Last spring, Google abruptly shut down “Isolated Region,” an initiative aimed at providing cloud services in China and other politically sensitive markets. The decision, which was first reported by Bloomberg, surprised some analysts because it ran counter to Google’s efforts to grow its cloud services globally to compete with Amazon and Microsoft. 

But in other ways, Google’s decision made perfect sense. While China’s cloud market is already massive, it is also notoriously hard to break into, since foreign firms operate under strict government oversight and are required to form a joint venture with a Chinese firm. 

“It’s a very protected market, so any provider that is trying to make inroads into the China region is required to have some kind of partnership with a China-based provider,” says Sid Nag, vice president in the technology and service provider group at Gartner, the research and advisory company. “That becomes a challenge because they’re not free to operate the way they operate in every other region.”

As a result of these regulations, companies like Google, which also decided to pull its search engine operation out of China in 2010 due to censorship, are restricted from competing against China’s home-grown internet behemoths. Alibaba Cloud, a division of the Alibaba Group, is the country’s dominant player, controlling over 44 percent of the market, while Huawei and Tencent each hold a 14 percent share, according to data from Canalys, a technology market analysis firm. 

Despite those restrictions, Microsoft and Amazon, two of America’s leading cloud service providers, have entered the market. In 2013, Microsoft’s cloud division, called Azure, formed a partnership with 21Vianet, a Chinese data center services provider. And in 2016, Amazon Web Services followed by striking a deal with Beijing Sinnet Technology, a Chinese internet services company.¹Amazon originally entered the cloud business in China and then, after Beijing tightened control over the space, had to make a deal with Beijing Sinnet, which involved selling some of its computing equipment. Under these agreements, the Chinese partner owns the data center infrastructure and conducts all the client facing operations, while the foreign firm owns and licenses the intellectual property, and shares some of the revenue. 

“This is done very specifically to relegate foreign firms to the back end of the house,” says Nigel Cory, an associate director covering trade policy at the Information Technology and Innovation Foundation, in Washington. “Thus denying the foreign firms the ability to build business and integrate their cloud services with other services they would naturally offer as a part of their suite of services. This is what they do in the United States and other markets and is obviously a critical part of their business model.” 

There are several reasons for this setup, analysts say. First, Beijing has grown increasingly suspicious of American technology companies, particularly after Edward Snowden’s revelations back in 2013 showed that some American firms have cooperated with U.S. government intelligence and surveillance operations around the world. And secondly, Beijing —  for competitive reasons — is eager to bolster the capabilities of Chinese firms.

And the strategy seems to be working. Though Amazon is a top player in the broader Asia Pacific cloud market, according to Canalys data, it only holds 6 percent of the Chinese cloud market. 

Globally, cloud computing has not penetrated the factory floor as quickly as the office park, and China is a valuable source of use cases for cloud with operational technology.

Trey Herr, the Atlantic Council

Amazon, Google and Microsoft each declined to comment for this article. But analysts say the three American companies are frustrated, not just because they lack access to the world’s biggest and fastest-growing major internet market, but also because the joint ventures may leave them vulnerable to IP theft and security breaches. They are also likely missing out on a wealth of new cloud innovations developed by Chinese firms, which they could then apply and capitalize on in other markets. 

“American cloud companies see value in the Chinese market, particularly for potential adoption by manufacturing and engineering firms,” says Trey Herr, director of the cyber statecraft initiative at the Atlantic Council. “Globally, cloud computing has not penetrated the factory floor as quickly as the office park, and China is a valuable source of use cases for cloud with operational technology.”

The U.S. government has made an issue of these restrictions. After the Trump administration touched off a trade war, U.S. negotiators pressed Beijing to grant American firms better access to China’s cloud market. And in 2017, 50 U.S. lawmakers even sent a letter to Cui Tiankai, Chinese ambassador to the United States, complaining about the challenges American cloud companies faced doing business in China.

But all of this agitating was for naught, as the recent round of trade negotiations did nothing to address the cloud issue. The two countries completed a Phase One deal that involves substantial agricultural purchases in January. But digital and tech issues were put off until a Phase Two negotiation, which many experts worry will never take place, given the U.S.-China political tension.

Foreign cloud providers may be given more access in the future, experts predict, but only after the domestic Chinese market is already locked up by local players. This is what happened in the electronic payments space, which was also a point of contention in the trade negotiations. Paypal, for example, was recently granted a license to operate in China, but now has to compete against the entrenched duopoly of Alipay and Wechat Pay. 

The reason American cloud services like Amazon and Microsoft are clamoring to enter the Chinese market is due to its sheer size and growth rate. “China is the second largest market in the world, behind the U.S.,” says John Dinsdale, chief analyst at Synergy Research Group. “Among the handful of leading country markets in the world, it has by far the highest growth rate.” 

The growth of the Chinese cloud market this year is unique in two ways, according to Blake Murray, a Canalys research analyst focusing on cloud and cybersecurity. The Covid-19 pandemic has accelerated trends towards digitalization, forcing many companies and educational institutions to transfer operations to the cloud. And this summer, China announced a new infrastructure plan, which will shell out $1.4 trillion over six years on digital infrastructure, including cloud services. 

“We’re seeing the impact of Covid all over the world, to different scales in different countries, but in China, that new infrastructure initiative is unique,” Murray says. “The Chinese cloud service providers are really leaning into that right now and using that to help them expand.” 

In April, Alibaba made a commitment to spend $28 billion on cloud computing over three years, and a month later, Tencent announced it would spend $70 billion over the next five years on new infrastructure, including cloud computing.

With the infusion of investment, Chinese cloud firms are honing their technology and expanding both in the Chinese market and the global market. Alibaba and Tencent both have cloud data centers in the U.S., and Tencent announced in 2019 that it was aiming to increase its overseas cloud revenue by four to five times in the next year. 

Though American firms still dominate globally, Chinese firms are gaining traction, especially in neighboring regions like Southeast Asia. “They’re definitely behind right now,” says Larry Carvalho, research director for International Data Corporation’s Platform as a Service practice. “But in the long term, there is no reason why they should not be able to catch up.”

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