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China's Innovation Deficit

Robert Clark
News Analysis
Robert Clark
4/9/2014
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Huawei CEO Ren Zhengfei and his senior colleagues liken their firm to BMW. Huawei needs to constantly adapt to remain relevant as new opportunities and rivals emerge, in much the same way as the auto giant is being directly challenged by electric car manufacturer Tesla.

But if Huawei is going to be disrupted by a startup, that threat won't come from the Chinese's giant's backyard.

China makes more telecom equipment than any other country, has thousands of experienced engineers, a huge domestic market, and a hyperbolic technology startup scene.

But none of those startups are making telecom networking equipment or creating a business primarily focused on network operators, while Huawei Technologies Co. Ltd. and ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763) clocked up $34 billion in sales of equipment and services to operators in 2013, close to a third of the global total.

Virtually all of the world's telecom startups, in hot sectors such as SDN, NFV, telco cloud, small cells, and smart antennas, for example, are in North America, Western Europe or Israel's so-called Silicon Wadi.

Interviews with analysts, industry executives, and VCs turned up just one recently formed, privately held supplier of operator networking solutions, seven-year-old Autelan, which sells carrier-grade IP WiFi to service providers and business.

The absence of aspiring telecom vendor startups is not because of a lack of interest in China or in Chinese hi-tech. Intel Capital , for example, one of the world's most successful corporate VC arms, has 314 startups in its portfolio, of which 25 are in telecom networking and 19 are in China -- but there is no overlap between those two sub-groups.

The pattern is repeated in other VC operations, foreign and domestic. DCM has 38 investments in China, but none is in its communications or infrastructure portfolio. Yet of its 44 Internet startup investments, 17 are Chinese. China-based outfits, such as AngelVest, China Equity Group, and China Broadband Capital, have all steered clear of comms infrastructure.

The prime reason for this disconnect is most likely the closed nature of the domestic services sector. China's 1.3 billion telephone users are served by just three telcos -- China Mobile Ltd., China Telecom Corp. Ltd., and China Unicom Ltd. -- whose priorities lean more toward continuity and building at scale than differentiation.

Milly Xiang, IDC China senior research manager and head of telecom practice, points out that the three operators put onerous qualification requirements on suppliers, such as company size and assets. Huawei and ZTE take advantage of that entry barrier to build out end-to-end solutions, she adds. They also have learned to "follow quickly in terms of the emerging areas such as small cells, really leaving limited opportunities to smaller startups."

Such an arrangement also gives the incumbent vendors massive market power.

One venture capital firm executive told Light Reading that Huawei in particular had attacked newcomers aggressively, often giving away their products for free, so no-one tries to break through any more. "After a while, no-one bothered. There are some really small players around mesh and indoor wireless, but that's about it," he said.

The absence of telecom networking startups contrasts with the fervor in the consumer and Internet markets, involving hundreds of well-backed firms and epitomized by the forthcoming Alibaba IPO.

While the size of the consumer opportunity dwarfs the carrier gear sector, that can also be said of North America and Europe, and yet they continue to foster startups in areas such as SDN or wireless-based fiber alternatives.

Telecoms infrastructure is not the potential bonanza it used to be but it still attracts money and talent. For example, DAS firm Mobilitie LLC last year raised $100 million to make Rutberg's list of top five funded startups. (See The Best-Funded Mobile Startups of 2013.)

There's an irony here. Huawei began selling security alarms and PBXs and bootstrapped itself into today's global powerhouse. But there is no path for the next Huawei: Entrepreneurial engineers laboring in research labs in Shenzhen or Shanghai are better off trying their luck in Silicon Valley or Boston.

For all China's ambitions to be a tech superpower, its industry structure ensures it is a technology follower in the one sector where it should be able to claim leadership.

— Robert Clark, contributing editor, special to Light Reading

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SachinEE
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SachinEE,
User Rank: Light Sabre
4/12/2014 | 11:09:14 AM
Re : China's Innovation Deficit
I would rather call it monopolization instead of massive market power. Qualifications like size and assets are just not understandable. It means that if, by luck, you are already the big player, and you can provide equipment of any quality because the operators don't consider quality as a qualification. They just put emphasis on size and assets.
brookseven
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brookseven,
User Rank: Light Sabre
4/11/2014 | 7:06:10 PM
Re: Great article, but are you surprised?
Gabriel,

I agree with your comment about sector's and change.  Which is why I have posted this.  Essentially my point is that startups mattered at one time and from what I can see they marginally change the industry today.

