Two big risks for Facebook in China

Chinese Internet Czar Lu Wei's high profile visit to Facebook founder Mark Zuckerberg's office this week is just the latest signal that China is engaging Western tech firms, but on its own terms.

Despite — and perhaps in part due to — criticism that the Chinese business environment has become more hostile to foreign firms, the visit hints Facebook may soon achieve its goal of re-entering the 1.3 billion person market. Along with the successful IPO of Alibaba and China's recent World Internet Conference in Wuzhen, a Facebook venture in China would signal to the World that China's internet is open for foreign business. But a closer examination suggests China is carefully defining and controlling its engagement in the world.

Caution signs
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The World Internet Conference was a chance to invite many of the leading global tech firms to be a future part of China's Internet market. But its motivation was to legitimize policing over the Chinese Internet while seeking the right to shape global Internet rules. On the domestic front, control of the Internet is broadening and deepening. Foreigners are welcome to try to partake in the commercial spoils of the market in return for deference to the government in China (and informal lobbying support in their home countries). At the conference, Lu argued "We cannot allow those who capture a share of the Chinese market and make a lot of money, but hurt the interests of China."

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This comes only a few weeks after President Xi indirectly told the New York Times to look to its own media coverage to understand the newspaper's difficulty getting visa's for its journalists to visit China. While to be fair the rules of the game in China have always been understood, they have perhaps never been articulated so clearly in public. Internationally, China wants not only a voice in how the Internet is shaped and regulated, but symbolically to redefine the default cultural norm that the Internet should be free and uncensored.

In this context, the media's focus during Lu's visit to the Facebook headquarters understandably centered on Zuckerberg's prominent display of Xi Xinping's book on his desk and his sharing it with executives to help educate them about China's economic system. The parallels to Chinese cadre sessions where party members meet to discuss the latest writings of the leadership were unmistakable to Chinese observers (and raised more than a few eyebrows). For many observers, the prominent Chinese news coverage suggests Facebook will be invited to enter the market, albeit only with a platform closely implemented and monitored by the Chinese government.

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For firms like Facebook, China presents two risks. First, not only does the Chinese market remain a very difficult one to crack, but favoritism toward domestic firms could quickly reappear if the firm is too successful. While the Alibaba IPO was a smashing success and a well-deserved source of national pride, lost on many was that the initial motivation was largely to buy out Yahoo's ownership stake in the firm. Also easily forgotten was the unusual VIE structure which gives foreigners a stake in the profits of the firm without actual ownership.

Meanwhile actual control resides with Jack Ma and a network of close associates (not unlike Facebook or Google's shareholding structure). Along with the success of Tencent in messaging and Baidu in search, it cements the primacy of Chinese firms in their home market. For Facebook, too much success present political dangers, even as Zuckerberg's charm offensive appears to set him on the long path to earning old friend status with Beijing.

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Second, in answering the siren call of 1.3 billion potential users, the firm risks alienating its global user base. Chinese tech firms not only live under the rules set by the government, but open their entire systems to government control — and even allow censors to physically operate out of their offices to enable full government control. Even for a famously younger generation of global Facebook users willing to share online, the firm's close partnership with China will create both reputational risk and privacy concerns.

Commentary by Joe Foudy, a clinical associate professor of economics at the NYU Stern School of Business. He teaches courses on Asian economies, international management and Chinese business and foreign relations.