Innovation comes to China's telecoms equipment makers

China's telecoms equipment makers are rapidly becoming innovators in their own right, according to E&T.

Finding symbols of national business success was a much easier affair back in the days when the world was physically global but economically local.

Today, you could think of Apple, Intel or Microsoft as examples of successful American companies; or RIM and its famous BlackBerry as Canadian icons; Nokia as offering typical Finnish finesse; or Sony as Japan's best-known consumer electronics manufacturer.

Trouble is, a substantial proportion of Apple's Macs, iPods and iPhones, Intel's motherboards, Microsoft's Xboxes, RIM's BlackBerries, Nokia's mobile phones and Sony's PlayStations are actually made in China by Foxconn, a Taiwanese-owned contract manufacturing firm.

China has established itself as the undisputed manufacturing centre of the world, especially for all things electronic. Shifting manufacturing operations to high-tech industrial parks in low-wage Asian locations has become a norm for Western-based hardware vendors with multi­national reach.

Consumers have got used to the 'Made in China' label that invariably comes with their new computers and TVs. Yet, deep down, they may suspect that there isn't much Chinese about the core creative and engin­eering processes that went into the design of these products.

Each new iPhone may well be assembled and tested in a Chinese factory before it is shipped to its final destination. But the radical idea of doing away with a physical keypad and replacing it with a more intuitive user interface on these devices is a 100 per cent Californian innovation and development.

The question is: can Chinese equipment manufacturers move up the value chain so that one day they come up with the next iPhone? After all, isn't this more or less what Japan so successfully did over half a century ago when the gradual transfer of know-how from American industry triggered a progression from technology imitation, to technology improvement and finally onto independent innovation?

At least in the telecoms sector, there are clear indications that they can. Both at the network infrastructure and user device levels, a growing number of Chinese telecoms equipment vendors are not only producing but also designing locally.

"They're not just copying," says Sylvain Fabre, research director of carrier network infrastructure at Gartner. "They are also bringing real innovation, and not just to the telecoms sector but also to the wider consumer electronics space."

Challenging the incumbents

If there is one company that shows how far Chinese telecom equipment engineering has come in only a matter or years, it is Huawei. Established in 1988 as a humble distributor of imported PBX (private branch exchange) products for the local market, this still privately-held vendor has grown to become one of the world's largest network infrastructure players.

Nadine Manjaro, a senior analyst at ABI Research, points out that while in 2005 Huawei held only 5 per cent of the global wireless infrastructure market, last year the vendor had sales of nearly $18bn. "As a result, the firm moved into third place with 12.5 per cent of the wireless infrastructure market. This is an extraordinary achievement," she says.

While market leaders Ericsson and Nokia Siemens Networks can still proudly claim the top two spots, Huawei's impressive growth means it is now a larger player than Alcatel-Lucent, Motorola or the struggling Nortel Networks.

"Following a couple of years when it was perceived mainly as a player that was going up the rankings (first within China, then in emerging markets and slowly going into more mature markets starting with their famous BT 21 Century Network contract win in 2005), Huawei is now an established vendor," Fabre notes.

In January this year, Nordic operator TeliaSonera awarded the Chinese company part of the contract to build what will be one of the world's first commercial cellular networks featuring long-term evolution (LTE) technology. The service will initially be available in Oslo and Stockholm from 2010.

"LTE is the next generation after 3G, so we're talking about the company having developed cutting-edge technology for mobile infrastructure networks which is practically ready to be deployed today," says Fabre. "Huawei has gone up from being a challenger competing on price (and they're still cheaper, by the way) to being really a leading player, an innovator."

By September 2008, Huawei had filed more than 32,000 patent applications. The company, which holds around 7 per cent of the essential patents for UMTS, claims it will own between 15 and 20 per cent of all essential patents for LTE.

"I think Huawei has certainly put a lot of time and effort into R&D," says Fabre. "It remains to be seen for how long they'll continue to have relatively cheaper R&D labour. In the meantime, they are innovating. We get feedback from some operators who claim that, sometimes, they find Huawei to be even more innovative in terms of roadmaps than other established vendors."