Not that startups don't add value or push things along, but that this notion of a gap in China is true and not true.  China has lots of startups outside of telecom.  The number of telecom startups has dwindled dramatically over the past decade.  The market at the carriers has gotten less friendly to startups.

China has an original innovation gap as most new types of products come from other places.  China has challenges and advantages in other areas.   It is not obvious to me that China has a startup gap in telecom that is meaningful.  Mostly because I think the telecom startup has become less meaningful over the last 30 years.  You have cited your examples in this last post....compare them to Cisco.

seven

 
Yulot
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Yulot,
User Rank: Moderator
4/11/2014 | 11:33:07 AM
Re: Great article, but are you surprised?
@ Gabriel: Yes, it is really representative of Europe, where it is the only answer operators have found to high competition on relatively small mature markets and a combination of relatively high capex/opex and fast decreasing revenue.

In the US, the ARPU is still high (though you could argue it does not particularly reflect innovation or quality -> moved a couple of years ago from Europe and never paid so much - probably 3 times more - for such a low throughput/high latency, etc), the competition probably more oligarchic on a huge market that is willing to pay.

To come back to start ups and regional differences, there is also something unique in the USA (and Israeli start ups have also understood this and make use of it): the access to investment is way more straightforward than in Europe. Does not always need to be a VC as such, there are plenty of very rich individuals ready to give what is enough for a start up to get going, because they have deep pockets and understand that business is about risk taking and too long and granular RoI analysis is detrimental to momentum. In Europe, it would be way more formal, slow and investors would screen you forever to analyse their hypothetic RoI than over here and would take too much of your equity share, etc.

This is really a massive boost to creation.

 
Gabriel Brown
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Gabriel Brown,
User Rank: Light Sabre
4/11/2014 | 6:47:28 AM
Re: Great article, but are you surprised?
@brookseven Agreed that it's not the same landscape as it was, but would you expect it to be?

You could argue that innovation in telecom today is coming from without -- say, virtual networking.

Examples of smaller companies innovating in networking might be Tail-f Systems, Affirmed Networks, ContexTream, Niciria (acquired).

Bridging SDN, data center, and telco networking is a promising avenue for start-ups (and innovation in networking in general). And it's not necessarily one-way traffic. Telecom can make a contribution in the reverse direction -- control-plane scalability and resiliency are sometimes offered as examples.

Sectors mature. Things change. The world moves on.
Gabriel Brown
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Gabriel Brown,
User Rank: Light Sabre
4/11/2014 | 6:26:08 AM
Re: Great article, but are you surprised?
"The way operators structures have recently evolved is also compounding this trend. In Europe in particular, with the bi-yearly restructuring going on at most large operators, the typical employee profile there has evolved from the subject expert to more that of a manager. I am caricaturing, but there is some truth in this: a good manager typically does not possess the required depth of experience to be able to conceptualize a totally new paradigm. Again with the restructuring trend, decision makers are more risk averse."

That's a good summary of European telcos. I wouldn't say it's across the board, because, of course, there are still many subject matter experts. And there is diversity between telco organisations. But as a directional comment it rings true (especially the reorgs).
Yulot
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Yulot,
User Rank: Moderator
4/10/2014 | 3:19:50 PM
Re: Great article, but are you surprised?
@ Brookseven: There you go!!! Completely agree and your choice of companies is to the point. Companies like Cisco are also acquiring relevant start ups all the time and thereby recognize their contribution to their own strategy (Starent is a good example).

The profile of a start up may or not bring a new paradigm. Starent has not invented GGSN and SGSN, but they did a better job at focusig on application delivery and QoE than the existing vendors that had products, but were perhaps too stuck in their voice view of the network. A bit like Apple did not invent the mobile phone, nor did it invent mobile data, but the industry was not taking data seriously, Nokia was surfing their glory and the i-phone just used what was there, but with the ambition of becoming something the market had never seen.

