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Telecom's China Syndrome

Light Reading

The inclusion of Huawei Technologies Co. Ltd. as a primary supplier for in BT Group plc's (NYSE: BT; London: BTA) 21st Century Network initiative is being viewed a huge step forward into the global marketplace for China's top telecom vendor – and other Chinese telecom vendors by extension.

There's no doubt that Huawei is making exceptional progress in its efforts to enter the international telecom arena, and that China's other big equipment vendors – UTStarcom Inc. (Nasdaq: UTSIE) and ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763) – are branching out beyond their home market as well.

The emergence of China's Big Three is ratcheting up the fear, uncertainty, and doubt among established incumbent vendors – and there's no denying that a clear and present danger exists, especially for vendors that have slipped into the second tier of suppliers. Buyer perceptions of China's telecom vendors continue to improve, as demonstrated in the 2005 Telecom Equipment Market Perception Study published this spring by Heavy Reading; and the ability of China's vendors to compete aggressively on price can seem limitless.

But there are, in fact, limits to how far China's vendors can go in their price aggression, as the latest edition of Light Reading Insider makes clear. In fact, after a thorough analysis of financial and operational data for China's Big Three, we identify several factors that may ultimately work against these vendors in their efforts to become international players.

Regarding price competition, the biggest advantage that China's vendors hold over suppliers from established markets is its significantly lower labor costs. But how big is that advantage, exactly? We worked the numbers for Huawei, UTStarcom, and ZTE and found that the labor-cost advantage is not as vast as their price-cutting would suggest.

While Chinese vendors often set their prices 25 to 50 percent below incumbent vendors' to win reference customers abroad, the cost advantage held by China's vendors on the labor front is significantly less than that. This report confirms the general view that China's vendors are sacrificing profitability for market share.

Clearly, they cannot continue to do so indefinitely: It's not in their best interests, nor in the interests of the Chinese government, to subsidize foreign telecom carriers. Moreover, as China's vendors increase their sales and marketing personnel in industrial markets, their labor-cost advantage will begin to deteriorate. The bottom line is that the Chinese cannot indefinitely rely on a low-cost strategy to seize business in developed markets.

The problem for Western vendors right now is figuring out a way to withstand the immediate threat from China's telecom suppliers without engaging in a suicidal price battle. Which markets and product sectors are Chinese vendors best positioned to compete in, and which incumbent vendors are at greatest risk from that competition? We managed to uncover some interesting vulnerabilities for each of China's Big Three in terms of product portfolios and market positions – even within their home territory.

One weak spot is wireless infrastructure. Even in their home market, Huawei, UTStarcom, and ZTE combined have managed to win only around 10 percent of the mobile infrastructure contracts awarded to date. As incumbent suppliers of analog systems, Ericsson AB (Nasdaq: ERICY) and Motorola Inc. (NYSE: MOT) have remained the dominant wireless vendors in China. On the GSM front, Nokia Corp. (NYSE: NOK), Siemens AG (NYSE: SI; Frankfurt: SIE), and Alcatel (NYSE: ALA; Paris: CGEP:PA) all succeeded in winning share before Huawei and ZTE launched competing products.

China's big vendors – and particularly Huawei – certainly have a solid opportunity to establish themselves in the global telecom market. But at present, incumbent suppliers still have a chance to defend their turf.

— James Crawshaw, Contributing Analyst, Light Reading Insider

China’s Big Three Vendors Take On the World, a 36-page report in PDF format, is available as part of an annual subscription (12 monthly issues) to Light Reading Insider, priced at $1,350. Individual reports are available for $900.

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User Rank: Light Beer
12/5/2012 | 3:14:49 AM
re: Telecom's China Syndrome
This is a great topic that needs exploration. The arguments presented thus far make sense from a typical business point of view. Having not seen the full report, I am wondering if Light Reading has a section that deals with the fact that we are not necessarily talking about a typical business operation when we are talking about any major Chinese company, whether it is involved in telecom, automobile manufacturing, etc.

For all of the openness in China--and there has been a lot on the economic front--we are still dealing with a country in which the State either plays a significant role in parts of the economy or can easily do so if wants to. And I am not talking just about heavy regulation or control over what is and what is not allowed to be transmitted over the Internet. I am talking about the continuing role of centralized management of the macro-economy by technically proficient bureaucrats in line with the major modernization goals traced back to Deng XiaopingGăÍs reforms.

