Chipmaker Qualcomm (NASDAQ:QCOM) was recently fined $975 million in China for allegedly overcharging OEMs for license fees for its mobile chipsets. The fine is just a slap on the wrist for Qualcomm, which generated over $13 billion in revenues in China-alone last fiscal year, but it represents another escalation of tensions between foreign companies and an increasingly protectionist Chinese government.
Let's take a closer look at why China is probing and fining foreign companies such as Qualcomm, and what it could mean for their investors.
Qualcomm's not alone
Over the past year, the Chinese government launched a series of probes against foreign pharmaceutical companies, automakers, and tech companies. Chrysler, Johnson & Johnson, GlaxoSmithKline (NYSE:GSK), Samsung (NASDAQOTH: SSNLF), and Volkswagen have all been hit by multimillion-dollar fines for reasons including bribery, price-fixing, and "monopolistic" behavior.
To be fair, some investigations were justified. GlaxoSmithKline confessed to bribing doctors and government officials through a network of travel agencies, and luxury cars in China often cost double or triple their overseas counterparts, more than offsetting import taxes and shipping costs.
However, many foreign companies believe that the Chinese government is intentionally throttling their growth to aid its own domestic brands. The automaker probes, for example, can be considered a reaction to foreign vehicles that are outselling China's domestic brands, which the government heavily subsidizes.
Bad for Qualcomm, good for Xiaomi
As part of its settlement with the government, Qualcomm agreed to stop bundling its 3G and 4G patents with other chip-related ones. The resulting lower license fees will make it possible for domestic companies such as Xiaomi, Lenovo, and Huawei to launch even cheaper handsets and undercut foreign rivals like Samsung and Apple (NASDAQ:AAPL).
This decision also helps the Chinese government, which has asked the three state-owned wireless carriers -- China Mobile (NYSE:CHL), China Unicom (NYSE:CHU), and China Telecom (NYSE:CHA) -- to reduce their promotional subsidies for smartphones over the past year.
If those three carriers pay lower subsidies, the cost of high-end Apple and Samsung devices would rise and make local brands look more appealing. Xiaomi, the largest Chinese smartphone maker, could benefit the most because it sells most of its unlocked phones through online retail rather than through major carriers.
Cooperation or extortion?
China certainly has the right to set up ground rules for foreign companies wanting to do business within its borders. However, many of the country's escalating protectionist strategies come dangerously close to extortion.
In the past, foreign companies kept the Chinese government happy by entering the market through joint ventures with domestic companies. This was often a winning situation for both sides -- foreign companies gained local partners which knew the market well, production costs were split, and import taxes were reduced or eliminated.
Today, China wants its own domestic brands, not just joint ventures, to flourish. However, China's rising middle class craves established foreign status symbols, such as Louis Vuitton bags and iPhones, instead of comparable domestic brands. To counter that trend and aid its domestic companies, the Chinese government is coming up with new ways to throttle the growth of foreign brands under the pretense of protecting consumers from price gouging.
But look in the mirror, America
Of course, investors should remember that America does the same thing by using "non-market economy methodology" to decide whether Chinese goods are being "dumped" into its market at unfair prices.
That practice, which lets the U.S. impose higher punitive tariffs to protect inefficient domestic industries, was previously considered illegal under WTO rules. When China joined the WTO in 2001, the U.S. demanded that a 15-year exception be passed to prevent an excess of Chinese goods from entering its market.
The U.S. claims it needs that exception because China keeps the yuan artificially low to produce cheaper goods. However, China claims that America's previous attempts to devalue the dollar with policies such as Operation Twist and quantitative easing aren't that different from its own monetary policies.
The "price of doing business"
In my opinion, both China and the U.S. are merely protecting their domestic economies by playing the hand they were dealt. China knows that the growth of its middle class is lucrative to foreign companies, and it's letting them know they need to play by its rules.
Investors in American companies with big plans for China shouldn't flee for the exits yet. However, they should understand that the Chinese government will probably keep aiding its own companies at the expense of big foreign companies such as Qualcomm for the foreseeable future.