China’s Cloud Computing Market: Developments and Opportunities for Foreign Players

China’s cloud computing market is the fastest-growing in the world. It is predicted that the global share of the Chinese public cloud service market will increase from 6.5 percent in 2020 to over 10.5 percent in 2024. Assessing the latest developments in the sector is essential for foreign businesses interested in entering the Chinese market. In this article, we highlight the developments and opportunities for foreign cloud service providers and provide some insight into the current trends in China.

While the pandemic disrupted traditional business activity across economies worldwide, it highlighted the value and competitive business scope of the digital economy.  

In 2020, China’s digital economy maintained a high growth rate of 9.7 percent to reach RMB 39.2 trillion (about US$6.16 trillion), accounting for 38.6 percent of GDP. 

China aims to increase the value-add of digital economy businesses to its GDP to 10 percent by 2025 – as stipulated in the 14th Five Year Plan (14th FYP). According to the plan, the government is pushing the digital transformation of Chinese industries to reach new heights. Beijing also plans to make digital public services more inclusive, so that the governance framework of the digital economy can also improve accordingly. The Chinese government aims to achieve this by increasing its support for 6G research and development and boosting innovation in strategic industries, such as integrated circuits and artificial intelligence (AI).

In this context, cloud computing has emerged as a critical component of digital technology and a pillar of the digital economy. The growth of the public cloud market in the world’s top 35 economies has been closely associated with their digital economic output in the past few years. According to recent data, in 2021, China’s cloud infrastructure services grew by 45 percent to reach US$27.4 billion. The country experienced 33 percent year-on-year growth in Q4 of the same year, reaching US$7.7 billion. Looking at specific Chinese businesses, Alibaba Cloud retained its lead over Huawei Cloud and Tencent Cloud, who came in second and third, respectively, with Baidu AI Cloud coming in fourth place.  

These top four cloud suppliers collectively held 80 percent of China’s cloud computing market in 2021, and all of them have already announced plans to seize growth prospects in industry vertical solutions. Thus, cloud computing is pivotal to China’s growth trajectory, both in terms of the real and digital economy.

What is cloud computing? 

Cloud computing is the on-demand delivery of computing resources, such as networks, servers, and storage, to a sizable number of end-users. Cloud computing uses web-based infrastructure to store information and provide additional computing capabilities, unlike the traditional use of localized general-purpose hardware and servers to save and process data. This process eliminates the need to construct sizable server farms and buy expensive storage systems. Greater flexibility is made possible by cloud-based services because they make information accessible online. Major players in the cloud services segment of the technology industry include Amazon Web Services, Google, Apple, and Microsoft.  

What business models facilitate cloud computing? 

Cloud computing can be facilitated in various ways, including software-as-a-service, infrastructure-as-a-service, and platform-as-a-service. We explain briefly below.:  

• Software-as-a-Service (“SaaS”): SaaS vendors provide a selection of online software programs that customers can access via a web browser. Hotmail and Office Web Apps are two examples of SaaS.  
• Infrastructure-as-a-Service (“IaaS”): IaaS suppliers provide customers access to more computer resources, such as webservers and more storage space. An example is Amazon’s Elastic Compute Cloud, which provides the New York Times with flexible cloud infrastructure to house its material.   
• Platform-as-a-Service (“PaaS”): PaaS providers offer a platform for software development and hosting, enabling customers to design distributed web-based applications. A well-known example is Google’s App Engine.  

Understanding China’s cloud computing  

The China Academy of Information Communications Technology (CAICT; in Chinese: 中国信息通信研究院) released a ‘Security Guide for Cloud Computing Services’ in 2016. The document defines cloud computing as: 

“A model that provides computing resource services through the network, through which customers, on a dynamic and self-service basis, receive and manage the computing resources provided by the cloud service providers according to their needs. Computing resources include servers, operating systems, networks, software, and storage devices.” 

Market size and growth  

In 2020, the total market size for public cloud services in China reached US$19.38 billion, growing at the fastest pace in the world – 49.7 percent – year-on-year. IDC predicts that the global share of China’s public cloud service market will increase from 6.5 percent in 2020 to more than 10.5 percent by 2024. 

The cloud computing industry in China is on a path of sustained and rapid growth. The market for public cloud services is steadily expanding, while that of the private cloud industry is dominated by the hardware sector. Chinese consumers have embraced cloud services and IaaS in particular. Small and medium-sized (SME) businesses, on their end, typically turn to the domestic IaaS market to produce IT resources for areas such as gaming, videomaking, and mobile internet.

