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Hello, China?

Kitty McKinsey - April 01, 2002

Sections:
More than idle chatter
Don't call them clones
Looking ahead to exports

Elaine Ho is the kind of customer domestic and foreign cell-phone


makers are fighting over in China. The successful 28-year-old was an early adopter of the mobile
phone, which she finds essential in her work as an English interpreter in the city of Zhaoqing, in the
booming southern Guangdong province. But from her first mobile phone purchase in 1995, she's
turned her back on Chinese-made phones in favor of imported handsets, even spending close to one
month's salary on her most recent Panasonic model. booming southern Guangdong province. But
from her first mobile phone purchase in 1995, she's turned her back on Chinese-made phones in
favor of imported handsets, even spending close to one month's salary on her most recent Panasonic
model.
"It's a good investment," she says. "For me, quality is much more important than price. If you buy a

cheaper phone, it breaks in a short time, but a quality phone you'll have for a long time."
Boosting quality so local producers can dominate the Chinese handset market quickly is a key goal
of the Chinese government. While domestic makers' share of China's handset market is only 13% to
15% today, the government has set an ambitious goal of 80% by 2005. Key to meeting that goal are
U.S. makers of digital-signal processors (DSPs), which have been busily seeding the market by
promoting their processors and reference designs. Intel, Texas Instruments, Motorola, Analog
Devices and Agere Systems all are pushing their chips and designs in this burgeoning market. As
Chinese manufacturers become more skilled, they obviously are looking further down the road to
exporting to the rest of the worldperhaps in competition with the multinational giants that are
helping them now.
In many ways, what's happening in the handset market is a replay of earlier developments in the PC
market. "Ten years ago, all the PCs were designed, assembled and sold by U.S. companies," notes
Joe LaValle, director of sales in Asia Pacific for Intel Corp.'s Communications Sales Organization in
Hong Kong. "Then the design was done in the United States and manufacture shifted to Taiwan.
Before you knew it, Dell and Gateway stopped all design activities and the original design
manufacturers [ODMs] in Taiwan did all the design. Then the manufacturing shifted to China.
"The PRC [People's Republic of China] phone market is clearly the hottest market in the world," says
LaValle. Santa Clara, CA-based Intel now sells flash memory to Chinese handset makers and helps
local OEMs design products through its Intel Wireless Competency Center in Beijing. Intel plans to
enter the Chinese baseband market soonit won't specify a datewith its own chipset and
reference system for a General Packet Radio Service (GPRS) handset. Intel's baseband chipset,
which includes a DSP, will capitalize on Intel's expertise in data, while competing DSP makers'
strengths lie in traditional voice transmission, says LaSalle.

More than idle chatter


The allure of China for Western companies is no mystery: China's Ministry of Information Industry
(MII) reports that the number of cell phone users soared from 83 million at the end of 2000 to 145
million at the end of last year, making it the fastest growing market in the world. For much of last
year, China was adding five million new cell phone subscribers every month, according to MII
figures. Although the number of new subscribers is beginning to level off, with a population of 1.2
billion, China will remain the world's largest handset market for a long time. And it will play an
increasingly important role on the world stage. More than a third of the world's mobile handsets
could be manufactured in China by 2005, predicts MFC Insight, a Beijing telecommunications
research consultancy. Specifically, Chinese handset production will rise from 80 million in 2001 to
232.8 million in 2005, out of a predicted world total production that year of 681.2 million units,
according to MFC's forecast.
Because no Chinese companies make DSPs, the brains of a wireless handset, U.S. DSP makers are
competing aggressively in China. They aim both to encourage indigenous Chinese handset
production and to satisfy their multinational customersMotorola, Nokia Corp. and Telefon LM
Ericssonwhich dominate the Chinese market and increasingly are transferring production to the
country.
"There are a lot of [Chinese] companies interested in getting into the handset market," says Zhou
Zhen-hong, chairman and managing director of Agere Systems (Shanghai) Co. Ltd. (Agere is the
former microelectronics division of Lucent Technologies.) Currently 24 Chinese companies are
licensed by the Chinese government to produce Code Division Multiple Access (CDMA) handsets,

