US to China: Do You Copy?

Chinese companies may be reverse engineering low-end optical components and selling them cheap

May 3, 2002

5 Min Read
US to China: Do You Copy?

Chinese vendors might come to dominate the market for low-end optical components in the not too distant future, and Western vendors are making it easier for them.

The problem is that low-end optical components -- such as simple lasers and detectors, thin-film filters, isolators, circulators, and fiber pigtails -- are labor-intensive, but relatively easy to manufacture. Companies in China are ideally positioned to break into this market because their workforce is skilled, yet labor costs are low.

In the past few years, several prominent Western vendors, such as Agere Systems (NYSE: AGR), JDS Uniphase Corp. (Nasdaq: JDSU; Toronto: JDU), and Oplink Communications Inc. (Nasdaq: OPLK), have set up their manufacturing operations in China, to take advantage of the cheap labor. What happens next, reportedly, is that the Chinese executives hired to set up these factories often leave and set up their own businesses in direct competition with the companies that hired them in the first place.

Thus, Western vendors are supplying the expertise and knowledge that Chinese startups need to compete with them. And that's not all, if this tale from U.K. components vendor Bookham Technology PLC (Nasdaq: BKHM; London: BHM) is representative of how things work in China.

Bookham's business used to be more biased towards low-end active components. "We had found a way of making a high-speed receiver in a mini-DIL package," recalls Andrew Rickman, Bookham's founder and chairman. "We sold it to a customer in China. They bought ten a month, then a hundred, then a thousand. All of a sudden they stopped buying, and when we asked them why, they said, 'Oh, because we've copied it now.' "

"There's a cultural difference," he adds. "They don't see any embarrassment in reverse engineering our products. A Western business would probably do it as well, but at least they'd be slightly ashamed."

Light Reading was unable to unearth any other examples of products being copied, so this could be an isolated incident. Unsurprisingly, some Chinese vendors contacted for this article were not particularly pleased at being asked if they "copied" components.

"We think maybe you have some misunderstanding to Chinese industry," Ellen Jiang, International Sales Manager for Guangzhou City-based Wealth Center Fiber Optic Inc. wrote in an email. "We haven't bought and then 'copied' optical components from the West. We understand quite well that 'copy' here is a word with immoral meaning."

Nevertheless, the fact remains that a huge number of Chinese components companies have sprung up, and many of them seem to specialize in low-end optical components. Furthermore, many of them now have the savvy to make it into the international scene, as demonstrated by the fact that approximately 40 Chinese component vendors took booths at the recent Optical Fiber Communication Conference and Exhibit (OFC).

Some of the bigger and more established players include Hi-optel Technology Co. Ltd., Photon Technology Co. Ltd., and Wuhan Telecommunications Devices (WTD), a joint venture between Corning Inc. (NYSE: GLW) and Wuhan Research Institute. One startup vendor is Accelink Technologies Co. Ltd.

Should Western companies be worried? In Rickman's view, the answer is a resounding yes. "This sector [of the components industry] will become dominated by Chinese and possibly Taiwanese companies," he contends. "They will change it from a premium business to a commodity business."

In Rickman's view, cultural attitudes and a banking system that doesn't expect as high a return on investment make Chinese companies very tricky opponents. Their competitiveness is extreme, he says. "They beat each other up. Not only do they destroy the margins of the companies in the West, they also destroy each others' margins."

Lower prices could wipe out a lot of value from Western businesses, he says. A few years ago, for instance, JDS Uniphase bought E-Tek Dynamics for its thin-film filter (TFF) technology in a deal valued at $15 billion (yes, billion). According to Rickman, TFFs were selling for $1,000 per channel at that time. Since then, prices have dropped to around $400, but Chinese companies can make them for about $50 per channel -- a 20 times price reduction overall. That knocks a big hole in the value of the acquisition.

Not everyone is so worried, however. Ken Brizel, senior VP of business development and strategic marketing at Oplink Communications, says that having its manufacturing located in China has really helped his company during the telecom downturn of the past 12 months. "It's better to be in China," he says. "We have the same labor rates as they do. At least it's a level playing field." He figures that Chinese companies are no more likely to steal ideas than companies in the West.

In fact, he says, more U.S. vendors are likely to relocate their manufacturing in China, because they desperately need to reduce their costs.

Indeed, Brizel seems to applaud the business culture in China. "They have a long-term vision of how to price products. They price them for what they are worth, not what it costs to produce." The Japanese followed this strategy with DRAM memory chips in the early 1980s, he says, and now the rest of the world competes with Japan -- an example that confirms, rather than denies, the threat of competition from China.

The big question is: How do Western vendors compete in such an environment? Bookham's Rickman says his company has now moved its business to high-end components, such as integrated switches and optical monitors. "There's no point manufacturing products that lots of other people do," he says. "All our products today are highly defendable."

Oplink's Brizel says the best protection is to offer a broad range of components. Systems houses are trying to cut down on the number of suppliers they need to qualify, not wanting to buy each different component from a different vendor, he says. For this reason, startups focusing on niche markets will face problems, whether they're Chinese or not.

— Pauline Rigby, Senior Editor, Light Reading

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