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Closing In on ‘Cloud Nine’: China’s Cloud Computing Market Jets Forward

Summary

China’s cloud computing market, while the second largest in the world, remains a fraction of the size of its US competitor. As Beijing continues to prioritize investment in this sector, China’s tech giants will continue to propel the quickly growing domestic industry outwards into the global stratosphere.

In September 2019, before the outbreak shut down industries across the world and introduced the act of social distancing, over 75,000 people gathered in Hangzhou Cloud Town, China, to discuss the latest trends in cloud computing.

Cloud computing was not always popular in China, with the current market coming from humble origins. In 2009, three years after AWS was first founded, Alibaba set precedent by investing in research and development of core cloud computing technologies. Now, more than 10 years later, China touts a globally competitive cloud computing market anchored by large tech players.

Despite the rapid growth of giants like Alibaba and Baidu, the Chinese cloud computing market still lags far behind that of the United States, though the industry will only become more integral as the Chinese government increases its focus on innovating and digitalizing its domestic industries. However, its significance comes with complexities, as China’s domestic companies are heavily protected by Beijing through joint venture regulations and restricted ability for foreign players to store Chinese citizens’ data.

Understanding Cloud Computing Services

There are three main types of cloud computing, each of which has its own distinct range of services and providers: SaaS, PaaS, and IaaS.

Source: The Economic Times, The China Guys

Software as a Service (SaaS)

SaaS is a cloud computing offering where the provider gives direct access to their cloud-based software. Some examples of SaaS include software like Salesforce, Slack, and Hubspot. Rather than installing an application on a local device, the end user can access the provider’s application using the web or an API connection. Through the application, the user can store and analyze data in the cloud, thus saving time and space by bypassing the need to locally install, manage or upgrade software.

Platform as a Service (PaaS)

PaaS is a cloud computing offering where the provider gives access to a cloud environment in which to develop, manage, and host applications. Some examples of PaaS companies include Google App Engine, Microsoft Azure, and Salesforce App Cloud. The user will have access to a range of tools through the platform to support testing and development, and the provider is responsible for any underlying infrastructure, security, operating systems, and backups.

Infrastructure as a Service (IaaS)

IaaS is a cloud computing offering where the provider hosts on-demand access to computing resources such as networking, storage, and servers. Some examples of IaaS companies include Amazon Web Services (AWS), Rackspace, and Google Compute Engine (GCE). Within the providers’ infrastructure, the user can run their own platforms and applications, providing a flexible hardware resource that can scale easily depending on the user’s storage and processing needs.

These computing types can be grouped into three classifications: public, hybrid, and private. A private cloud is a platform through which companies host their own data centers and internet, while companies offering public clouds rent out their datacenter infrastructure. Hybrid contains qualities of both. Alternatively, multi-cloud is a strategy when companies use two or more cloud computing platforms to perform various tasks. Essentially, this is best when organizations cannot fulfill all of their needs with one provider, and can refer to a combination of any of the many cloud platforms listed above. As shown by the chart below, public and hybrid cloud solutions are the most popular solutions by Chinese consumers and offer the most growth potential.

Public vs. Private Cloud Usage in China

Sources: CHYXX.com, The China Guys

China’s Cloud in the Global Stratosphere

Industry at a Glance

China boasts the world’s second largest cloud computing market, though it is only about one-tenth the size of its US counterpart. China’s cloud spending accounts for just a tiny fraction of the country’s total IT spending, and was dwarfed by the US’ US$124 billion cloud budget in 2019. Still, huge market demand and increasing investment in the sector suggests tremendous room for growth in the Chinese market.

Annual Global Cloud Spending

Sources: Statista, The China Guys

During 2019, the country’s cloud infrastructure spending increased by 63.7% to US$ 10.7 billion, making it the second-largest cloud market in the world with a 10.8% market share. Over the past 3 years, China’s public cloud infrastructure market has grown incredibly quickly, from US$1 billion in H1 2017 to US$3.9 billion in Q1 2020, with the industry consolidating around China’s tech giants like Baidu, Alibaba, Tencent, and Huawei.