Global System for Mobile Communications (GSM) handsets, or both, although not all have started
production (see table, below). Agere has targeted only two or three Chinese handset makers, "so
that leaves a lot of room for the other [DSP] companies," says Zhou.
Schaumburg, IL-based Motorola Inc., which manufactures both semiconductors and cell phones, last
summer began licensing to Chinese customers all the technology needed to build a basic mobile
phone. Its i.250 (pronounced eye-dot-250) platform is billed as a "comprehensive silicon-to-software
solution" for building 2.5G GSM GPRS wireless handsets. It consists of chips (including Motorola's
DSP56621), the design layout for the computer board, software, development tools and testing tools.
Motorola says this approach reflects a realization that the basic technology to build a mobile phone
is so standardized that it no longer differentiates a company. "No one can compete by saying 'my
GSM is better than your GSM'," says Stephen Tsao, senior technical marketing manager for
Motorola Semiconductors' Asia Pacific Wireless and Broadband Systems Group in Hong Kong.
Motorola will compete by offering advanced features and designs, he says.

"One year ago, the local OEMs were basically manufacturing off the manufacturers
reference board. Now some of them are beginning to have their own design capability."
Joe LaValle, director of sales in Asia Pacific, Intel Communications Sales Organization
Motorola won't name the Chinese customers who've bought i.250. "Some of our customers don't
want anyone to know whose platform they are using until they've brought the product to market,"
says Tsao. The only publicly announced customer is Taiwanese competitor Benq Corp. (formerly
Acer Communication and Multimedia Inc.) of Taipei. Benq plans to market the first GPRS phones
based on this platform in the first quarter of 2003, selling them at first only in Taiwan, according to
Alex Liou, a top Benq executive.
Agere Systems is trumpeting success of its own. Beijing's government-owned Capitel Group is
using Agere's semiconductor and software system-level platform for what Capitel claims is the
world's smallest and lightest commercially available GSM phone. About 30% smaller than a business
card when closed, the company's C6088 and C6288 models weigh only about 2.4 ounces each, about
70% lighter than the mean weight of wireless handsets. The models debuted on the Chinese market
in September.
The Capitel models use Agere's Sceptre system-on-a-chip, which integrates the company's DSP16000
architecture, a microcontroller, mixed signal functionality and other circuitry, as well as the Agere
integrated baseband with its W3020 GSM radio frequency chip. The Capitel deal is significant
because "this is the first [Chinese] customer that took our platform and designed their own handset
with their own IP [intellectual property] in it," says Agere's Zhou. "This is our first localized
manufacture and design of the handset."

