China Accelerates Replacement of U.S. Technology with Domestic Alternatives Amid Sanctions

According to government tenders, research documents, and four individuals familiar with the situation, China is increasing its expenditure to substitute Western technology with domestic alternatives as the United States imposes stricter restrictions on high-tech exports to its competitor.

Reuters is reporting for the first time details of government, military and government-linked tenders that show an acceleration in domestic compensation since last year.

China has spent a lot of money to renew computer equipment, and the next targets are likely to be the telecom and financial sectors, said two people familiar with the industry. The state-backed researchers also found that digital payments are particularly vulnerable to potential Western hacking, according to a review of their work, making the indigenization of such technology likely.

The number of bids for the nationalization of state-owned enterprises, government and military equipment doubled to 235 from 119 in the 12 months to September 2022, according to a Reuters Finance Ministry database.

At the same time, the value of awarded projects listed in the database was 156.9 million yuan, or more than three times compared to the previous year.

Although the database represents only a fraction of national tenders, it is the largest publicly available collection of government tenders that reflects third-party data. China will spend 1.4 trillion yuan ($191 billion) replacing foreign hardware and software in 2022, a 16.2 percent year-on-year increase, according to IT research firm First New Voice.

But Beijing’s lack of manufacturing capacity for advanced chips prevents it from fully replacing products with alternatives made entirely locally, analysts say.

Previous domestic replacement efforts stalled because China didn’t have “the technical tools to do localization until now, and to some extent they still don’t,” said Kendra Schaefer, director of technology policy research at Trivium, a Beijing-based consultancy. China.

FEAR OF ADDICTION

State-owned enterprises were last year urged to replace office software systems with domestic products by 2027, the first time such specific deadlines had been set, citing a September 2022 order by China’s State Assets Supervision and Administration. Reuters could not independently confirm the order.

Domestic compensation projects this year have clearly focused on sensitive infrastructure, tenders show.

One partially redacted bid from “a certain ministry in Gansu Province” allocated 4.4 million yuan to replace intelligence system equipment, but did not provide further details.

The People’s Liberation Army units in the northeastern city of Harbin and the southern city of Xiamen last December issued a tender to replace foreign computers.

Technology researchers such as Mo Jianlei of the Chinese Academy of Sciences, the country’s largest state-run research organization, said the Chinese government is increasingly concerned that foreign powers are hacking Western equipment.

The state property control authority did not respond to a request for comment.

Over the past year, state-linked researchers have also called on Beijing to strengthen anti-hacking defenses in its financial infrastructure over geopolitical concerns.

One study published in March highlighted the dependence of China’s UnionPay credit card system on US software company BMC for payments.

“Beware of hardware and software security holes set by the US side…build a financial ‘firewall,'” the researchers wrote.

The BMC declined to comment.

An article published this year in the journal Cyberspace Security by researchers at the state-run China Telecommunications Corporation found that the country was over-reliant on chips made by US-based Qualcomm for backend management, as well as iOS and Android systems.

“(They) are tightly controlled by American companies,” the researchers wrote.

Since China is not a signatory to the World Trade Organization’s government procurement clauses, the countermeasures do not appear to violate international agreements, according to the US Treasury Department. The U.S. has introduced similar rules that prevent Chinese companies from bidding for the public sector.

Qualcomm, Google and Apple did not immediately respond to requests for comment.

WINNERS AND LOSERS

China’s effort to build an independent computing system goes back at least to its 2006 five-year science and technology development plan, in which semiconductor and software systems were listed as national priority areas.

This effort gave birth to state-owned companies, which are increasingly awarded large contracts. The two companies that won the Harbin tender were subsidiaries of China Electronics Corporation and China Electronics Technology Group Corporation – both of which are subject to US sanctions.

The state regulator’s 2022 order pushed state-owned companies away from U.S. companies such as Microsoft and Adobe, according to an employee of a Beijing-based company that develops domestic office processing software.

For example, China Tobacco started switching some subsidiaries from Microsoft Windows to Huawei’s EulerOS operating system in July, said an employee of a software supplier serving the state-owned manufacturer.

The people spoke on condition of anonymity because they were not authorized to discuss customers and competitors.

For years, Western technology companies have shared their source code and formed partnerships with domestic firms to address Beijing’s concerns, but prominent computer science researchers such as Ni Guangna of the Chinese Academy of Technology have said such measures are insufficient to meet China’s security needs.

China Tobacco, Microsoft and Adobe did not respond to requests for comment.

In September, Reuters and other outlets reported that employees of some central government agencies have been banned from using iPhones at work.

“In certain sectors, customers… choose domestic suppliers, and foreign suppliers often face informal barriers,” the European Union Chamber of Commerce in Beijing said in response to questions from Reuters.

In a 2023 report from the American Chamber of Commerce (AmCham) in Shanghai, 89% of the organization’s technology industry members cited procurement practices favoring domestic competitors as a regulatory barrier. That was the highest percentage of any industry.

Eric Zheng, president of AmCham Shanghai, acknowledged China’s national security concerns, but said he hoped “conventional procurement procedures will not be politicized so that US companies can compete fairly and pursue commercial opportunities … to benefit both countries.”

The US Department of Commerce, China Electronics Corporation and China Electronics Technology Group Corporation did not respond to requests for comment.

HUAWEI AWARDED

Chinese technology company Huawei has emerged as the leader in this exchange cycle, according to three people familiar with China’s corporate technology industry, who spoke on condition of anonymity because of the sensitivity of the matter.

In 2022, Huawei’s enterprise business, which includes software and cloud computing operations, will have a revenue of 133 billion yuan, up 30% from the previous year.

One of the people said that privately held Huawei was seen as more nimble than state-owned groups in bringing products to market and executing projects.

Two other sources highlighted Huawei’s broad range of products – from chips to software – as an advantage.

Customers also value Huawei for its ability to process data on the company’s internal servers and in external cloud networks, as well as for its wide range of cyber security products, says an employee of China Tobacco’s technology supplier.

Huawei declined to comment.

The replacement position has redrawn entire sub-sectors of the software industry. The combined Chinese market share of the top five foreign database management system manufacturers — most of them American — fell from 57.3 percent in 2018 to 27.3 percent by the end of 2022, according to industry group IDC.

Despite the high cost of domestic replacement, however, foreign companies are still the dominant suppliers in banking and telecommunications database management. According to technology consultant EqualOcean, non-Chinese companies held 90% of the market share of banking database systems at the end of 2022.

Financial institutions are generally reluctant to change database systems despite government pressure, said one industry source, adding that they have higher stability requirements than many other sectors and local players are not yet able to meet their needs.

Even for personal computers, banks switching from an international brand to China’s dominant supplier to Lenovo would still depend on critical chip components supplied by Western companies, one of the industry sources said.

($1 = 7.3165 Chinese Yuan)