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Due to its low cost, rapid deployment, and comprehensive application programming interfaces (APIs) for developers, PaaS services have emerged as a significant platform and the top choice for online firms. The market is seeking to adjust its services from initial search to user application. It does so by requiring services, such as basic search or map tool services, to advance with the use of big data analysis, security monitoring, and other more advanced tools from the standpoint of user application.  

The bulk of demand for cloud computing, however, is driven by SaaS services.  

Estimates predict the cloud infrastructure market in mainland China will reach US$85 billion by 2026, representing a five-year compound annual growth rate (CAGR) of 25 percent. Moreover, the market is experiencing a trend of customer-based diversification, with conventional sectors such as manufacturing, banking, and retail joining the Internet business. Through operational workload transfer and the creation of cloud-native applications, increasing business resilience serves as a major fuel for efforts to implement digital transformation. 

Cloud service providers now have huge market potential because enterprises are investing heavily in digital transformation. However, these initiatives necessitate technological prowess and industry expertise from cloud suppliers in order to meet specific objectives. To fulfill these needs, win over consumers’ trust, and ultimately improve competitive posture, businesses will have to develop deeper trust among channel partners, which is more crucial than ever for them to grow. 

Key players in China’s cloud computing market 

Alibaba Cloud 

With a 37 percent share of the market for cloud infrastructure services as of 2021, Alibaba Cloud retained its first position in China’s cloud computing market. The company increased its market share by 30 percent, propelled by the development of its operations in conventional sectors and long-term consumption pledges from important clients.

Alibaba Cloud also successfully launched the campaign “DingTalk with Cloud”, allowing cloud services to permeate conventional business sectors through the enterprise communication and collaboration platform DingTalk.  

Huwaei Cloud 

Coming in second place, Huawei Cloud grew by 67 percent in 2021, holding an 18 percent market share. Huawei Cloud has always had a position of leadership in this market because of its expertise in government relations. The company is consistently growing its clientele of Internet enterprises as the only “non-Internet” company among the top three providers. Huawei uses its “cloud-to-cloud collaboration” approach to establish itself as a significant partner for clients in China’s Internet industry.  

Tencent Cloud 

Tencent Cloud, the third-largest provider, held 16 percent of the mainland’s market in 2021 and increased its share by 55 percent. The overall growth of Tencent Cloud was consistent and diversified across several industries. The company has begun to diversify its clientele to encompass more established industries as a pan-entertainment industry-focused Internet corporation.

By offering strong big data solutions, it has gained important clients in the government sector, among other areas. Given Tencent’s expertise in gaming, social media, and online commerce, the possibility of metaverse interests will present new commercial prospects in the future. 

Baidu AI Cloud 

Baidu AI Cloud, whose presence increased by 55 percent to hold a nine percent share in the market, is the fourth top player in this space in China. Regulations issued in 2021 affecting the Internet industry at large had less of an impact on Baidu than on Tencent and Alibaba since the company’s business model is primarily centered on online marketing and AI.

To distinguish itself, Baidu AI Cloud blends AI technology with cloud infrastructure services and emphasizes intelligent services. With important victories in the industrial Internet, smart manufacturing, energy, and power utilities, Baidu AI Cloud has selected the industrial market as its primary target potential. 

Regulatory framework and compliance requirements for cloud businesses in China

Since identifying cloud computing as a critical emerging sector in 2010, the Chinese government has strategically invested in and supported China’s growth of cloud computing. When the State Council published the goals of the 12th Five Year Plan (12th FYP) (from 2011 to 2015) for fostering cloud computing, key government departments responded with detailed proposals for how to meet the requirements. Provincial and local governments, research institutions, businesses, research laboratories, and supporting organizations in turn all produced their own development plans in line with the interests of the central government.  

Prior to 2016, there were no specific laws and regulations governing cloud computing services in China. The Ministry of Industry and Information Technology (MIIT) then released a Classified Catalogue of Telecommunications Services 2015 (“2015 Telecoms Catalogue”) which became effective in 2016. The law was then amended in 2019. Although “cloud service” or “computing” are not defined in the 2015 Telecoms Catalogue either, it is widely acknowledged that the phrase “internet resource co-ordination services” (IRCS; in Chinese: 互联网资源协作服务业务) in the catalogue refers to cloud services.  

