How Corporate Giants Manage Business Risk In A Changing China

Building a business in China has never been for those with weak nerves. However, the stakes and obstacles to operating in the PRC have recently grown more acute.

Management consulting giant McKinsey has been reportedly scaling back its team on the mainland after drawing heat from U.S. lawmakers over its contracts with arms of the Chinese government. Its top competitor, Bain & Company, has said it is reducing work in “sensitive industries” after Chinese authorities raided their offices in Shanghai last year. General Motors (NYSE: GM) has seen its China operations swing to a loss this year, while the CEO of rival Ford (NYSE: F) has labeled China’s EV brands “an existential threat” to markets in both China and the U.S.

In a report issued by the business intelligence firm Strategy Risks, Ford was identified as the large U.S. company most at risk from its exposure to China, along with Carrier (NYSE: CARR), Apple (NASDAQ: AAPL), Coca-Cola (NYSE: KO), and Tesla (NASDAQ: TSLA). With no immediate prospect of easing geopolitical tensions, foreign direct investment into China has continued to decline by over 30% in 2024. FDI is now a mere 12% of its peak of $344 billion in 2021.

Isaac Stone Fish, CEO of Strategy Risks, explained that companies with significant China exposure need to think about how “they navigate within China with the Communist Party and how they do that ethically, which can often be quite challenging from a global perspective… How do you ensure the stability and the sanctity of your supply chain? How do you protect the safety of your employees working on China issues? And what plan do you have in place for a massive geopolitical convulsion?”

Stone Fish says that his firm chose to highlight those risks since they may often be discounted by investors in multinational giants and to push for transparency so that investors can make better-informed decisions.

James Tunkey, Chief Operating Officer of I-OnAsia, has decades of experience advising U.S. executives on managing the risks of operating in China and other Asian regions. His firm has conducted over 20,000 background screening searches to vet potential acquisitions, scrub supply chains, and investigate fraud and corruption. “Many of our clients have invested billions in China over the years,” he said. But on more than one occasion, multinationals have walked away from transactions based on information that his firm unearthed.

“Our clients’ top concern is whether they have the right local partner to achieve success in China. They’re looking for professional counterparts who have a strong business reach, solid networks in China, and an untarnished brand,” he said.

Tunkey said businesses and investors must now pay more attention to emerging regulatory trends to avoid getting caught flat-footed. While he believes there is arguably less risk of becoming embroiled in fraud today, the policy environment has become more challenging.

“There are strategic guardrails unique to each industry in each country, but many companies missed those changes, whether in management consulting, e-cigarettes, tutoring services, or electronic gaming,” he explained. If they fail to monitor shifts in regulations and civil society, management can face their business disappearing virtually overnight.

Stone Fish, whose clients include hedge funds and private equity investors active in the PRC, observed that: “A lot of the best Chinese investors, even though they don’t talk about this publicly and they rarely talk about it privately, understand how crucial political risk is and who’s up and who’s down is so key to the business decisions that they make.”

Tunkey feels that business risks are just as likely to emerge from regulators and politicians in multinationals’ home countries as tensions over trade imbalances and national security concerns continue to ratchet up. “Are their new sanctions, export restrictions, and anti-China rulemaking right around the corner? Businesses don’t invest abroad if there’s uncertainty at home,” Tunkey observed.

Companies have adopted various risk management strategies, including localizing data management, separating their China operations, and diversifying their supply. Most recently, HSBC (NYSE: HSBC) announced that it would split its Greater China business into a separate unit managed out of Hong Kong to better straddle the conflicting regulatory regimes.

Stone Fish points to YUM! Brands (NYSE: YUM), a company that relatively early decided to hive off its PRC business into the separately listed Yum China Holdings (NYSE: YUMC), has succeeded with that strategy. He advises companies to protect their China-based employees and the integrity of the process by conducting some sensitive compliance work outside of China.

Stone Fish says companies must consider complex risk vs. cost calculations when considering their supply chains. Very broadly speaking, “importing from China is twice as quick and half the price. So, what would it do to my business if I just could not get this particular item? Or if the supply chain shut down or if there was a heavy tariff on it? Or if I had to perform certain political machinations to keep accessing that item?”

Tunkey believes China’s economy is undergoing a seismic shift as it moves from relying on property and investment towards more high-tech and hard-tech industries.

When pressed on why Western companies are losing out in China, Tunkey stated: “Companies with profitable businesses often fail to innovate and change with the times. They do not invest enough in building an agile, lasting legacy. It’s natural for brittle companies to get complacent and then fail when there’s a structural shift,” he opined.

However, Tunkey believes that withdrawing from the Chinese market could pose an even more profound risk.

“Companies that shift too far away from China today will be blindsided by Chinese competition tomorrow. The only way to maintain your edge is to go deeper and empower your local partners to a degree they may not have done in the past,” he said.

Stone Fish said that, in his view, the companies that do the best job of managing their relationship with China don’t usually appear on lists, including his firm’s, because “they do it in a low-profile manner that benefits them and benefits Beijing.”

“One could argue that Starbucks (NASDAQ: SBUX) or Apple or Microsoft (NASDAQ: MSFT) has done a very good job of managing the relationship with the Communist Party, but those companies also often get criticized for the closeness of that relationship in the United States,” Stone Fish said. “And so it’s certainly a double-edged sword when you’re doing it publicly.”

In this sense, some of the best advice for companies hoping for success in China might have come from how Deng Xiaoping once described China’s approach to the West: “Observe calmly, secure our position, cope with affairs calmly, hide our capacities and bide our time, be good at maintaining a low profile, and never claim leadership.”

Difficult advice for a typical, brash American CEO to follow, but wise counsel in turbulent times.