The Long March for Chinese Handsets
By Eric Ransdell, Thu Jul 10 11:30:00 GMT 2003

When China's domestic manufacturers find the mainland too competitive or are faced with a huge oversupply of inventory, they go abroad...

Only a few years ago consumer electronics giants such as Sony, Panasonic and Taiwan's LG dominated the Vietnamese television market. But that was before Chinese manufacturers targeted Vietnam after facing fierce competition and huge oversupplies at home. Though their televisions were not as innovative, they were every bit as good in terms of quality control. Today most of the televisions sold in Vietnam are cheap, but well-made Chinese imports. And the big foreign vendors find themselves struggling in a market they once took for granted.

From refrigerators to rice cookers, the story is the same. When China's domestic manufacturers find the mainland too competitive or are faced with a huge oversupply of inventory, they go abroad in search of new markets. In the last few months, three of China's biggest handset manufacturers - TCL, Ningbo Bird and Kaijian - have found themselves in just that situation and their response has been to begin exporting to Hong Kong, Vietnam, Thailand and the Philippines. Though they are still finding their feet in these new markets, industry analysts are already beginning to wonder if this doesn't herald a new chapter in the worldwide battle for handset market share. A chapter that may well be entitled: MADE IN CHINA.

If their performance on the mainland is any indicator, the big foreign handset manufacturers should be very worried indeed. On the mainland today, according to China's Ministry of Information Industry, domestic manufacturers control almost 50 percent of the handset market. Though independent analysts put their market share in the 35-40 percent range, that's still a huge slice of the world's biggest handset market for a domestic industry which, for all practical purposes, didn't exist five years ago.

Surprisingly, China's leading handset manufacturers didn't gain their huge domestic market share by underselling their foreign competitors. Cheap labor makes them ultra-competitive. Yet when Ningbo Bird, for example, tried to capture the low-end of the China market, they were beaten back by Nokia and Motorola, who lowered prices on two- to three-year-old mainland-manufactured models still in inventory.

Instead, Ningbo Bird and other mainland players began targeting the mid- and high-end sectors of the market with models whose designs were outsourced to Korean, Japanese and European firms and whose price-points were actually higher than their foreign competitors. With fashionable models advertised by some of Asia's biggest pop stars, such as Taiwan's Coco Lee, the mainland players hit upon a strategy that will serve them well in other Asian markets where consumers care as much about a handset's appearance as the technology inside.

The No-Tech Advantage

Technology, or the lack thereof, is what makes China's handset manufacturers such fierce competitors. With few exceptions, almost none of China's 40-odd handset manufacturers spend a significant amount on research and development. Instead, they wait for foreign firms to develop new technologies and then incorporate them into their own models through licensing agreements or outsourcing . "Technology is no longer a barrier because the value chain of handset manufacturing has disintegrated," says Dongming Zhang, an analyst with BDA China in Beijing. "It's not like in the past where Nokia and Motorola developed everything from the most basic software to chipsets. Now you can purchase chipsets from one supplier, designs from another, and components from yet another."

Adds Kenneth Leung, founder of Hong Kong's Irwin Capital: "The Nokias and Motorolas have to keep innovating to stay competitive, while the Chinese can just follow what they do. They're fast-followers, similar to the Taiwanese on the PC side. Basically they just do a little bit of R&D, see what other people have done and follow very closely. And that's a huge difference in terms of cost."

A pro-active government intent on developing a handset-exporting economy gives mainland players another clear advantage. Last year, for example, when the government issued licenses to manufacture CDMA handsets for China Unicom's new network, 18 of the 19 licensees were domestic players.

Beyond that, the government negotiated a master royalty agreement with Qualcomm that applies to all domestic manufacturers and is much lower than that paid by the Koreans, who make the bulk of the world's CDMA handsets. As a result, in any given market Chinese-made CDMA phones already have an in-built cost advantage over their Korean competitors.

Domestic manufacturers' distribution networks also give them a huge advantage on the mainland. Unlike the centralized systems used by foreign vendors, many domestic players use a more regional approach, hiring local people and aggressively using incentives to get retailers to push their handsets. That strategy could work well in Southeast Asia, particularly for huge Chinese conglomerates such as TCL and Haier, who already have distribution networks in place for their televisions, refrigerators and other consumer items.

But will they Play in Peoria?

While Southeast Asia is up for grabs now that the Chinese are entering the market, the larger question is how mainland manufacturers will fare in Europe and North America? The biggest obstacles Chinese companies face is a system where handset manufacturers work closely with operators on everything from standards to sales. In China and the rest of Southeast Asia handset manufacturers have almost no contact with operators, which puts them at a definite disadvantage in Europe and North America, whose operators subsidize huge percentages of the handsets sold.

And though low or no spending on R&D gives them a definite cost advantage, that could also prove to be mainland manufacturers undoing in more mature wireless markets where the name of the game is innovation. "Everybody in the world wants cheaper phones," says Irwin Capital's Kenneth Leung. "The difference is that in Asia and China it's just a phone, whereas in the rest of the world it's the technology that matters." Which is why many analysts believe Chinese handset makers will be tough competition as fast-followers, but it will be some time before they threaten to take the lead.

Eric Ransdell is the former Silicon Valley Bureau Chief for US News and World Report magazine. Now living in Shanghai, he covers mobile technology in Asia.