Looking Beyond ZTE: How Chinese SOEs Will Learn from Adversity

Many observers have looked with interest at the furor surrounding Chinese telecoms and mobile phone giant ZTE in the U.S. This major state-owned enterprise (SOE) has been hit by the U.S. Department of Commerce imposing a sanction that prevents any U.S. company from trading with them, resulting from an investigation that concluded ZTE had traded with North Korea and Iran.

Some have assessed the U.S. Department of Commerce’s threatened sanctions against ZTE as an excessive action that would destroy a large multinational with a stroke of a bureaucratic pen; others have criticized the Trump administration for its willingness to consider a political resolution i.e. an exception for what should be a legal issue.

However, few have examined what it shows about how ZTE as a State-Owned Enterprise – has acted and communicated with regulators.

The facts: what has happened

The ZTE issue hit the news in April 2018 after the U.S. Department of Commerce re-imposed a ‘denial order’ on ZTE originally dating from a case in March 2017. In that case, ZTE were found to have sold telecommunications equipment with Iran and North Korea, in contravention of U.S. trade sanctions with these countries, and tried to hide this activity.

Under the original sanction the Department of Commerce threated ZTE with a seven-year ‘denial order’, sometimes imposed in sanctions cases, which would have banned U.S. companies from trading with ZTE. If enacted, this would have been crippling to ZTE, which is reliant on complex supply chains, many of which involve U.S. companies and cannot be replicated elsewhere.

To resolve this issue ZTE agreed to pay a large $1.19bn fine and punish individuals involved with the actions through withholding personal bonuses etc. In response the Department of Commerce suspended the denial order while the ‘remedial action’ took place, and neither did it impose the usual sanction of requiring ZTE to seek Department of Commerce permission each time they wanted to trade with a U.S. company.

However, following an investigation earlier in 2018 – including seizing documents on ZTE’s offices in the U.S. – the Department of Commerce found clear evidence that that the individuals concerned had not been fined, but had instead been awarded bonuses, and that it had attempted to cover up doing so (again).

In response, the Department of Commerce re-imposed the earlier seven-year Denial Order. At this point the world’s media noticed the event, especially as it became clear that the Denial Order would in practice cripple ZTE as a company, and there was no clear mechanism for ZTE to appeal i.e. the sanction is usually final.

Threatened with the implosion of this c. $800bn company, this then became a diplomatic issue discussed at the highest levels.

President Trump announced that a solution was near following his face-to-face meeting with Xi at their bilateral meeting, and in June the Department of Commerce announced a new resolution under which ZTE not only pays another $1bn fine and another $400 million in escrow, but also agreed to retain a team of special U.S. government ‘compliance coordinators’ for 10 years who will monitor ZTE’s compliance with U.S. export control laws. Finally, ZTE was required to replace its entire board of directors and senior leadership.

Trump faced some opposition to arrangement from Congress and the Senate. In August 2018 the Senate backed down from its initial threat to re-impose the Department of Commerce’s earlier sanction against ZTE, although still banned government agencies and companies that do business with the US government from buying products from both ZTE and Huawei and giving them five years to remove existing ones.

ZTE’s approach to the Crisis

The above lists the rough story but examining ZTE’s actions is enlightening.

To start, ZTE’s involvement in Iran & North Korea in violation of U.S. sanctions when they have major operation in the U.S. is quite reckless for a large commercial company, given that this could be subject to severe legal repercussions. Additionally, as China has much closer relations to both countries than the U.S., it gives the impression that the decision to do so was for national reasons and not just business interests.

ZTE’s failure to comply with the Department of Commerce’s initial conclusion in March 2017 is particularly rash: despite being threatened with a crippling sanction, they decided not to comply with requirements, and then got caught covering it up.
Finally, ZTE’s public statement to the re-imposed sanction also deserves comment, stating that it is “unacceptable” that the Department “insists on unfairly imposing the most severe penalty”. One might have expected either a blander statement without emotive language or possibly even an abject apology.

Furthermore, the statement itself is an undated, clumsy direct translation from Chinese using a Chinese sentence structure, sloppy grammar and even with typography in Chinese fonts, e.g.:

  • “It is unacceptable that [the Department] insists on … and disregarding the fact that … ZTE self-identified the issues in the correspondence and self-reported by ZTE immediately.”
  • “Since April 2016, ZTE Corporation has continuously reflected on lessons from its past experience in Export Control Compliance and has attached great importance to Export Control Compliance. Within ZTE, compliance is regarded as the foundation and bottom-line of the Company’ s [sic] operation.”
  • “ZTE will unite all of its employees as one with full confidence to work together.”

