The two companies have changed the shape of the international telecom supply industry in the past four years and have become known for their effective and efficient R&D processes and competitive pricing. That's resulted in stellar growth, but the global price war it created may finally be catching up with them as profit margins plunge, sources say. (See Huawei 2006 Target: $8 Billion, ZTE Reports 2005, and ZTE Makes International Headway.)
At the same time, new Chinese regulations -- being brought about by international pressure to reduce subsidies -- will reduce tax benefits, forcing the companies to live on fewer government incentives. Details about the potential impact of this emerged in a recent ZTE financial report, in which the company's tax benefits were greatly reduced.
The two companies have engaged in what one industry observer in China has termed "a suicidal price war" -- both domestically and internationally -- that is affecting the profitability of both.
That competition was evident again today (Tuesday), as Huawei announced it has won a deal as "sole winner of a bid to build an IP DSLAM broadband access and broadband bearer Metro Ethernet network" at Greek national operator OTE S.A. ZTE had previously announced several DSLAM deals with the Greek carrier. (See ZTE Supplies OTE, ZTE Wins Greek DSLAM Contract, and ZTE Lands OTE DSL Deal.)
The observer, who wishes to remain anonymous, believes the increasingly tough pricing pressure under which the duo put each other contributed to a decline in Huawei's operating profit margin in 2005, which fell to 14 percent from 18 percent in 2004, while ZTE's operating profit margin edged up only slightly to around 8 percent. (See Table 1 for Huawei and Table 2 for ZTE.)
Table 1: Huawei Key Financials, 2002-2005
|All figures in US$ millions||2005||2004||2003||2002|
|Cash flow from operations||708||396||385||311|
|Operating profit margin||14%||18%||19%||10%|
|Cash and cash equivalents||883||1,101||Not stated||Not stated|
|Source: Huawei Annual Report 2005|
Exchange rates used by Huawei in its annual report 2005: US$1 to RMB8.07 for 2005, and US$1 to RMB8.27 for 2004
Table 2: ZTE Key Financials 2002-2005
|Figures in US$ millions||2005||2004||2003||2002|
|Operating profit margin||8.30%||8.20%||8.60%||9.50%|
|Cash in banks and on hand||696||949||not known||not known|
|Source: ZTE annual report|
Exchange rate used to convert ZTE results into US$ is $1 to RMB8, the current exchange rate as of 18 July 2006
Huawei's annual report, audited by KPMG International , shows that Huawei's cash reserves fell during 2005 to $883 million from $1.1 billion at the end of 2004.
That competition is particularly fierce in the vendors' domestic market, which is worth billions in revenues to the duo. In 2005, the Chinese market accounted for just more than 42 percent of Huawei's total revenues of nearly $6 billion, while domestic business accounted for 64 percent of ZTE's 2005 revenues of $2.7 billion.
International competitors have also experienced the sharp end of that battle. One vendor executive noted during this year's Globalcomm tradeshow in Chicago that his company couldn't compete in China even if it offered to sell its equipment at zero profit margin.
Reports from China suggest this is having a significant impact on Huawei, and that the vendor initiated a cost-cutting program earlier this year, including a freeze on new staff hires.
Huawei denies this. "We are in a stable and healthy condition," says Huawei spokeswoman Sharon Chen in an email response to our questions. "Huawei did not specifically initiate a cost reduction program at the beginning of this year," she says, adding that reducing costs is an ongoing strategy at the company, and one that has "enabled us to become more competitive."
Chen also says that Huawei has not frozen hiring, domestically or internationally. "In fact, our workforce has consistently increased throughout Huawei’s history. Especially in 2006, our workforce has increased rapidly, and currently new recruits are joining our team daily."
In March 2006, Huawei had 40,000 staff, 10,000 of which were based outside China. In mid-2005, the company said it had "more than 30,000" staff, up from 24,000 at the end of 2004. (See Huawei Plans to Triple Euro Business.)
Huawei does admit that its gross margins are "narrowing" as technology becomes more commoditized. "As a leading player in the industry, Huawei has experienced the effects of this trend and considers it a normal industry phenomenon," notes Chen.
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