China’s Shanghai Composite Index dropped 7 percent on the first day of trading in 2016, sparking a global selloff and renewing fears over the health of China’s economy, which slipped below 7 percent GDP growth in Q3 2015 for the first time since 2009. This has set the stage for what is sure to be a volatile first quarter for the tech industry in the United States.
In general, there are three interconnected themes to why the Chinese market is showing signs of stress: weak domestic demand for imports, overcapacity in key industries and currency devaluation.
As to the first point, China’s rise to be the second-largest economy and its voracious demand for raw materials and industrial equipment has benefited economies worldwide in the past. But Forrester Research predicts the slowing of China’s real GDP growth from more than 10 percent in 2010 to around 6 percent in 2016 and 2017—meaning that it’s still a positive growth force in the global economy, just not as much as in recent years. However some segments are slowing more than other others, technology among them.
As far as how the volatility in the Chinese market specifically affects the bottom line for U.S. tech companies, a devalued currency means less buying power, so imports to China from the United States will become less attractive. At the same time, China's latest export figures showed an increase for the first time since June 2014 – much better than anticipated by most analysts.
"I think the pick-up in export is due largely to the devaluation of the yuan,” said Kamel Mellahi, professor of strategic management at Warwick Business School and an expert on China. "A weaker yuan can help China shore up economic growth by boosting exports, but at the same time, as we have seen over the last couple of weeks, it creates volatility in financial markets.”
Harry Wang, director, Health & Mobile Product Research, at Parks Associates, added that “the slowdown is going affect their ability to sell products. The devaluation of the currency there makes Chinese products more competitive while making U.S. products pricier as imports.”
At the same time, the volatility in the stock market is affecting the Chinese consumer’s ability to purchase products from western companies. The Chinese middle class is a big market for American luxury brands, and it’s this group that’s most affected by the stock market fluctuations.
“The first wave of impact has taken its place on SMEs and enterprises, as well as stock holders (the big decline of stock market value recently),” Huang said. “The middle class who have business or stock shares may suffer the most. I do not foresee very big impact to the rest unless the inflation increases largely.”
For those selling smartphones and other new-entrant technologies (especially a company like Apple, which hopes to tap into the Chinese market as a growth market) the decline of wealth for Chinese consumers could set off a chain reaction.
“The Chinese middle class consumer will purchase fewer high-tech products from the U.S., causing order reductions and performance declines,” explained Wang. “That means that those companies will likely get hammered in the American market, reducing future production. In turn this would significantly impact their ability to manage manufacturing capacity and fund R&D and product launches.”
And, in spite of its slowing growth profile, China’s debt-fueled economy has yet to embark on a process of deleveraging, compounding concerns over a credit bubble. This may generate an increase in corporate defaults as companies struggle to repay debt, especially in sectors hardest hit amid the slowdown.
While all of this is happening, competition within the manufacturing supply chain is growing as a force to be reckoned with.
“Workers in China are much more skilled than in other countries, so for tech companies that want efficiency and skilled labor to mass produce products, China is still the best place to be,” said Wang. “But with that looking more and more attractive, wages are on the rise and the domestic supplies may not meet requirements. There will be several companies competing for the same pool of labor, and that is pushing costs higher.”
Overall, Analysys Mason expects that labor costs will rise around 8 percent in 2016 in China.
“Foreign companies may consider moving factories to cheaper countries like southeast Asia, and local companies may move their functions to western China or less developed areas,” Huang said.
However, she added, “leaving where there are already mature and efficient logistics and an industry ecosystem will lead to other cost and risks,” she said. “So [leaving is] not easy and there won’t be a lot of this moving happening in the near future.”
There are other dynamics that play into this heady mix as well.
“Anti-monopoly and anti-terrorism laws and policies can lead to some effects: Anti-monopoly may have negative effect on large MNCs, and anti-terrorism can bring changes on data ownership, regulatory requirements, security and safety,” Huang said. “[And], the land argument with neighbor countries hopefully won’t lead to wars, but will lead to arguments and conflicts here and there, preventing further collaboration and closer relationship from forming.”
Taking everything together, in terms of the tech sector's go-to-market strategies and product/sales outlooks for the rest of the quarter and beyond, Huang noted that China is still a large, attractive market that U.S. companies cannot afford to lose. But there will likely be some corrective action taken, especially for those who have large business with China market first, including some smartphone manufacturers.
“But, they may gradually shift their focus to other growing market and adjust development targets/expectation down for China market,” she said. “Tech/network upgrades of private sector companies may be postponed. Mid-end handsets may gain more attention compared to high-end handsets--similarly in other consumer electronic product segments.”
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