's telecom market for hardware, software, and services, which was worth $30.4 billion in 2014. For routers/switches alone, Cisco pulled in nearly $410 million last year in China-third after Huawei's $1.7 billion and ZTE's $855 million-an indication of how much it stands to lose moving forward.

Cisco fell into disfavor following Edward Snowden's revelations that the company's equipment was being used by the US National Security Agency for spying into other governments, including China's. Cisco's fall, in turn, has driven China's mobile services providers-China Mobile, China Unicom, and China Telecom-to team up with home champions Huawei and ZTE. The lack of an American presence will also benefit Alcatel-Lucent, which has strong intellectual property of its own.

A larger question, globally speaking

While Chinese hegemony over the country's internet use is ostensibly the aim of the new decree, the ramifications go much further and touch upon the very essence of the global internet. The United States, long the acknowledged leader in the digital realm, has always argued for an open internet where freedom of expression reigns. Now with this move, China is putting forth its own contrarian vision: that a country has the right to enforce Internet control within its boundaries; deem what can be seen by its citizens on the Web, censoring content if necessary; and force foreign companies to comply with local laws.

If adopted as written, the new law could entirely reframe the terms of this contentious debate. In particular, other countries sharing this nonconformist internet-with-borders idea might well wish to join China's mutinous example, in effect seriously testing the currently accepted US-led world order of an unrestricted, unregulated Internet. By extension, the appeal to so-called internet sovereignty could be used to justify state control over online speech, data protection, privacy rights, access to information, and license to operate.

This new law could be the uneasy herald of a potentially tectonic change-one that not only shapes future American response within technology in China, but also throws into play the much bigger question of internet governance between two world powers of diametrically opposing visions.

Dale Ford is vice president and chief analyst, IHS Technology. Contributing to this article are Stephane Teral, senior principal analyst; Michael Howard, senior research director; and Daniel Knapp, director-advertising-all with IHS Technology.