Why Companies Are Thinking Twice About Buying American

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John Chambers, chief executive of Cisco Systems, confirmed this week what many analysts had suspected following recent revelations about spying by the National Security Agency. Some customers are starting to think twice about buying American technology.

Sales in China declined 18% in the latest quarter, at least partly because of fallout from the surveillance, he said. It’s a potentially significant development and one that is sure to increase concern among other technology executives. But it is also a highly complex situation that involves far more than meets the eye.

China’s is displeased with a U.S. Congressional report last year that raised serious security concerns about two Chinese technology companies. The report all but killed any chance for Huawei Technologies and ZTE Corp. to sell their equipment for connecting phone calls and routing Internet traffic in the United States.

Inevitably, China wanted to retaliate, said Christopher Tang, a business professor at University of California at Los Angeles who specializes in manufacturing and China. The NSA leaks, which started in May, were a convenient excuse to curtail spending on American technology and an opportunity to pressure U.S. officials on other trade issues. “It’s tit for tat,” Tang said. “This gives them an easy way out.”

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News about the NSA’s surveillance of data stored with U.S. technology companies or passing through their networks raised the alarm bells with many overseas firms. Articles based on classified documents leaked by Edward Snowden, a former NSA contractor, detailed the vulnerabilities in U.S. technology and, in some cases, significant cooperation by the companies involved.

In recent months, several reports tried to quantify the financial risk to U.S. technology firms. They all highlighted the serious potential cost if customers – particularly those located overseas – stopped buying American and instead shopped elsewhere.

Forrester Research estimated the cost to U.S. cloud providers, which store data like email, documents and customer information, could reach $180 billion annually. A separate study by the Information Technology & Innovation Foundation, an industry group, said the cost to cloud providers could be as high as $35 billion in 2016.

Finally, a survey published this summer by the Cloud Security Alliance, which develops security standards for Internet companies, examined the number of technology customers had already defected. Out of 207 overseas respondents, 10% said they had cancelled a project to use U.S.-based cloud providers while 56% said they were less likely to use such a provider in the future.

In the conference call yesterday, Rob Lloyd, president of development and sales for Cisco, said that the NSA surveillance has caused his company’s Chinese customers “to stop and then rethink” buying from Cisco, which competes against Huawei and ZTE in selling equipment for telecommuniations. But he added that the impact of any lost sales was immaterial to Cisco’s overall business, given its huge size.

China accounts for less than 5% of the company’s overall revenue, which totaled $12.1 billion in the quarter ending Oct. 26. Apprehension about buying Cisco products in other countries was “fairly nominal,” according to Chambers.

Cisco has denied any involvement in surveillance efforts by U.S. spy agencies and does not customize its equipment.

In citing the fallout of NSA surveillance, Chambers went further than executives at most other large technology companies. Most don’t mention the issue during the calls or they blame other factors for declining revenue, even when it involves China.

For example, last month, IBM reported that its sales in China dropped 22% in its recently completed quarter; hardware sales alone fell 40%. Mark Loughridge, IBM’s chief financial officer, explained the decline as the result of a slowdown in decision-making as customers waited for the Chinese government to finish an economic reform plan.

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Still, some U.S. technology companies say they’re doing fine in China. Joseph Tucci, chief executive of EMC, a data storage firm, said recently that “we are growing nicely in China,” although he declined to provide any details. It was a similar story with Juniper Networks, a Cisco competitor.

Separating what exactly responsible for a decline in technology sales is difficult, of course. China’s economic growth has slowed from its rapid pace a few years ago, resulting in more muted demand for new technology in some cases.

Furthermore, China’s domestic technology industry including Huawei and Lenovo has made big gains in quality. Buying from Western companies is no longer a given. In any case, with the economy slowing somewhat, Chinese officials are more apt to pressure companies to buy domestic equipment.

Ray Mota, managing partner for ACG Research, a market research firm that tracks the technology industry, doesn’t expect any quick détente in what he called the “cold war” between the United States and China over technology. Meanwhile, he pointed out that Cisco will almost certainly continue to win contracts in China because of its reputation for reliability and speed over its Chinese rivals.

“I think this is going to get worse before it gets better,” Mota said. “But in the long run, it will play itself out.”