But not in the way most people think.

Sun Tzu, who wrote “The Art of War” roughly 2500 years ago, distilled many military strategies that are studied by both military and business leaders everywhere. One of the more well-known psychological warfare tactics he espoused is called 围三阙一 (pronounced: wei san que yi).

In essence, it means when you are besieging a city or a castle, the best way to defeat your enemy while incurring the least amount of cost is to siege three sides but leave one opening. If all four sides are sealed off, your enemy would quickly grow more desperate and determined to fight back. With an opening available, your enemy would waver between fight and escape, making them either easier to defeat by ambush when they try to escape or more susceptible to surrender when there’s hope to stay alive. 

This tactic is what AI entrepreneurs in China fear the most when it comes to how US technology sanctions would hurt their dreams and ambitions. The founder and CEO of Zhipu AI, Zhang Peng, articulated this view in an interview last month. Others have shared the same view in private. (Zhipu AI is a Tsinghua University spinout foundation AI model unicorn backed by Alibaba, Tencent, HongShan, Hillhouse, Xiaomi, Meituan, and many others. It is often considered the Chinese startup closest to OpenAI, given its deep academic roots and commitment to developing AGI.) 

One of the unintended, second-order consequences of the expanded US AI chips sanctions instituted in early October may be that Zhang Peng and his fellow entrepreneurs in China will have less to fear about this worst case scenario. The sanctions may have become so stringent that it is akin to a complete, four-sided siege with no opening left. Evidence of this is showing up in just how quickly Nvidia’s China business is shrinking.

Nvidia’s China Sacrifice

Nvidia reported its Q3 earnings right before the US Thanksgiving holidays. The main storyline was that its China business, which accounts for 20-25% of its total revenue, may soon disappear. (Fabricated Knowledge has a good summary of the earnings main takeaways.)

In its effort to comply with the new round of US sanctions while still pursuing one of its largest markets, Nvidia is once again developing alternative products just for the China market. However, the key one that’s most relevant to generative AI, the H20 – a lower-performing, more compliant alternative to its H200 series that may perform better than its H100 chips according to SemiAnalysis – is delayed until Q1 of 2024.

It’s hard to predict how well the H20 will sell when it becomes available. What does seem clear is that as these sanctions become more strict, the appetite for Chinese firms to throw money at US-designed chips, even if they are compliant, is shrinking, because the specter of more strict sanctions is now always on the horizon.

That appetite did exist not that long ago. There was a striving “black market” for all kinds of banned or soon-to-be-banned Nvidia chips earlier this year, according to ChinaTalk. Stockpiling A800s and H800s, the once-upon-a-time China-compliant alternatives to the A100 and H100 series, has been an important survival strategy for both big firms, like Tencent and Baidu, as well as startups like 01.ai. In fact, Tencent proactively shared its stockpiling of Nvidia chips on its most recent earnings call, which it claimed would be enough to keep developing its own foundation AI model, Hunyuan, for the next two years. Baidu more or less offered the same assurance during its own earnings call a few days later. 

The strategic “opening” that was leading Chinese firms to still drink out of the Nvidia well, which would’ve been a correct application of Sun Tzu’s tactic, is closing. Rather than a total siege to choke off China from all US-made options, intentionally and strategically leaving an opening would’ve served America’s geopolitical strategy better. It would’ve been the worst nightmare in the long-term for every AI builder in China. Maybe the H20 could still be that opening. But it’s looking unlikely. (Update: one day after this post was published, Commerce Secretary Gina Raimondo spoke at the Reagan National Defense Forum and explicitly called out Nvidia’s new product modification as “not productive.” Looks like any semblance of an “opening” has closed.)

After this current phase of stockpiling is done, Nvidia’s China business will become a sacrificial lamb. The beneficiary of all this is, of course, Huawei. 

Consolidation Around Huawei

The desperation and determination bred from this full-siege technology sanction is embodied in Huawei. This is not to say that Huawei’s own AI chips, the Ascend series, is close to where Nvidia’s products are right now, but simply that Huawei has become the only game in town. There is no more wavering between Huawei and Nvidia.

This direction is starting to show up per Baidu’s recently reported order of Huawei Ascend chips. Baidu buying Huawei chips is remarkable, because Baidu has had its own semiconductor R&D division for a long time, which would’ve been a competitor to Huawei’s chips if US sanctions weren’t an issue. Abandoning its own home-grown division in favor of Huawei’s product is an implicit recognition that domestic competition on critical, choke point technologies is a waste of national resources. Every firm must now consolidate behind the designated national champion for the good of the country.

Huawei is not only receiving implicit support from the purchase orders of would-be domestic competitors. Per Bloomberg’s long piece on the company, it is receiving plenty of explicit subsidies from multiple layers of government, from the usual land and tax breaks, to investments in many smaller suppliers in a vast ecosystem all geared to make Huawei, and China, more self-sufficient. 

Huawei is also doing some smart things to expand its reach and surface area in competition with Nvidia. It recently became a Premier Member of the PyTorch Foundation in order to steward the PyTorch stack, an open source development stack initially out of Meta that competes with Nvidia’s CUDA, to work better with its Ascend chips. 

Huawei’s advancement, showcased in its Mate 60 Pro smartphone, was the big surprise development that catalyzed much of the October expanded sanctions. Was this really a surprise though?  Not according to Jensen Huang, Nvidia’s co-founder and CEO, who said during his interview at the New York Times DealBook Summit that “I don’t think anyone in the industry was surprised…”: 

When asked about the new round of US sanctions that are throttling Nvidia’s China business, Huang was on message, compliant, and paid due respect to the need to balance business growth with national security concerns. But his tone and demeanor was no doubt resigned, ending his answer with “what can you do?” followed by a shrug. 

His resignation was understandable. Nvidia is not getting a dime of subsidy from the US government, while it kills one of its largest markets and billions in revenue. And these changes, while painful to China in the short-term, may end up undermining the US geopolitical and strategic positioning in the long-term. 

If Nvidia has a somewhat restricted but still viable business in China, the US can predictably know how far behind China’s AI computing power is by simply tracking what products are getting sold there – the intentional “opening”. If Nvidia no longer has a viable business there, with the whole market consolidating around the black box of Huawei, there will only be more, unpleasant surprises in the future. 

To truly advance US long-term interests vis-a-vis China, it may serve folks in DC well to brush up on some Sun Tzu.