The Bottom Line:
Telecom talk, with Alain Lejeune (TLC Communications, BlackBerry Mobile Division): In this Chinese markets insight, Alain Lejeune explores past, current and future developments in China’s Telecoms market. From the rise of a market to the development of a truly globalized telecommunication industry strategically supported under the “Made in China 2025” efforts, Mr Lejeune tells a fascinating industrial story built around innovation, forward-looking anticipation, daring business models and far-reaching investments. In case you wondered what global (and Chinese) telecoms are about, this insight is a must read.
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China’s Telecom markets: a structurally globalized industry?
[By Alain Lejeune]
To fully understand China’s current position in the telecommunications sector, it is necessary to trace the evolution of this industry over the past thirty years and to consider the prospects for the future.
The starting point was the creation of the GSM standard in the late 1980’s by a European consortium (“Groupe Spécial Mobile”, in French in the text). By then, the GSM technology was designed to allow decoupling the network from the terminal. This allowed the cost of terminals to be reduced very quickly by facilitating the modularisation of the technology, the emergence of specialists per module (semiconductors, software, antennas, etc.) and thus helped to generate rapid economies of scale since the terminals were standardized and could operate on all networks.
The European companies behind the technology (Alcatel, Nokia, Ericsson, Siemens, Philips, etc.) and Motorola, a member of the GSM consortium, were the main beneficiaries of the global development of mobile networks until the mid-2000s. As far as network equipment was concerned, the market was divided between Alcatel, Ericsson, Siemens, Nokia, and Lucent, Nortel for the United States. For mobile phones (there were no such things as smartphones at the time), the leaders were Nokia, Samsung, LG, Motorola, and Ericsson. There was little to say about Chinese technology at the time, however.
Some Chinese brands existed, yes. But they were seen as “local kings” at best, or as inferior quality brands at worst. But things changed, eventually, and in the mid-2000’s two developments significantly reshuffled the cards, at the expense of European actors.
The rise of a Chinese Telecommunications market.
On the one hand, the standardization of technology (standardization maintained through the GSMA association) and the rapid development of the Chinese technology helped with the emergence of a Chinese market.
New strategic players appeared, focusing on specific parts of the system (network or terminal), and providing innovative solutions at lower costs (this is particularly the emergence of Huawei, ZTE, TCL, etc.). Furthermore, the size and growth of the Chinese market combined with pro-technology policies on the Chinese government’s side of things led to the creation of a very complete ecosystem
To some extent, this ecosystem supported Western companies that established local production and R&D in China. Nonetheless, the creation by the Chinese government of a China-specific standard for 3G (TD-SCDMA) essentially gave local actors an advantage and a major incentive to invest in R&D for domestic markets.
At that time, Huawei and ZTE were developing their technological capacity very rapidly, at a pace comparable to that of the major European and American players – which were also slowed down by repeated restructuring linked to a slowing market in Europe and the United States. Things then started to change.
New standards have appeared.
On the other hand, the arrival of the iPhone and its revolutionary interface, followed by the massive deployment of 4G networks, enabled the advent of the mobile Internet.
The creation of Android by Google, one year after the launch of the iPhone, created the conditions for a very rapid and massive development of smartphones thanks to the development of new business models. Not only did Android offer a turnkey software solution, this Operating System – or OS – also had the advantage to be free. The only condition was to respect the constraints imposed by Google for the installation of its own services, a business model which allowed Google / Android to grow very quickly, within an ecosystem of applications that positioned it as the only alternative OS to the iPhone.
In reality, these new “technological building blocks” standards also created the conditions for the rapid development of China’s leading smartphone brands (Oppo, Vivo, Xiaomi, Huawei, TCL…), simplifying R&D and lowering costs through new economies of scale.
The ecosystem and supply chain that developed in China in the field of telecoms allowed, through a very strong integration of the various players, a massive reduction in production costs and an increase in the efficiency of R&D processes. As a result, the development cycles of new products was almost halved between 2000 and 2010 (the development time of a new mobile phone typically goes from 18-20 months to 9-10 months).
The emergence of mobile internet markets.
Eventually, new entrants also benefited from the extraordinary development of the Internet in China, and the massive adoption by consumers of the mobile digital economy.
Between 2008 and 2018, China has reached a smartphone equipment rate of 55% (more than 720 million users), going up to even 90% for the 18-35 age group. Said differently, China is now the world’s largest market, representing about 30% of the global market in volume terms.
The very dynamic Chinese market, driven by very demanding consumers, is, therefore, becoming extremely competitive, forcing manufacturers to be ever more innovative. This competitiveness imperative translates in a constant pressure on costs and on employee productivity. R&D engineers are naturally pushed to work harder, as with the Xiaomi’s famous 996 rule (working from 9am to 9pm, over a minimum of 6 days). Said differently, white-collar workers in the technology industry have become the new “working masses”.