The gist of DengGăÍs Four Modernizations plan was to increase ChinaGăÍs economic strength and accelerate modernization across four key sectors G㢠agriculture, industry, science & technology, and the military. This modernization effort relied in large part on increasing foreign trade with industrialized countries in order not only to generate hard currency but to permit China to purchase advanced machinery and technologies from the U.S., Japan, and Europe.

Fast-forward to today, and we see professionals raised on a healthy diet of DengGăÍs enlightened Communism running the show. In the view of this outsider, the original Modernization program and follow-on plans have been remarkably successful in fueling ChinaGăÍs economic growth, helping the country gain access to virtually every technology imaginable, and increasing ChinaGăÍs economic and geopolitical influence throughout the world.

If we are to understand what is happening in Telecom, we must understand there is a much larger game at play here G㢠and the telecom vendor executives in Shenzhen understand they are playing by different rulesGă¬even if no one else does.

So, what should we expect?

Chinese vendors will continue to be brutally aggressive on pricing in order to gain footprints in the worldGăÍs major operators even if these means they operate with little or no profit for a very long time. Folks must remember, patience is a more highly valued virtue within the Chinese culture, and we can be assured these vendors have a longer term view about what they are doing. They donGăÍt just want to establish trophy customers. Their goal is to gain ground, hold it, and watch their top-heavy competitors crumble. And crumble they will G㢠as long as the currency exchange rate favors China and government policy makers stay on the sidelines and let market forces run their course.

If you consider the possibility that there is at least minimal coordination and planning among government officials and executives in ChinaGăÍs telecom sector, then there very well could be two additional motivations for being brutally competitive in trying to establish a foothold in major telco networks.

First, it is unmistakably clear that major Western vendors have little tolerance for pain and are quick to cry uncle when they start losing money. When they cry uncle, there is nearly a 50/50 chance that they will outsource R&D and other business functions to China. In effect, there is a bit of Lenin at play here, as the capitalists sell the rope by which they would be hanged. As vulnerable Western vendors ship more and more technology into China, the Chinese workforce will gain greater experience and make increasingly sophisticated products and solutions. Over time, they will sell more & more platforms into Western and other world markets, with or without partners. In this environment, the only solace the Western vendors can take is the fact that Chinese vendors currently are lousy at marketing and also initially will need some help on the customer service front. Over time, they will gain ground in both these areas.

Second G㢠and here is where folks need to consider the geopolitical environment G㢠it can only serve ChinaGăÍs longterm strategic interests if its products are deployed in the worldGăÍs major communications networks. LetGăÍs be clear. From the standpoint of everyday communications, it really shouldnGăÍt matter whether a network is built on with Huawei, Nortel, Alcatel, Marconi, or Lucent equipment, as long as it is reliable. But if there ever is a crunch period say 10 or 15 or 20 years out, and China happens to become engaged in a military conflict for any reason, understanding where equipment is deployed, how it operates, and what its vulnerabilities are can be very important in gaining the upper hand in information warfare or in taking down a countryGăÍs communications network.

Fred Flintstone
User Rank: Light Beer
12/5/2012 | 3:14:48 AM
re: Telecom's China Syndrome
One interesting area to explore is the products themselves manufactured by Chinese vendors.

Most "Western world" telecom vendors used to develop for years very expensive, strong, robust products for incumbent operators (good old time of PSTN networks, X25 technology, ...). Where telcos were investing with ROI of 10 to 20 years, in many cases subsidied by the local governments (before regulations went to liberalize this market).

Now things have changed, uppon competition & financial pressure telcos are looking at 2 to 3 years ROI, cheaper products, where time-to-market is more important than quality. No one cares anymore that a telco box will last for 20 years...
Chinese vendors understood this pretty well, and learned to develop faster & cheaper products.

Actually, achieving a similar level of quality as incumbent western vendors (ok, maybe in 20 years their products may break first...).

This translates into different product design, "cheaper" hardware, more optimized for cost & fast delivery components layout on cards, quicker software architecture design (better make something which works than something nice).

There Chinese vendors defintly have a cost advantage at a product level, giving them more room to discouns/dumping.
Since most western incumbent vendors are already outsourcing a lot in china and india, the labour cost difference is maybe not the most important criteria.
User Rank: Light Beer
12/5/2012 | 3:14:38 AM
re: Telecom's China Syndrome
FYI...Reuters just issued a report noting that the U.S. Treasury has issued its toughest warning yet on China to deal with the currency issue. Any appropriate response on the part of the Chinese govt is likely to take quite a while, given their recent comments, but there appears the possibility of some relief within the next year or so if the US Congress keeps up the pressure and the European economies continue limping along.

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