In summary, ZTE appears to have:

  • Made decisions based on national priorities and not commercial ones;
  • Been caught covering up trying to avoid complying with a regulatory penalty;
  • Called into question national authorities judgments;

Communicated with very senior local stakeholders on critically important issues in a style that illustrates their differences to the country concerned.

Irrespective of whether the Department of Commerce’ sanction was or was not disproportionate, it is difficult to envisage how ZTE could have created a worse impression with a regulatory authority.

Furthermore, an internal document purporting to be from SASAC, the Government Ministry responsible for ZTE, was leaked to Chinese media shortly after the Department of Commerce sanction was re-imposed appears to agree with much of the above assessment. This document castigates ZTE for a failure of internal governance: i.e. terrible risk analysis in the face of a potentially devastating punishment; taking confidential documents overseas i.e. the ones found by the Department of Commerce; and opening up a ‘can of worms’ that the possibility that the sanction could be imposed on other companies.

Worse, it appears that this latter threat may be realized. Reports in April show that the Department of Justice had begun a criminal – and therefore potentially even more serious – investigation into Huawei for potentially also trading with Iran, while the Senate’s decision to ban companies trading the U.S. government from using both ZTE and Huawei equipment is even clearer.

Learning from the debacle
Given the above hint that SASAC was very unhappy with ZTE’s handling of the issue, not to mention their willingness to remove all of ZTE’s senior management (albeit in compliance with the Department of Commerce’s sanction), it seems very likely that they will conduct a detailed review of what went wrong.

China will certainly realize that the ZTE case (and Huawei threat) are a ‘wake-up call’ that they are easily threatened by the US in this strategic sector and will push hard to develop domestic alternatives to US chip technology.

However, what does the ZTE case mean for Chinese SOEs corporate behavior?

  1. Internal Controls
    Major Chinese companies may reassess expansion plans into mature markets. ZTE appears to have gotten into trouble from combining large-scale operations in the U.S. while also operating in ways the U.S. government finds unacceptable. However, not all Chinese companies take such a reckless approach to mature markets. Leading PC company Lenovo, for example, delayed expanding its mobile business to mature markets like the U.S. and EU for several years at a time when it was expanding market share rapidly in many emerging markets, only doing so after its acquisition of Motorola, which provided established market access and, probably most importantly, significant patent rights i.e. intellectual property (IP).
    Future investments into mature markets, especially by major SOEs, are unlikely to be as cavalier, and are likely to consider more advanced levels of internal controls, especially risk assessment.
  2. Re-assess SOE behavior
    Aside from the issue of risk assessment, the ZTE case illustrates how corporate behavior normal in China can be inappropriate abroad. ZTE may be used to being ‘top dog’ as a representative of government in China, but this can backfire abroad: the West does not respect SOEs for their status as SOEs per se as it is in China. Indeed, relying on this in interactions with domestic governments simply reinforces negative stereotypes of Chinese SOEs.
    Chinese SOEs are proud of their links with the Chinese government, but if they continue to operate in the same way in Western markets, they are likely to lead to a reputational backlash – exactly what China wants to avoid.
    China is unlikely to reduce controls over SOEs, which are necessary to avoid the above point, and also run counter to a main policy of the Xi administration (increasing central control). Instead, SOEs are likely to be pushed into adopting a more careful investment policy, and less reliant on the government to ‘bail them out’ when things go wrong.
  3. Stakeholder communication
    Western companies have learnt the hard way that they need not only to act like a good local stakeholder in China but be seen to be.

Chinese SOEs need to re-evaluate their communications approach when investing abroad, empowering communications functions to:

  • deliver appropriate messages to stakeholders conveyed in suitable channels; and
  • have sufficient internal clout within the organization to avoid embarrassing announcements as illustrated above.

This is easier said than done. Good communication is not Chinese companies’ strong point: Chinese companies, especially SOEs, are used to a tame, subordinate and uninquisitive domestic media. This results in senior management under-emphasizing the value and importance of communications abroad, especially in advanced mature markets.

Time will tell how Chinese SOEs will change their corporate behavior and stakeholder communication.