Don't call them clones


In fact, multinationals acknowledge that the Chinese are doing much more than just cloning Western
designs. "Just cloning and copying for the low-end market is not a model that will work," says Zhou.
"GSM handsets are actually extremely complex. It requires a lot of engineering, testing, a lot of work
to make a usable product." Particularly in China, he says, choosing his words carefully, there are a
lot of "strange issues" in making GSM roaming work, because not all base stations are up to
standard.
While DSP chipsets and platforms sometimes are described as a blueprint to allow an inexperienced
manufacturer to produce a handset in a short time, this really isn't the case, Zhou argues. "Given the
complexity of the handsets today, with several hundred components and millions and millions of
lines of software, I don't think any company can get into the business by cloning a handset."
Chinese manufacturers increasingly are doing more of the complex work for themselves, capitalizing
on a wealth of low-cost engineering talent, DSP sellers in China report. "Before, baseband suppliers
would sell a form-fit reference design ready-to-manufacture to handset manufacturers and they were
modified only slightly," says Intel's LaValle. "One year ago, the local OEMs were basically doing
manufacturing off the manufacturer's reference board. Now some of them are beginning to have
their own design capability. Companies want to have greater control over the products they bring to
market."
Texas Instruments Inc., Dallas, the world leader with 60% of the DSP market, is working with local
Chinese manufacturers to develop their own products. "Our strength is our programmable DSP,"
says Desmond Wong, communications manager for TI in Asia, based in Taipei. "We would like
customers to develop their own features. We like for our customers to have their own IP."
Doug Grant, director of business development for Analog Devices Inc. (ADI), Norwood, MA, sees
Chinese manufacturers becoming more independent and more innovative. "We have seen a very
significant shift that these manufacturers in China want to do their own design rather than taking
someone else's designs." In China, ADI supplies major GSM handset manufacturers with DSPs, RF
chipsets and power management chips. "Our SoftFone chipset supports both ends of the market and
everything in the middle," says Grant.
Even with that advantage, Chinese companies face a challenge: "They've got to take chips from
someone like us and do a complete design of their own, including hardware and software, and then
set up a production line without a lot of guidance from a handset manufacturer," Grant says. "But
they're learning very quickly."
And while many multinationals are moving handset production to China to take advantage of rockbottom labor costs, not all Chinese-produced phones are aimed at the low end of the market. One
manufacturer is turning out an expensive glitzy phone aimed at China's nouveaux richeswith a real
diamond shimmering from the handset cover.
In more significant ways too, many Chinese companies are trying to turn out premium products.
"We're seeing a lot of requests for features that, a year ago, we were only hearing about from the
top-tier manufacturers," says ADI's Grant.
"Chinese manufacturers are stronger in the low-end product range, but they're improving their R&D
to produce better quality high-end products," says Tara Tranguch, an analyst at MFC Insight.

Looking ahead to exports


As Chinese handset makers become more competent and competitive, it's only natural that they'll
look abroad for sales. "Of course, a couple of years from now, indigenous Chinese manufacturers
may want to expand beyond their borders," says Will Strauss, president of Forward Concepts Co., a
market research firm in Tempe, AZ. "Anybody who gets into cell phones wants to look at a
worldwide market."
Doesn't that mean that companies such as Motorola are breeding their own competition in China?
"But we believe there is a bigger pie out there," says Motorola's Tsao. "You can't eat the whole pie
by yourself. There will be a lot of players." What he doesn't say is that not every Chinese consumer
can afford a Motorola phone, so this is a way for Motorola indirectly to get a piece of the action at
the low end of the market. What's more, "as aggressive as Motorola is, we don't have the billions and
billions of dollars to get into every city in China. This is a place where local brands see an
opportunity, and we have an opportunity to help them build up their businesses."
In addition, before Chinese manufacturers reach for the world market, they have some obstacles to
overcome at home. Most observers feel there are far too many domestic producers to survive.
Gartner Group predicts that by 2005, probably only three to five domestic manufacturers will still be
in business. Possible survivors: Eastcom, Zhongxing, Konka, Shouxing, TCL, Kejian and Soutec.
China's acceptance into the World Trade Organization (WTO) also portends a serious challenge to
Chinese producers, if Motorola, Nokia and Ericssonwhich already dominate the Chinese
marketare allowed to compete on a level playing field within China.
For example, despite the support of the Chinese government for local players, the Big Three have
advertising and marketing budgets that local companies can't even dream of. "The local OEMs are
starting to get a little bit of traction, but they're finding it's tough sledding against the big
multinational corporations (MNCs) like Nokia, Motorola and Ericsson that spend million and millions
on marketing," says Intel's LaValle. Just as crucial, he adds, is their volume, the key to making
money in the handset business. "The MNCs produce hundreds of millions of phones, whereas all the
local OEMs together produced just six to eight million last year."
Nevertheless, the government's target is for domestic production to account for 45% of the market
by the end of next year, and ultimately 80% by the end of 2005. "The government hashit their past
goals," says analyst Tranguch. "It can be assumed they will work hard to hit their future
projectionsby whatever means."
Observers would do well to remember China's success in consumer electronics as evidence of what
the Chinese can do when they put their mind to it. In 1990, Chinese color TV companies had
precisely zero market share at home; 10 years later they controlled nearly 100%.
If the Chinese companies come anywhere close to meeting government targets, exports will be the
natural next step. Some observers expect low-end Chinese manufacturers to first target other
developing markets, like India and Malaysia, with simple, cheap handsets. They may also find some
niches in the West; Zhou says some Western companies already have expressed interest in
marketing Capitel's ultra-small, ultra-light phone as a kids' phone in the West. But a more natural
route to the West may be as contract manufacturers for the Big Three. "It probably will work out
better for them to partner with some existing brands," thereby eliminating the need to build their
own international brands, Zhou says.

