Recoupling through Controlled Localization

The Ukraine conflict is increasingly impacting the business of foreign companies in China. China is responding to massive Western sanctions on Russia by accelerating decoupling in order to become self-sufficient more quickly. Western companies are responding by recoupling their Chinese branch or subsidiary through controlled localization. Headquarters are putting their Chinese subsidiaries back on a shorter leash because the new geopolitical situation and its economic consequences now require centralized management that keeps an eye on the entire corporate environment. The management of branches and subsidiaries is usually overwhelmed with disrupted global supply chains, cross-border financial risks and strategic upheavals of this magnitude.

We have observed this reconnection of Chinese branches and subsidiaries to corporate headquarters for some time. It has been recognized that the lack of alignment with functional executives at headquarters on key issues of value creation, resources and decision-making authority often leads to lasting problems. Three examples from our consulting practice:

IT compliance: the Chinese subsidiary did not know that it had to submit its IT systems to a legally required security certification. Internal IT processes were neither surveyed nor documented. The advice came from headquarters, where the specific knowledge is available. Intellectual property protection: The subsidiary and its Chinese lawyers assumed that illegal copying of an industrial design cannot be legally prosecuted because the design is functionally mandatory. They overlooked the fact that individual design components are protected in China if they have a sufficient design level. Know-how: Technical knowledge was lost at the subsidiary because they were not aware of the data encryption options permitted in China. The consequences of these skill deficiencies are governance risks and loss of competitive advantage. 

Currently, the risk of being drawn into an economic war in new and existing business is relatively high for foreign branches in China. They can be put in a bind by sanctions and counter-sanctions. Particular caution should be exercised with dual-use goods and with conspicuous requests that may be behind circumvention deals. Chinese business partners may be affected by sanctions, and patent piracy imported from Russia may allow IP-infringing products to enter the company’s export markets via China. These are all cases for the specialists at Headquarters.

Picture: Shutterstock

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