The definition of IRCS in the 2015 Telecoms Catalogue is  

“Data storage, internet application development environment, deployment, and operation management, as well as other services provided for users through the internet or other networks in the manners of access at any time and on-demand, expansion at any time, and coordination and sharing, by using the equipment and resources built on database centers”. 

Along with the catalogue, the MIIT additionally published the Notice on the Regulation of Cloud Service Market’s Business Conduct (in Chinese: 关于规范云服务市场经营行为的通知) in November 2016. In this document, it is explicitly stated that “cloud service” is one type of IRCS mentioned in the 2015 Telecoms Catalogue. 

Licenses required to operate cloud services in China 

IRCS is a form of Internet Data Center Service (IDC; in Chinese: 互联网数据中心业 务) that is categorized as a value-added telecommunications service (VATS) in the 2015 Telecoms Catalogue. Providing such VATS in China requires licensing. Therefore, the operation of cloud services in China requires a special VATS license for IDC businesses (also known as an IDC license).   

Because all three types of cloud services – IaaS, PaaS, and SaaS – are included in the Chinese definition of IRCSs, each of these cloud services must operate with a VATS license specifically designated for their IDC activity. Some SaaS service types may be operated without a VATS license if they are deemed to be “pure software services” and do not incorporate additional VATS as defined by the 2015 Telecoms Catalogue.  

However, IDC VATS licenses are only available to Chinese companies – or at least, they are more easily accessible to them than to foreign businesses.

Restrictions on foreign businesses 

In theory, foreign-invested businesses (FIEs) can apply for an IDC license per the Provisions on the Administration of Foreign-Invested Telecom Enterprises of 2008 (revised in 2016). However, ever since China’s accession to the WTO, IDC services have never been directly open to foreign investment. As a result, foreign businesses have not been able to receive licensing.  

On the other hand, Chinese authorities have confirmed the eligibility of investors from Hong Kong and Macao for IDC licenses in the separate Closer Economic Partnership Arrangements (CEPA) that China has co-signed with the two special administrative regions.  

Each CEPA agreement enables investors from Hong Kong and Macao to form joint venture companies in China with Chinese investors to offer IDC services. There are no geographical restrictions on the delivery of the IDC services within China, and the shareholding of service providers from Hong Kong and Macao in these joint ventures cannot exceed 50 percent.  

Yet, as of August 2020, only 20 Sino-Hong Kong joint ventures have received the VATS license to operate IDC services.  

Entry strategies for foreign businesses engaged in China’s cloud computing market

Since most foreign businesses are not eligible for the IDC license, they are not allowed to run cloud services in China under their own name. However, foreign companies can turn to several options:  

Joint venture (JV) 

In principle, a JV with a Chinese partner is feasible, especially if the JV is established in accordance with CEPA. However, getting the necessary licenses – notably the IRCS license for cloud computing services – would still be exceedingly challenging in practice.  

Licensing model  

The licensing of a foreign firm’s technology and trademarks to a Chinese partner would be a more practical solution since it makes it much simpler for the Chinese partner to secure the necessary licenses under the name of a local company. The downside is that the foreign side of the business wields little influence over the activities of the Chinese partner.  

Variable interest entity (VIE)  

Under a VIE structure, a foreign investor creates a wholly foreign-owned enterprise (WFOE) in China. The WFOE then signs several agreements with a company that is entirely owned domestically and has an IDC license (the VIE entity) and a few PRC citizens acting as nominee shareholders of the VIE entity.  

Through those contracts, the WFOE can acquire indirect influence over the management of the VIE entity as well as the vast bulk of its income. Importantly, based on this collection of contracts, even though the foreign investor has no direct equity investment in the VIE entity, accounting standards require the consolidation of the financials of the VIE entity. This is significant from the standpoint of a potential future listing.

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Although the VIE structure has been widely utilized in China for 20 years, it is generally thought that under PRC legislation it is in a grey area that is neither explicitly authorized nor forbidden. On January 19, 2015, the PRC Ministry of Commerce issued a draft of the Foreign Investment Law (FIL) for public comment. This draft made it plain that the VIE structure would no longer be allowed to be used as a means of getting around Chinese foreign investment regulations. However, the FIL’s final version (effective January 2020), does not include any rules pertaining to VIEs, placing the VIE structure once more in a precarious position. 