But Intel's LaValle suspects the Big Three are glancing nervously over their shoulders. "I've got to
believe all of the MNCs are paying very careful attention to the local OEMs," he says. "In some
cases, they're doing ventures to try to share in that business, and in some cases they're looking at
them as serious competition in the world market for five to 10 years down the road."
Then he chuckles and offers some free advice to the Big Three, quoting the title of Intel founder
Andy Grove's best-selling book: "Only the paranoid survive."
Kitty McKinsey is a freelance writer living in Hong Kong. She is a former staff writer for the Far
Eastern Economic Review. Contact her atk.mckinsey@att.net.
HANDSET DEMANDin millions of units
China Global China as % of global demand
1998 11.9

164

7.2%

1999 18.4

277

6.6

2000 44.2

409

10.8

2001 68.9

400-410 16.8-17.2

2002* 87.5

450-480 18.2-19.4%

*Estimate.
SOURCE: MFC INSIGHT
NUMBER OF MOBILE SUBSCRIBERSin millions
China Global

China as % of global demand

1998 24.7

307

8%

1999 43.0

474

9.1

2000 87.6

721

12.1

2001 144

981

14.9

2002* 220

1,220-1,240 16.2-16.5%

*Estimate.
SOURCE: MFC INSIGHT
LICENSED TO CELLMobile-phone producers licensed by the Chinese government
Chinese manufacturers

GSM CDMA

Amoisonic

Beijing P&T Equipment Factory (Capitel) X

China Kejian

China Zhenhua Science & Technology

Dalian Daxian Group

Datang Telecom

Eastern Communications (Eastcom)

Guangzhou Southern Hi-Tech (Soutec)

Haier

HiSense

Konka

Nanjing Postel Telecom. (Nanjing Putian)

Ningbo Bird

Panda

Quingdao Haier Group

Shandong Langchao Group


Shanghai Debtel

X
X
X
X

Shenzhen Konka Group

TCL

Telsda (Lehua)

Top

Xiamen Zhongqiao (CHABRIDGE)

Xiamen Huaqiao Electronics (Xoceco)

Zhongdian Telecom Technology (CEC)

Zhongxing Telecom (ZTE)

Foreign manufacturers
Alcatel Suzhou

Beijing Ericsson

Beijing Nokia

Beijing Panasonic

Beijing Suohong (Sony)

Beijing Zhongling (Mitsubishi)

Dongwa Nokia

Hangzhou Eastcom (Motorola)

Motorola (China)

Panda Electronics (Ericsson)

Philips Sangda

Samsung

SVA (Siemens)

Wuhan NEC

SOURCE: MFC INSIGHT


MOBILE HANDSET PRODUCTIONin millions of units
China Global China as % of global demand
1999 40.9

279.6

14.6%

2000 54.3

462.4

11.7%

2001 80.0

347.4

23.0%

2003* 130.0 481.2

27.0%

*Estimate.
SOURCE: MFC INSIGHT
HOMEMADE HANDSETSChinese companies' percentage of domestic Chinese market for handsets

1999

3%

2000

8%

2001

13%-15% (estimate)

2003

45% (goal)

2005

80% (goal)

SOURCE: CHINA CENTER OF INFORMATION INDUSTRY DEVELOPMENT, A DIVISION OF THE


MINISTRY OF INFORMATION INDUSTRY