A smaller but equally rapidly growing telecom infrastructure vendor is ZTE. Based in Shenzhen, this Chinese equipment manufacturer has been making headlines since it joined the list of the world's ten largest mobile phone vendors in 2007. Already at number six in this category, ZTE's stated goal is to become the third largest handset maker by 2014.

The company claims to spend 10 per cent of its annual revenues on R&D, an area in which it says 40 per cent of its workforce is involved. ZTE has 14 R&D centres distributed across Asia, North America and Europe.

Much of the research work carried out by the vendor is done in collaboration with Western companies such as Alcatel, France Telecom, Microsoft, Ericsson, Intel, Qualcomm, Texas Instruments and IBM. It's an ideal way for ZTE in particular, and the new breed of Chinese telecom equipment makers in general, to acquire the know-how that they will need to compete at the top end of the market.

Native innovation?

With around 700 million active users, China is by far the world's largest mobile phone market. It certainly is big enough to make companies such as Qiao Xing Mobile Communication (QXMC) happy to concentrate only on catering for this domestic demand.

QXMC, whose products are mainly sold under the CECT brand name, may be virtually unknown outside of China. But from the R&D labs of this GSM handset maker a technology has recently emerged that shows just how big the potential for home-grown innovation can be in China. The company developed what it calls 'ultra-long standby' technology. Already applied to some of its phones (such as the C8000), a single charge of the battery will keep these handsets running on standby for an astonishing 125 days, according to QXMC.

But what many in the West are asking is: how can we be sure these types of breakthroughs are truly home-grown? A number of industry observers have expressed concerns about the integrity of intellectual property rights (IPR) in China.

"You hear these rumours from time to time," says Fabre. "China is a difficult place in terms of IPR, with very little enforcement in place. The government claims they're now more serious about this issue, but it's going to take time. This is going to be an ongoing issue for all companies."

In 2003 Cisco filed a lawsuit against Huawei, accusing the Chinese vendor of having stolen Cisco's intellectual property to develop a line of routers and switches. After 20 months, the American networking giant agreed to drop the case in exchange for a promise from Huawei to modify the design of the products in question.

Unlike ZTE, which is now a public company listed on both the Hong Kong and Shenzhen Stock Exchange, Huawei can afford the luxury of revealing only partial information regarding its finances. So, when Huawei undercuts rival bids from European or North American competitors by up to 40 per cent for the supply of certain telecom gear - as some operators have admitted has frequently been the case - there's no clear way of finding out how exactly the Chinese vendor manages to do that.

Lower R&D costs, as Gartner's Fabre mentioned, are certainly one of the tactics that Huawei employs. What many suspect - but no one has been able to prove - is that the Chinese government has been providing a helping financial hand.

"Huawei doesn't have to report to the Street on a quarterly basis; it doesn't have to demonstrate profitability," says Fabre. "So it's possible that they are able to accept deals that others would walk away from. And I think they'll continue to do that."

What's in a name?

As China's communications hardware vendors keep on gaining market share around the world, Fabre believes they're still short of one vital piece of the jigsaw: "All they lack is maybe the development of stronger brands," he says."But they will also do that, and their R&D will certainly be part of that."

If you're not fully convinced by the arguments of those who pontificate about the value a brand has in a company, consider for a moment the difference between the terms that Apple, on the one hand, and ZTE, on the other, have each agreed with the cellular operators that welcomed their mobile phones to their line-ups.

In every country where Apple decided to market the iPhone, Steve Jobs was able to not only handpick the operator it wanted to work with but also deny the resulting 'contract winner' the right to stamp the carrier's logo on the slick device. In some cases, Apple even negotiated a share of the traffic revenue generated by the handsets.

Then you have ZTE USA, which, as Forbes magazine recently reported, is "trying to build up its brand by asking US carriers to allow a ZTE logo on its phones".

Even if all goes according to plan for the new breed of Chinese telecom equipment vendors, there will be new challenges to confront as their global footprint increases. "What's going to be interesting to see as they keep on winning businesses and expanding beyond their home base is how well they manage the delivery aspects and support issues," Fabre wonders.

"It's one thing to win your business; it's another thing to actually deliver successfully and maintain a support infrastructure. The more stuff that goes into the rollout of a network, the more resources it takes in maintenance, in fixing bugs and similar issues."

It's the kind of challenge that comes with success. Success that, in a global economy, can be dangerously deceiving.

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