The Chinese government’s attitude towards VIE structures has been ambiguous, and to date, there is no specification in the FIL on whether it is considered legitimate. The use of VIE structures by foreign investors to indirectly invest in IDCs in China could be a target of regulation by the PRC government in the foreseeable future, as a 2020 legislative draft prohibits VIEs in some sectors. Thus, this strategy may, in fact, be less successful than direct equity ownership, even if it grants foreign investors contractual power that is similar to direct equity ownership. Companies are advised to weigh the compliance risks carefully.    

Commercial cooperation  

In other instances, international investors can gain access to the PRC IDC market by working commercially with local Chinese partners who have IDC licenses, generally by using one of two models: the Technical Support Model or the Co-Investment Model.  

The commercial cooperation models provide foreign investors with a relatively simpler and more practical path to investing in the IDC sector in China compared to the JV and VIE structures discussed above. This is because they do not involve a highly ambiguous approval process through CEPA or any “grey area” issues in connection with a VIE structure.  

However, it should be noted that, like the VIE structure, only the PRC business partners (or the VIE entity in the case of the VIE structure), as owners of an IDC License, are able to enter direct contracts with clients and charge them for IDC services. 

Due diligence before investing in China’s cloud computing market 

There are several considerations to keep in mind before investing in China’s cloud computing market besides choosing the right business model and corporate structure. 

Where to invest 

First-tier Chinese cities, such as Beijing, Shanghai, Shenzhen, and Guangzhou, are now home to most IDC enterprises. The authorities in these cities have started to limit new IDC projects or are applying stricter permission criteria for new businesses in their communities, as the market in these locations is mature and becoming saturated.  

Local governments in other regions can be friendlier. Several towns in western and central China even provide preferential tax treatment, among other incentives, to entice foreign investment. Additionally, these locations may have far cheaper rates for some essential resources than first-tier cities, such as land and electricity supplies. Consequently, there is a growing interest among international investors. For instance, since March 2022, Microsoft’s Azure intelligent cloud portfolio in China has doubled its capacity by covering a new North China region. 

Cybersecurity  

In China, the year 2021 turned out to be a turning point for cybersecurity and data protection. In particular, the Data Security Law (DSL) and the Personal Information Protection Law (PIPL) both went into effect in September and November, respectively. The troika of the Chinese regulatory framework for data protection and cybersecurity is made up of the PIPL, the DSL, and the Cyber Security Law (CSL). China is ramping up regulatory efforts in the area of cyber security and data protection. Among other things, these laws impose increasing responsibility on cloud service providers, as they require “network operators” to adhere to stricter security requirements.

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In 2021, the Cyberspace Administration of China (CAC) released further Regulations on Network Data Security Management, implementing portions of the three main laws regulating the Chinese cyberspace, that is the DSL, CSL, and PIPL. The 2021 regulations also include additional restrictions for data processing operations, implementing stricter compliance requirements on businesses than the PIPL does.  

In general, we anticipate that the Chinese government will continue to tighten its enforcement in this area and that stricter and more comprehensive data localization regulations will be established. These data localization rules have forced current cloud computing service providers to adapt to the growing demand for local IDC services on the mainland. 

Conclusion  

Cloud computing serves as the backbone of the new economic infrastructure and the basis for next-generation digital technologies like big data and artificial intelligence. We expect that China will take full advantage of the opportunities presented by technological advancement with cloud computing at its core, quickly closing the gap with the information technology industry in developed nations. Three of the top seven worldwide public cloud IaaS market service providers – Jinshan, Tencent, and Alibaba cloud – are Chinese, according to a 2020 report from IDC. 

At the same time, startup SaaS businesses are multiplying quickly. Internet vendors are leveraging collaborative office tools like DingTalk to provide a platform to offer customers industry solutions. In the next few years, the ecosystem of China’s SaaS market is bound to be refined, and the industry’s service capability will improve rapidly. 

Cloud suppliers in China need to focus on providing higher technical performance while also ensuring data security. The government support for digital transformation resulted in increased cloud adoption in more traditional sectors. Thus, the industry’s future depends in part on conventional businesses adopting cloud services.

In conclusion, foreign cloud providers entering the Chinese market should follow in the footsteps of larger companies, partnering with Chinese firms and learning from their best practices.

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