In China, Foreign AI Companies Banned or Disadvantaged, Says Top China AI Company

By: John Honovich and Charles Rollet, Published on Aug 28, 2019

Non-China (PRC) companies are prejudiced and unfairly targeted inside of the PRC's booming AI market, which not only denies them revenue inside of the PRC but fosters domestic PRC giants that can then unfairly compete around the world.

Foreign AI Providers Banned or Disadvantaged In China

One of China's largest AI providers, Megvii, disclosed in its IPO filing that:

Foreign-owned entities are prohibited or disadvantaged in the relevant City IoT project bidding process in practice. In practice, when selecting service providers, many end users, as well as many direct customers (which are our system integrators) engaged by such end users to assist them in the supplier selection process, would set implicit requirements that the service provider must not have any foreign shareholder, or at least consider foreign ownership as a disadvantage in their decision making process. Some government agencies even explicitly set forth such requirements in their project bidding invitation documents [emphasis added]

This disclosure comes in stark contrast to the PRC government and major PRC manufacturers complaining strenuously about how unfair and unjust the US NDAA ban is.

Megvii Revenue Rocketing

Megvii's IPO document show 2018 revenue of ~$200 million, with H1 2019 revenue tripling, putting the firm on pace to generate $500+ million revenue in 2019.

PRC AI Market Booming

This shows a huge market in PRC for AI solutions, which Megvii estimated at almost $42 billion total (300 billion RMB) last year for the "city and community management" segment:

Owing to the gradual replacement of existing security solutions, implementation of smart community solutions and cost reduction of human staff, the market for computer vision technology under the city and community management context is approximately RMB300 billion as of 2018

This is driven in part by the PRC government's smart city spending, which Megvii expects to skyrocket from $1.66 billion in 2018 to over $14 billion by 2023:

The market size of China’s smart city management vertical in terms of revenue is expected to grow from RMB11.9 billion in 2018 to RMB103.1 billion in 2023 [...] Smart city management solutions are primarily provided to government agencies [...] Our growth, especially with respect to our City IoT solutions, depends in part on government spending and favorable government policies [emphasis added]

Indeed, a new IDC market report on PRC video surveillance says that the government accounts for nearly half of all PRC market spending:

The government is the largest industry in China's video surveillance, accounting for 47.6% of total expenditure.

Adds To Historic Video Surveillance Barriers

With all this spending, being shielded from foreign competitors is certainly a plus. However, this is neither new nor surprising. For years, the PRC has considered foreign video surveillance systems to be a security risk.

As such, even the biggest non-PRC companies such as Axis, Avigilon, Genetec, and Milestone have a negligible share of the PRC market.

Major Problem For Non-PRC Vendors

The outcome will be huge PRC AI vendors that will be far larger and have far more resources to compete globally against non-PRC AI vendors. This, of course, has already happened with surveillance cameras as Dahua and Hikvision built up huge protected markets inside of the PRC and then leveraged that to spend vastly on sales while undercutting the pricing of their foreign competitors. With these barriers, this could repeat with AI.

Contrast To The US NDAA

While the PRC is banning and disadvantaging foreign AI providers, the PRC, and its largest manufacturers have made repeated claims of how the US NDAA is unfair and unjust. This is ironic, since surely Huawei and Hikvision know the same thing Megvii knows, that they have benefited from unfairly undermining foreign companies inside their home country.

Both hurt targeted providers (in the case of the PRC, all foreign companies, in the case of the US, just PRC companies).

Outlook

Ideally, both countries would support open trade and trust each other. This is unlikely to happen.

With AI becoming core to video surveillance in the next decade, this is shaping up to be a repeat of the 2010s, with huge PRC providers, benefiting from an unfairly protected home market, having far greater revenue and resources to undermine rivals throughout the rest of the world.

8 reports cite this report:

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Hikvision Dissolves North American Business Unit, Splits Canada and USA on Oct 15, 2019
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US - China Review Commission Cites IPVM on Foreign Provider Threat on Oct 01, 2019
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Comments (9)

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As an interesting footnote, the reason that Megvii disclosed this is that even though they are, in reality, a Beijing HQ company with founders from Tsinghua (the top PRC university that, e.g., Xi Jinping attended), Megvii, like Alibaba, is structured with a holding company based in the Cayman Islands. So theoretically, the 'prohibition' against foreign companies could be applied to them, though, as they explain, at great lengths, this is unlikely to be the case.

The original / core operating company is:

As they explain in the IPO document, they created a Cayman Islands holding company later on:

To attract foreign investors to support our growing business, we incorporated our Company as an exempted company with limited liability in the Cayman Islands on January 30, 2013 as the holding company of our Group and exercised control over Beijing Kuangshi through the Original Contractual Arrangements

But that company does not directly own the PRC company, it has only a "Contractual Arrangements" with the PRC operating business, as they note:

we do not directly own any equity interest in our Consolidated Affiliated Entities.

The reason for this is that the PRC blocks foreign ownership, as they explain:

The PRC government imposes certain restrictions or prohibitions on foreign ownership of companies that engage in certain value-added telecommunications services

The company adds that while it does not have any equity interest, it has a contract that will allow it to receive economic benefits of the PRC operating company:

Although we do not have any equity interest in our Consolidated Affiliated Entities, we are able to exercise effective control over them and receive substantially all of the economic benefits of their operations through the Contractual Arrangements with Beijing Kuangshi and its shareholders.

Though they acknowledge that the PRC could change this in the future:

we have been advised by our PRC Legal Advisor that there can be no assurance that the PRC government authorities will not take a view in the future that is contrary to or otherwise different from the opinion of our PRC Legal Advisor stated above, and there is also the possibility that the PRC government authorities may adopt new laws and regulations in the future which may invalidate the Contractual Arrangements

That is business in the PRC.

On the plus side, these technicalities have resulted in Megvii disclosing something very important (that "Foreign-owned entities are prohibited or disadvantaged") that PRC companies tend to ignore or hide.

Isn’t that logically correct? If China become banned from west, why should west become welcome in east?

my 0.02$

The temporality is reversed, i.e., If the West becomes banned from China, why should the West welcome China?

China has been doing this for many years, it's just very rare for any official document from inside the PRC to acknowledge this publicly.

Same stuff, no difference in my opinion.

In your opinion, if you were any other country but China, what would you do if China blocked your country's companies from competing fairly in China?

Block them too of course.

Ideally, both countries would support open trade and trust each other.

“Ideally” as in if China was actually trustworthy?

Sure, though, keep in mind, from the PRC perspective, the US is not trustworthy either. More generally, when it comes to security, the PRC generally does not trust liberal democracies, as they view them as a threat / opposing their government. Of course, nearly all tech, outside of the PRC, comes from liberal democracies.

I think most Americans support free trade and have benefited from it for the most part (Consumers and outsourced mfgs have at least temporarily, as China as unloaded products artificially cheap into the US). We are a global economy but we are not in another sense. China has been playing unfairly for L O N G time and though it hurts, the Trump administration is doing the right thing with the trade war. Free trade needs to be fair trade and China has bee manipulating and cheating America for way too long. The standards the US uses in tech are generally universally applied in most every other country. China has finally got its hand caught in the cookie jar. They need to fess up, wash up and play fair.

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