Cisco Seeks Partnerships To Revive Its China Business Amid Geopolitical Headwinds

Cisco (NASDAQ:CSCO) played an important role in building up China’s Internet backbone, but it has struggled there lately due to geopolitical concerns. The networking giant’s revenues from the Chinese market have reportedly fallen 30% since 2012, as customers have aggressively shifted to Chinese equipment manufactures due to national security concerns and strong government support. ^[1]

In response, U.S. tech giants have been inking deals with their Chinese counterparts to gain some local support, and Cisco is no exception. In June, Cisco announced its plans to invest over $10 billion in China (including partnerships) over the next several years. ^[2] The company recently unveiled one such partnership when it announced a $100 million joint venture with Chinese server manufacturer Inspur to sell networking and cloud computing products in China. ^[3]

Inspur’s controlling stake rests with Assets Investment Holding Co., which is state-owned, and its sales have been growing sharply thanks to local government support. Both of these factors bode well for Cisco, as it seeks to make Inspur a valuable partner in the Chinese market. Though the initial investment is relatively small, the company expects the deal to grow in the years to come. ^[1]

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Geopolitical Headwinds Behind Cisco’s Struggle In China

Cisco’s struggles in China began in 2012 when a U.S. Congressional report pointed out that Chinese agencies may be able to use Huawei’s equipment for cyberspying in America. Though Huawei denied the possibility, it isn’t allowed to operate in the U.S., due to national security reasons. Cisco, which was instrumental in setting up China’s Internet infrastructure, faces similar geopolitical headwinds in the world’s second-largest economy. The issue isn’t just limited to Cisco, however. The Chinese government has been favoring local companies in order to deter foreign tech players’ expansion in the market, citing security as the major concern.

Cisco’s image and consumer trust took a serious hit in China in 2013, when Edward Snowden (former U.S. National Security Agency Contractor) proclaimed that American agencies are modifying U.S. made equipment to spy on foreign governments. Though Cisco responded that its proprietary equipment is not customizable, many Chinese customers still switched to local manufacturers. Chinese leaders prompted the government to draft strict regulations for foreign players, which make it tougher for companies such as Cisco to win contracts.

According to Bernstein Research, Cisco accounted for more than half of router sales in China about 10 years ago, but its share has now come down to just 10%. Its loss has been Huawei’s gain, as Huawei currently holds over a 67% share in router sales in the market. Cisco’s sales in China have been down 30% since 2012, when its net sales were estimated at over $2 billion. Last year, the company laid off about 30% of its sales staff in China on account of a drought in orders. ^[1]

Though China may not be the main market for Cisco, contributing less than 5% to its net revenues, it does present lucrative growth opportunities, with its rapidly evolving Internet of Things (IoT) domain and continued 4G adoption. By the end of 2020, China’s IoT market is expected to double from its current size of 500 billion yuan ($80.3 billion), and the number of 4G connections is projected to hit one billion, up from 100 million in 2014. ^{[4] [5]} Accordingly it makes sense for Cisco to strive harder for growth in China.

How Cisco Plans To Bounce Back

In order to revive its growth in China, Cisco announced earlier this year that it will strike partnerships and make investments worth up to $10 billion in the medium to long term. A few years back, the company announced a joint venture with state-owned China Electronics Technology Group Corp., but it failed to take off due to a delay in government approvals. The joint venture was eventually called off in 2014, two years after it was announced.

Under the terms of the $100 million joint venture deal, Inspur will resell Cisco’s networking gear in China and the two parties will jointly develop hardware and software. Cisco’s partnership with Inspur can help it bypass certain regulations and even the set the precedent for better customer response, given that a state-owned company holds the controlling share in Inspur. Since Cisco and Inspur together are investing $100 million in the joint venture, the deal looks small at the moment. However, people close to the matter have signaled that it could expand going forward. ^[1]

The potential of this deal and other such deals that may follow will largely depend on the initial performance of the joint venture. Initial success with Inspur can do wonders for Cisco in China as it seeks a turnaround there. The company’s equipment orders from the region declined just 3% in Q4 fiscal 2015, marking its best performance in the last two years. ^[1]

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1. Struggles in China Push Cisco to Strike Deal, The Wall Street Journal, Sept 22 2015 [↩] [↩] [↩] [↩] [↩]
2. Cisco Unveils $10 billion China Plan, The Wall Street Journal, Jun 17 2015 [↩]
3. Cisco joins flurry of U.S.-China tech partnerships, Reuters, Sept 24 2015 [↩]
4. IoT in the News: China Invests Heavily in the Internet of Things, Harbor Research [↩]
5. Smartphones to Account for Two-Thirds of Chinese Mobile Market By Year End, GSMA, Jul 13 2015 [↩]