All these factors explain the rise of Chinese brands, which have in practice progressively replaced the European brands at the top of the world ranking. On the network side, in fact, the leading global manufacturers in 2018 are now Huawei, ZTE, Nokia and Ericsson. As for smartphones, Apple, Samsung, Huawei, Oppo, Vivo, Xiaomi and Huawei represent nearly 70% of the market (note that Oppo and Vivo, still little-known in Europe, are controlled by the same shareholder BBK, making this group the number two worldwide).
>> Related reading: More insights on digitalization, digital transformation, and technology.
A globalized industry and a new geopolitical situation favoring protectionism.
The Chinese telecom industry has, therefore, become global. Huawei is ahead of all its competitors in 5G networks, and, for terminals (smartphones), new companies such as Xiaomi, Oppo or Vivo have been expanding very rapidly, driven by their success in China and by the necessity to go beyond their borders to continue their growth.
Interestingly, however, this globalization trend has over the years created a very strong interdependence between the major technological players in the sector. For instance:
- The leader in smartphone processors (“chipsets”) is the American manufacturer Qualcomm, the main supplier to most of the major Chinese companies in the sector, which outsources the production of its processors to Taiwanese factories (the leader being TSMC).
- Qualcomm itself is dependent on the British company ARM based in Cambridge (UK) which provides the technology to define mobile phone processors (even Apple depends on ARM). ARM is now controlled by the Japanese SoftBank.
- The leader in high-density memory, an essential component of all smartphones, is Korean Samsung.
- All Chinese smartphone manufacturers use Android and are therefore dependent on Google.
- The new generation displays (AMOLED and P-OLED) are manufactured by Samsung and LG, which retain strong leadership in these technologies, which are also used for TV sets but are gradually being transferred to China.
This interdependence is the consequence of the structuring of this industry into highly specialized technological sectors, built around massive economies of scale.
For example, an AMOLED display or semiconductor factory requires an investment in the billions of euros and is only profitable if the production volume is sufficient, i.e. if several smartphone manufacturers use the same component. Similarly, Google can only support the investments necessary for the development of Android and related services through the monetization of user data.
This business model not only makes it possible to make services and innovations accessible to categories of users who would otherwise not be able to afford them. Market globalization has also become a form of investment pooling that has allowed mobile Internet and mobile communications to develop with unprecedented speed while lowering costs for users (today the cheapest smartphone costs less than 50 EUR, and allows Internet access equivalent to the most expensive iPhones).
In other words, the telecom industry has therefore benefited greatly from globalization (one could also say that it has contributed to this globalization), but it is now caught up in a new geopolitical situation that encourages protectionism. And, in this new context, this interdependence is suddenly seen by China as a risk to its economy and in a way to its sovereignty.
A concrete risk.
This risk materialized dramatically in April of this year (2018) when ZTE was banned from using components or services incorporating US technology.
This ban was imposed by the US Department of Commerce, due to ZTE’s failure to comply with its obligations regarding the embargo on Iran and North Korea. Suddenly, ZTE had to stop its operations completely, as it could not continue to develop and manufacture its equipment and smartphones without Qualcomm components or Google’s operating system, to name just two.
To make matters worse, ZTE found itself having to negotiate with the US Department of Commerce in the midst of a trade war between the two countries and was inadvertently the subject of President Trump’s morning tweets. The case was recently resolved in exchange for a fine of approximately USD 1.4 billion and the obligation to change the entire management of the company.
But this situation of dependence also exists in the other direction. In response to the ZTE case, China for example blocked Qualcomm’s absorption of NXP by refusing to give its consent to the acquisition. Another example is Apple, which makes nearly a quarter of its sales in China, where it produces almost all its iPhones. Paradoxically, Apple could be impacted both by the American escalation (which could tax smartphones made in China) and by Chinese retaliation (which could impose more constraints on American companies operating in China). It seems that for the time being, Apple has managed to negotiate to be kept out of the trade war between the two countries.
“Made in China 2025” and the challenges of the Chinese telecom industry.
In retrospect, it seems that the trade war initiated by President Trump has triggered an alarm and has made people aware of the risk associated with this dependence. Paradoxically, in fact, this trade war has had the effect of increasing China’s and its companies’ determination to develop the “Made in China 2025” plan and use it to reduce this technological dependence as quickly as possible.
The Made in China 2025 plan aims to accelerate China’s rise to power in advanced technological fields, such as 5G, artificial intelligence and robots. One of the motivations is the up-scaling of Chinese industry to anticipate the loss of the country’s attractiveness as a “world factory”. In a way, this plan must enable China to follow in Japan’s footsteps, then Korea’s, and move from a low-cost subcontracting or production economy to a strong creative and value-added economy, supported by a high-tech industry, which implies an increase in the quality of production and R&D.
The point is worth emphasizing, if only because the R&D investment of Chinese companies in telecoms is already one of the highest in the world. Huawei’s annual R&D budget for example amounts to more than USD 12 billion, compared to just one third for the Nokia Group. This makes Huawei one of the largest patent generators, with approximately 4,000 applications filed in 2016 (compared to 2,500 for Qualcomm).
