Siloing and Diversification: One World, Two Systems
This article was originally published in Italian in Class on 16th Apr 2025.
Please note that this is a courtesy translation of the Italian language article originally published on the Class webpage Issue at: https://www.classxhsilkroad.it/news/industria/come-evitare-il-rischio-dell-isolamento-per-le-imprese-attive-in-cina-202504161623344301
European companies face increasing difficulties in perpetuating profitable businesses in China, with a politicised regulatory environment marked by burdensome administrative procedures. For instance, in the Business Confidence Survey 2024, a survey from the European Chamber, only 15 per cent of responding European companies saw China as a top destination for current investments and only 12 per cent for future investments.[1]
In parallel, over the last years, multinationals have sought to diversify their supply chains, with events such as COVID-19, geopolitical tensions, or Russia's invasion of Ukraine. In this context, multinational companies are applying several strategies, relying on both onshoring and offshoring. One strategy that goes one step further is siloing, which is particularly used in China. But what is siloing? How does it apply in the Chinese context?
Siloing refers to the disconnection of a company’s functions or entire operations from the rest of the world in a given environment. It is often to respond to market changes and cope with a changing local and global environment. In the Chinese context, multinationals aim to fully comply with local regulations to be trusted as reliable partners for the local market and continue their business activities.
The rationale for siloing in China brings us back to the beginning of the century when the country aimed to upgrade their industrial capabilities and improve their economy. By the mid-2000s, the idea was to catch up with economic global players such as the United States and Europe by gaining autonomy in specific strategic areas. As a result, China implemented several industrial policies to support domestic innovation backed by domestic and global market share targets for their products.
European companies that choose to silo in China do so because of the economic perspectives that the Chinese market can offer to continue working with local partners and be eligible for China's procurement. Several European Chamber members have already heavily invested in this process so that they look all Chinese-like but by name: they have a localised supply chain, employees, sales, and procurement functions, and have siloed their Research and Development and IT systems. Let’s look at a few examples.
In human resources, companies recruit fewer and fewer foreign nationals to work in China, a phenomenon that COVID-19 has amplified. In a survey from the European Chamber addressed to its members, 1 out of 10 respondents reported not employing any foreign nationals.[2] Relying only on Chinese nationals might have advantages (better local market knowledge, cost considerations, etc.), but it also has its drawbacks. For example, companies witness a more substantial decoupling between headquarters and Chinese branches and difficulty finding local talent. One of the reasons is that many Chinese believe that working for a foreign company would hamper their ability to work later for state-owned companies or government agencies, as they become increasingly cautious of hiring people with experience in a foreign company or who studied abroad.
Regarding data and IT, 23% of companies acknowledged the need to localise their data system due to security regulations and laws put in place by China. It contributes to the continued disconnection between HQs and Chinese branches, but more importantly, it affects companies' efficiency and aspiration for global innovation, ultimately favouring Chinese competitors.
On R&D and standards, many companies have implanted R&D sites in China for different strategic considerations. Yet, risk management is the main reason for establishing R&D sites in China for sensitive areas, as it disconnects global products from Chinese products. This situation might duplicate work and affect innovation, as companies would need new components on top of already functioning ones. Likewise, this disconnection results in global operations not profiting from the Chinese-driven innovation.
Hence, siloing is a serious trade-off: while it might mitigate some issues, it also creates inefficiencies due to duplication of operations, which comes with higher costs and reduced innovation capacity, ultimately affecting companies' global competitiveness. Additionally, even if foreign companies siloed their operations in China, they are not necessarily eligible for China's procurement. Indeed, the requirement to qualify as domestic producers is unclear, which ultimately might penalise foreign companies, even if they siloed their operations. It results in a situation where companies lose on both sides, making themselves easily substitutable while losing their ability to act as global players.
From a Chinese perspective, this strategy seems to work from the outside, supporting domestic competitiveness while disorganising global operations from foreign companies. However, although some companies are eager to abide by the rules, others decide to offshore their operations and move away from China. It ultimately isolates and weakens China's importance as companies' global headquarters will prefer to continue their global operations than silo their operations for one market. Ultimately, it results in a lose-lose situation for Europe and China, which do not reap the full benefits of globalisation.
In a period marked by increasing global trade tensions and protectionist measures from the United States, Europe and China have the opportunity to enhance their economic cooperation. Easing the establishment of European multinationals in China without disconnecting them from their global operations would be a significant step forward. The declarations made by Xi Jinping at the Chinese Economic Forum to open foreign investment and its recent meeting with global CEOs late March show positive signals. However, concrete actions remain to be taken to restore business confidence fully and enable unhampered participation of European companies in the Chinese market.
By: Avv. Carlo D’Andrea, National Vice President of the European Union Chamber of Commerce in China and Chairman of the Board of the Shanghai Chapter，Founder and Managing Partner of D’Andrea & Partners Legal Counsel
[1] European Union Chamber of Commerce in China, European Business in China – Business Confidence Survey 2024, 10th May 2024, https://www.europeanchamber.com.cn/en/publications-business-confidence-survey
[2] See first footnote