Top Four Providers Account for 62% of Global Cloud Spending

Sources: Canalys Estimates April 2020, The China Guys

The chart below gives a sense of the current prioritization of traditional IT vs private and public cloud computing, and makes projections of the estimated growth potential of each area. From 2018 to 2023, the public cloud computing market is expected to grow from 31% of IT infrastructure investment to 38%, while traditional IT is expected to shrink by 9% and private cloud is only expected to grow 6%. Evidently, the cloud market has particularly strong growth potential, underpinned by government initiatives and major investment by vendors in infrastructure and human capital.

Projected China IT Investment Composition

Sources: IDC China, The China Guys

Resiliency throughout the pandemic

Unabated by the coronavirus in Q1 2020, China’s number two cloud computing market position held steady, accounting for 12.5% of total global market share. Compared to 10.8% in Q1 2019, the increase highlights the quickening pace of cloud adoption in China as part of the country’s digital transformation process. Alibaba, Huawei, Tencent, and Baidu lead the domestic market with a combined market share of 81%.

China’s Cloud Infrastructure Services Market in Q1 2020

Sources: Canalys Estimates, The China Guys

After accounting for the impact of the coronavirus, the seven largest cloud computing companies in the world are expected to increase revenues and capital expenditure by 36% and 9%, respectively – a decrease of only 0.4% and 3% compared to pre-pandemic estimates. Despite clients facing a likely decline in revenue, this relatively small decrease points to the resiliency of the low elasticity industry.

Why does China lag in capex spending?

The regulatory environment surrounding cloud computing in China is heavily governed, making it less appealing to foreign entrants. For example, foreign cloud providers are unable to compete independently in the Chinese market due to ‘negative list’ restrictions under China’s foreign investment law. As such, international providers are only permitted to offer services in China via a joint venture with a local Chinese company. 

The US Department of Commerce explains that, because foreign cloud providers are required by law to partner with local companies to serve customers, it “raises questions about how much control foreign providers will ultimately have over their partnerships and joint ventures given that their Chinese partners may fully manage daily operations.” As a result, the industry remains insulated from foreign competitors, which means less pressure for growth and innovation.

What will drive growth going forward? 

In a short amount of time, China has emerged as a global leader in data-intensive computing that includes artificial intelligence (AI), the internet of things (IOT), virtual reality (VR), online-to-offline (020) services, smart cars, and online payments. In order to support these new business verticals, China is scaling its IT infrastructure and technical expertise. However, rather than building large new server rooms or hiring teams of technicians to manage clunky IT equipment, companies are instead turning to the cloud to power their business expansion.

Huge private sector investment and strong government backing are rallying behind the growth of China’s cloud computing industry. Domestic firms are working towards China’s Ministry of Industry and Information Technology’s goal of increasing cloud revenues by at least 50% annually over the next few years, which includes a focus on establishing China’s presence in foreign cloud computing markets. In 2020, as much as USD$ 423 billion has already been invested in new projects that will benefit 5G base stations, data centres, industrial internet, artificial intelligence, and more.

As China’s tech sector continues to further develop, the quality of the underlying infrastructure will become increasingly important. As has already been discussed, public cloud adoption has been relatively slow in recent years. However, it is expected that more companies will begin to adopt public and hybrid cloud platforms to keep up with the pace of innovation.

As such, some industries Alibaba specifically names include on-demand video and mobile gaming as well as in areas prioritized by the party, such as smart city initiatives. Given the growing appetite for on-demand video, mobile gaming, and even areas prioritized by the party, such as smart city initiatives, Chinese content creators and infrastructure builders will need to invest in elastic computer service, auto-scaling, content delivery networks, and server load balancers in order to provide uninterrupted service and fast download speeds – all of which can be satisfied through cloud service providers. 

On-demand video

On-demand video has seen a large uptick with the rise of internet streaming platforms such as Youku, iQiyi and Tencent video. China’s revenue in the video-on-demand segment is projected to reach US$2,958m in 2020 via an annual growth rate (CAGR 2020-2024) of 4.2%, resulting in a projected market volume of US$3,490m by 2024. The market’s largest segment is Video Streaming (VSoD) with a projected market volume of US$2,027m in 2020.

Mobile gaming 

The far-reaching popularity of mobile gaming will also require cloud computing services to decrease latency, support HD gaming, and provide a uniform playing experience to improve gameplay. Mobile games generated US$18.5 billion in 2019, up 18.2% from the previous year, and are forecasted to reach US$32.0 billion by 2024. This excludes revenue from mobile game exports, which reached US$6.4 billion, up 21% year-on-year.