The impact of dependency reduction?
The rapid reduction of dependency gives a new dimension to the Made in China 2025 plan. In the telecom sector, in particular, it means that China must quickly acquire its own solutions in two fundamental areas:
- that of chipsets, now dominated by American companies;
- that of the operating system, now in the hands of Apple (iPhone) and Google (Android).
The first challenge is probably being met, as several companies have already invested in the field for several years with good results. We can mention the semiconductor company Spreadtrum, which, in partnership with Intel, is one of the first to offer a 5G solution, and also, of course, Huawei, the world leader in telecommunications equipment, which has developed its own processor (Hi-Silicon, and whose technological level is probably now very close to that of Qualcomm).
In this respect, the “winner takes it all” rule applies 100%. Once the leader’s ecosystem is sufficiently developed, it is difficult to convince consumers to switch to a competing system, which will necessarily be less efficient – which explains the domination of the two main current systems: iOS (exclusively Apple) and Android.
Several Chinese initiatives are already attempting to overcome this problem, nonetheless.
The main attempt is to develop a variant of Android, which will now be compatible with existing applications – a direction Alibaba is taking with its AliOS. Tencent is rather focusing on integrating applications into its messaging (WeChat), gradually replacing Android.
Another direction is to focus on a future revolution, linked to Artificial Intelligence (AI), that will make it possible to rethink the user interface. Coupled with the arrival of new types of smartphones (thanks to flexible screens), this could create the conditions for a new OS. The Chinese government has clearly determined that AI must be a national priority and has established a program to encourage R&D in this field and the creation of a “National AI team”, including Tencent, Alibaba, iFlytek, etc.
User data control: the ultimate challenge facing company models.
But the real challenge is not necessarily technical.
One of the key conditions for any intelligent operating system that aims to become global is to be able to access user data, both because of what is necessary to provide the service (Google Maps needs to know the precise location, or Google Assistant systematically listens to what is said in order to be able to eventually recognize and execute an order), but also because it is the way to create value and therefore to make the corresponding technological investment profitable.
This need to access private data is however confronted with increasingly stringent regulations (Europe being the leader in this field with the GDPR), which respond to the greater sensitivity of users and public authorities. The Facebook case highlighted the power of influence that large social networks can have – a phenomenon that China understood very quickly, deciding very early on to prevent Google, Facebook, and in general any Western Internet company from operating in China (which probably makes this country the one where the “fake news” problem is the least widespread…). In terms of privacy, two very different conceptions clash, corresponding to sometimes opposing models of society.
Until now, the expansion and globalization of large telecom companies has been based on exporting the Western model, putting the user’s benefit above political interest – the extreme example being Apple, which has even refused to assist the FBI in unblocking one of its phones.
One of the major obstacles to the expansion and emergence of a truly global and iconic Chinese brand (including in the West) in the telecoms sector is undoubtedly the confidence of users in the respect of private data. This problem does not arise in China, as state control is an established fact and companies’ collaboration with the government is total – to the point that the country is in the process of establishing a social rating of individuals based on their behavior on Chinese courier and Internet services.
Huawei and ZTE are already victims of this barrier in the United States, Australia and probably soon in the United Kingdom. Beyond the political and strategic aspects motivating the governments of these countries, the question of the use of private data by companies very close to the Chinese state is clearly raised. The answer will remain complex, as it is a confrontation between different societal models.
This insight was originally published in French as part of the Lettre de la Chine hors les murs – n°25 – septembre 2018 (spécial 120 ans), by the French External Trade Advisors (Comite National des Conseillers du Commerce Exterieur).
Alain Lejeune | TeleCommunications Expert Contributor.
Alain Lejeune has 25 years of senior management experience in the telecommunication industry, in multicultural organizations, and cross-border M&A initiatives. During his career, he has built many partnerships between Chinese and European Companies, in the form of joint ventures, mergers or acquisitions.
Alain has led the new BlackBerry Mobile Business Division of TCL since it took over the global licensing rights from the Canadian-based BlackBerry Limited end 2016. Under his leadership, TCL has re-launched BlackBerry smartphones, first with the successful KeyOne introduced mid-2017, and more recently with Key2, introduced in June 2018. Since then, the BlackBerry Brand is re-positioned as a Premium Brand, focusing on best in class productivity, reliability, security and privacy control.
He joined the TCL Group in 2004 when TCL acquired the Alcatel Mobile Phone Division. He initiated this acquisition (one of the first international acquisition in the tech sector by a Chinese Company) and led the integration of the two teams. He then had many positions in the Company and since 2012 was in charge of the Mobile Phone Division, including the management and development of the 5 product innovation centers in China.
Disclaimer: The views expressed are those of their author(s) only and do not reflect those of The Asia-Pacific Circle or of its editors unless otherwise stated.
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