Optical components

Forum Airs China Questions

The pros and cons of becoming a player in China’s fast growing optical components market were aired yesterday at Asia Forum 2004, a seminar held on the eve of the Optical Fiber Communication Conference (OFC).

China has become an offshore haven for low-cost manufacturing. Offshoring is unique neither to China nor to optical components, of course (see Headcount: Offshoring, Dude!). But China's low-cost labor pool is particularly attractive for components, which often rely on manual assembly.

At the same time, the country is emerging as a promising consumer of components, a factor that's drawn companies such as Oplink Communications Inc. (Nasdaq: OPLK) and Salira Optical Network Systems Inc. to shift the bulk of their operations there (see Oplink Goes for Outsourcing, Salira Gets Another China Deal, and Salira Gets New CEO).

"Because of pricing pressures, [foreign companies] are moving their operations to China or partnering with Chinese partners," said Austin Na, CEO of O-Net Communications (ShenZhen) Ltd.. Na gave this sample scale of China strategies:

Table 1: The China Plan
Level of Involvement Examples
100%: "Totally" Chinese operation with foreign incorporation Fiberxon (incorporated in California), Oplink
50%: Manufacturing in China, core R&D elsewhere AFOP, Finisar, JDS Uniphase
30% Some manufacturing in China, most operations kept at home Avanex, Fujitsu, Hitachi
The "Don't Know" model Many others
Source: O-Net Communications

The country's ambitions extend beyond low-level outsourcing, too, as an influx of optical experts, driven by the dotcom boom, is helping to make China a potential R&D hub, Na said. As noted at last year's Asia Forum, dozens of components firms are congregating in areas such as the Pearl River Delta region.

And Chinese firms are beginning to sell into foreign markets. Fiberxon Inc. received 95 percent of its revenues from China in 2002, but that figure fell to 50 percent last year and should be around 30 percent this year, said Jack Lu, vice president of marketing.

Then there's Avanex Corp. (Nasdaq: AVNX) founder Simon Cao, who is gathering a consortium of companies to deliver materials and manufacturing for the components industry. Greater China Photonic Solutions (GCPS), which includes Cao's own Arasor Corp., is debuting at OFC this week (see Cao Unites Chinese Components Vendors).

The IP Question

Beyond manufacturing, components companies are hoping to license intellectual property into China. That brings into play China's legal system, which has a reputation -- somewhat justified -- for being convoluted and unfair, said Howard Chao, a partner with O'Melveny & Myers LLP and head of the law firm's Asia practice.

Contracts, for example, don't mean the same in China as they do in the United States. They require several stages of approval and a seal -- an actual dipped-in-ink seal called a "chop." Foreign companies must register with the Chinese government; otherwise, the contract is worthless.

Chinese companies also have restrictions on what they can promise -- some aren't approved to make deals with foreign companies, for example. "You should not assume the company you're dealing with can sign a license with you," Chao said.

After surfing the bureaucracy, there's the matter of wringing the money from the contract. Most Chinese firms prefer to pay in three stages, with payment coming only after certain parts of the job are completed satisfactorily. If the foreign company is small or desperate, the three-staged plan gets awfully lopsided.

"We have seen payment terms like zero-10-90 [no initial payment, 10 percent during the project, 90 percent after completion] or even zero-zero-100," said Rick Li, vice president of technology management and strategic planning for Salira.

Then there's the occasional dispute. While fears of intellectual property theft often get raised, China has plenty of laws covering trademark and patent protection, Chao said. The problem is that the laws aren't always enforced the way companies would like (see US to China: Do You Copy?).

Companies should insist on an international arbitration clause, Chao said. "A lot of people have been disappointed with the domestic arbitration apparatus in China as well as [with] the domestic courts in China," he said. "The court system is controlled by the government and ultimately by the Party, and there are inevitable situations where the court system will listen to the government or the Party if it's a matter of national policy."

That doesn't necessarily happen "for malicious reasons or evil reasons," Chao pointed out. Nor does the government always side against a foreign company. Chinese companies have lost unfair decisions, too, he said.

The twists of the Chinese system are scaring away some businesses, including one O'Melveny semiconductor client. "Even though the primary market for their product is in China and they can get low-cost manufacturing there, they've decided to put their manufacturing in Japan," Chao said.

— Craig Matsumoto, Senior Editor, Light Reading

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