Smart Cities

The current dominant form of the smart cities concept, “New Smart Cities,” refers to adopting a new generation of information technology such as IoT, cloud computing, pervasive mobile networks, and big data systems to improve the level of intelligence and automation in urban planning and governance.

President Xi Jinping has voiced his support for smart cities initiatives in his public speeches, going as far as to describe urban internet, cloud computing, and big data infrastructure as on the same level of importance as roads and bridges for urban planning. Xi believes that building “new smart cities” and facilitating enhanced data collection and sharing among state organs will be key to achieving China’s urban management objectives.

Growing Abroad

While China’s cloud computing companies still have room to grow domestically, some are already looking abroad for additional growth opportunities. As of 2019, Alibaba Cloud was the world’s third largest IaaS cloud services provider and the top in Asia for the third year running. Alibaba’s IaaS market share in the Asia-Pacific region increased to 28.2% in 2019, up from 26.1% in 2018, and in the first quarter of 2020, Alibaba Cloud was the only major cloud company to increase its market share (growing from 5% to 6%). Microsoft’s share dropped from 18% to 17%, while Google and AWS maintained their respective market shares.

Sources: CHYXX.com, The China Guys

Tencent, China’s second-largest cloud company, is also an up-and-rising player. Tencent serves more than a million paying customers, and reportedly services 75% of domestic gaming companies through its cloud solutions.

Tencent has forged a partnership with Huawei to develop a cloud gaming platform that will stream games directly to a user’s device, thereby reducing gamers’ hardware requirements (though this requires a high-speed internet connection and powerful streaming servers to ensure a smooth user experience, hence the partnership with Huawei, a major 5G player). The gaming platform will be hosted on Tencent’s cloud infrastructure, and with the gaming market expected to grow at a CAGR of 20% between 2019 and 2025, Tencent is well-positioned to expand along with it – potentially narrowing the gap in market share between Tencent and Alibaba.

Foreign Companies Entering the Chinese Market

How should foreign cloud providers enter the Chinese market?

When first entering the Chinese market as a foreign company, there are several elements to consider regarding regulatory and security concerns, various trade tensions, and of course, the Great Firewall. 

Due to the Great Firewall slowing internet connections, it is highly recommended to work with a China-based cloud infrastructure provider. Because this could expose systems to security vulnerabilities, cybersecurity experts recommend companies segment their China IT systems from their global IT systems as much as possible to shore up any ability for the Chinese government to access research done outside its borders. 

When establishing an IT infrastructure, companies will have both Chinese and Western options. To better understand the process of setting up with a cloud provider in China, companies can refer to a guide put together by Microsoft Azure. This includes a regulatory checklist to ensure things like real name verification for online service users and ICP filings have been completed.

Are there any near-term opportunities for foreign cloud providers in China?

As previously mentioned, there are regulatory barriers in place that prevent foreign cloud providers from setting up storage facilities in China. Chinese regulations require foreign tech companies that want to enter the country to form a joint venture with a local company that holds control over Chinese user data. 

However, US-China trade discussion may lead to more opportunities for foreign cloud computing companies to enter the Chinese market. During trade deal negotiations in 2019, Premier Li Keqiang disclosed a proposal to allow trial operations for fully independent foreign cloud-service providers via a “liberalization pilot” in a free-trade zone. Under the cloud proposal, foreign providers would be allowed to own data centers in the free-trade zone, though they would need to offer adequate “privacy protection” to their Chinese users. The most likely zone is in the southern city of Guiyang, which is a center for big data. However, given the potential escalation in tensions between the US and China during the upcoming election season, this seems unlikely in the near future.

Looking Forward

As potential customers begin to transition away from traditional IT infrastructure and towards cloud computing, these services will inevitably scale to new heights. Looking ahead at the Chinese cloud computing market, onlookers can expect further growth for domestic cloud computing companies as many begin looking abroad for new revenue channels. Foreign players looking to take advantage of this increase in cloud usage, on the other hand, will have to traverse government regulation and privacy restrictions that continue to challenge entrants without a joint venture with Chinese companies.

That being said, the growth of domestic competitors could eventually make it easier for foreign companies to enter the Chinese market, as increased competition would ultimately encourage further innovation in the Chinese cloud computing industry.

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