My view is paradigm changes are challenging because human nature is such that it always wants to explain the future based on what they know best: the past. I have worked for start ups and when you have a product that is based on a too different approach or a new paradigm, operators will love to talk about it, but in the end most of them will default back to what they know best or looks like what they are used to. In addition, new paradigm can be too steep a revolution, with impacts on operational processes and organisational structure/politics.

The way operators structures have recently evolved is also compounding this trend. In Europe in particular, with the bi-yearly restructuring going on at most large operators, the typical employee profile there has evolved from the subject expert to more that of a manager. I am caricaturing, but there is some truth in this: a good manager typically does not possess the required depth of experience to be able to conceptualize a totally new paradigm. Again with the restructuring trend, decision makers are more risk averse.

Then beyond the technological developments and offerings, there is cash flow mismanagement, founders arguing between themselves and investors, etc... I guess this explains why 90% of them fail, even if they often have a good idea to start. But as the French say: you have to break eggs to make an omelet.
Yulot
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Yulot,
User Rank: Moderator
4/10/2014 | 2:27:03 PM
Re: Great article, but are you surprised?
@ Brookseven and Mitch

Government intervention has been the key to their incredible success/growth; at least for most of the first 2000 decade.

We are not in real economics and business rules here. We have a communist government that has enabled a seemingly private company to operate at loss for numerous years to buy itself a market share and become a global player. This in conjunction with the industrialization of IPR piracy and all sorts of reverse engineering/cut and pastes. And to make it more successful, the government was threatening the likes of Ericsson that if they would sue them, they could forget selling anything in China.

It surely solves the need of starting up or acquiring a company and taking on board the significant business risk that goes with it. They have done it at a scale such and with so much success that the operators trust them today to be able to develop any roadmap they propose, which gives them that extra edge. If you have worked for or with start ups, you will notice that selling on roadmap is increasingly difficult for them in comparison with 10/15 years ago.
brookseven
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brookseven,
User Rank: Light Sabre
4/10/2014 | 2:24:58 PM
Re: Great article, but are you surprised?
 

So, just to be clear I thought I would throw out some older startups and then folks can reconsider whether the newer ones are impactful.  Of the newer ones Starent seems like a contender for impactful for me....but to my list:

1 - Cisco:  Need I say more?

2 - Ciena:  Anybody else really jump start an entire segment?

3 - Tellabs:  Anybody want to argue that the TITN DACS was one of the greatest products of all time?

4 - Juniper:  See Cisco

5 - Qualcomm:  How would the wireless business be different?

6 - Huawei:  Yeah, think about that one a bit and then add in ZTE

I think what I am driving at is that the kind of startup that really shifts the game in telecom (and I think there are more) is much bigger than many that get mentioned.  Let me use my classic counterexample:

7 - Adtran:  A great company, but really didn't change the landscape.

I am simply asking the community here, if the market we are in has moved away from transformative change at this time.  If you want to think of a model, try reading Thomas Kuhn's "Structure of Scientific Revolutions".  This is where paradigm shifts comes from in our language.  He defines new paradigms and normal science.  I believe we are in a market cycle of "normal science" not of a paradigm shift.  The reason to me is people and the scale of operations at carriers.  I think that the existing large carriers are going to struggle with transformative change, even if they really want to do so.  

So, I hope I have provoked some thought and made some people at least uncomfortable with this conversation.

seven

 

 
Gabriel Brown
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Gabriel Brown,
User Rank: Light Sabre
4/10/2014 | 11:31:45 AM
Re: Great article, but are you surprised?
On the other hand, think about something like Cloud RAN. This technology is being driven by Chinese operators and vendors. It's a huge effort that is potentially a true game-changer in terms of the mobile network architecture.

Arguably, this type of innovation can only be achieved through long-term development programs sustained by large companies or government-backed research.
Mitch Wagner
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Mitch Wagner,
User Rank: Lightning
4/10/2014 | 10:59:21 AM
Re: Great article, but are you surprised?
R Clark - "Even if not successful, startups play an important role in focusing dedicated resources on problems - it's that different path to innovation that China is missing out on."

Dedicated resources to problems = competitive pressure forcing entrenched companies to change strategies?
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