Up, up and Huawei

IN THE 1960s, when Japan emerged as a manufacturing exporter, it soon became a byword for low cost and low quality. Much fun was made of unreliable Japanese watches and cheap Japanese cars. But quality improved and Japan became a powerful force in electronics, carmaking and other industries. Today Toyota is held up as a model of efficient manufacturing, and Japanese firms lead the world in clean technology, carmaking and consumer electronics. China hopes to make a similar transition. For now, foreigners think that its home-grown electronics and cars are cheap and shoddy, as Japan’s were thought to be 40 years ago. But quality is steadily improving and China is being taken increasingly seriously as an innovator. The firm that embodies this new, high-tech China is Huawei, the country’s largest telecoms-equipment company.

Founded in 1988, Huawei has risen astonishingly fast. Last year it was the world’s fourth-largest maker of network equipment, ranked by sales (see chart 6), and this year it is expected to move into third place, according to BDA, a consultancy. It is already ranked a close second in optical networking and third in mobile-network gear. Only slightly behind is ZTE, China’s second-largest maker of telecoms equipment, founded in 1985. Last year it was in eighth place, and it is moving up the field—not least because Nortel, the number seven, went bankrupt in January. Both Chinese firms specialise in network infrastructure, but they also make handsets. In a fiercely competitive market, ZTE became the world’s sixth-largest handset-maker last year. Its goal is to be the number three in handsets within five years.

The two Chinese firms’ global market share is still relatively small, but their impact on telecoms has been colossal. Together they have driven down costs and brought about consolidation across the industry. Having offered discounts of as much as 50%, they were in large part responsible for the mergers in 2006 between Alcatel and Lucent and the network-equipment arms of Nokia and Siemens, and the collapse in January 2009 of Nortel and the sale of many of its assets to Ericsson.

Huawei and ZTE are now winning the lion’s share of equipment contracts for China’s three third-generation (3G) mobile networks, spending on which will total $59 billion between 2009 and 2011, according to the Ministry of Industry and Information Technology. This will further increase their market share, to the disappointment of Western vendors that had hoped to benefit from China’s adoption of 3G, one of the biggest telecoms projects in history. “The vendor community is struggling, but Huawei and ZTE are still growing, largely on the back of the emerging markets,” says Informa’s Mr Jotischky.

The Chinese are coming

Huawei and ZTE are not just strong at home; both firms also ventured abroad in the 1990s, selling fixed-line equipment in Asia and Africa. Western vendors’ interest in those regions was limited and their prices were too high, says Zhu Xiaodong, ZTE’s technology chief in Europe. Next, the Chinese firms began selling wireless equipment in the Middle East, South-East Asia, Africa and Latin America. Mr Zhu, who led the team that designed ZTE’s first mobile base-station based on the GSM standard, says Chinese companies had two advantages in the wireless-equipment market: much cheaper labour and, by that time, settled standards. Nokia and Ericsson, the pioneers of the GSM standard, took years to develop the technology; ZTE built its first base-station in six months.

Huawei was the first of the two firms to move into Europe, the home market of Ericsson, the world’s largest telecoms-equipment supplier. At first only smaller operators, and the eastern European subsidiaries of bigger ones, bought its equipment, but now it supplies several leading European operators, including Vodafone, Telefónica, T-Mobile and BT. In America Huawei is selling 3G network gear to Cox Communications, and its equipment is being tested by AT&T.

Customers needed time to get to know Huawei, says Edward Zhou, its marketing chief in Europe, but now “we are accepted as a provider of innovative solutions and high quality.” A few years ago Huawei had only a small booth at Mobile World Congress, the industry’s biggest annual trade show, notes Mike Thelander of Signals Research, a consultancy. This year it had a whole building to itself, which had been Ericsson’s sole prerogative. “It’s impressive what they’ve done in a short period of time,” says Ericsson’s Mr Svanberg.

Perceptions of the Chinese vendors within the industry shifted suddenly between 2004 and 2006, says Vodafone’s Mr Colao, who spent that period working outside the industry as head of an Italian media group. “When I left, I think I had heard of Huawei twice, but I would not have been able to remember their name,” he says. “When I came back in 2006 they were a supplier to Vodafone, and they are now one of the main ones.” Having got started by offering low prices, he notes, the Chinese firms have since gained scale and a reputation for innovation.

Huawei and ZTE led the way in something called “remote radio-head” technology. In a mobile base-station the radio circuitry usually sits in a cabinet and is connected by a cable to an antenna on the tower overhead. Replacing this cable with an optical fibre, and moving the radio circuitry into the antenna itself, eliminates power losses in the antenna cable, cutting energy consumption by around one-third and reducing the size of the equipment.

More recently, says Weiran Zhuang of BDA, the Chinese vendors have shown that they can innovate by launching reconfigurable base-stations, the functions of which are defined in software rather than hardware. That means the base-station can be quickly rejigged to support different mobile-network technologies, or even several such technologies at the same time. Most mobile operators are now running 2G and 3G networks alongside each other, using separate sets of equipment, so the prospect of being able to replace them with a single system is enticing. América Móvil, the largest mobile operator in Latin America, found that deploying Huawei’s reconfigurable SingleRAN hardware reduced the power consumption of its base-stations by 50% and the volume of equipment needed by 70%. ZTE makes a similar system which reduces power consumption by 40% and has already been deployed by CSL, an operator in Hong Kong. Both systems can also be upgraded to LTE, the emerging 4G standard. This has particular appeal for Chinese operators, which are still upgrading from 2G to 3G as 4G already looms on the horizon.

A few years ago Huawei used to boast of its cost advantage in research and development, mostly because its Chinese engineers commanded much lower salaries than its rivals’ staff. But as foreign firms have shifted more of their own R&D to China, and Huawei has expanded outside China, it is now keen to present itself primarily as an innovator rather than a low-cost provider. “It is a misperception to say that Huawei is a low-cost company,” says Mr Zhou. The firm now has over 100 offices abroad and maintains research centres in Europe, America and India as well as China. In January Huawei topped the World Intellectual Property Organisation’s 2008 rankings for international patent applications, a sign that the company is outward-looking and determined to defend its intellectual property abroad.

A TD-S diversion

Even the Chinese government has been surprised by the speed at which Huawei has established itself as an international force. Since the late 1990s the government has been pursuing an elaborate industrial policy designed to boost the prospects for Chinese equipment-makers at home and abroad. But the plan has fallen so far behind schedule, and Huawei and ZTE have done so well on their own in international markets, that the entire scheme has become almost irrelevant.

The plan involved the development and promotion of a Chinese 3G technology called TD-SCDMA, or TD-S. A decade ago, as operators in America, Europe and Japan prepared to build the first 3G networks, there was a fierce argument over the merits of two rival 3G technologies: one called W-CDMA, backed by European operators and vendors, and one called CDMA2000, backed by American firms. It was clear that W-CDMA would predominate in Europe and CDMA2000 in America, but both camps had their eye on foreign markets. Chinese officials decided that China should also enter this competition and develop its own 3G standard. By mandating its adoption in China they could provide enough scale to get the technology established. TD-S could then be offered to operators abroad, particularly those in Asia whose customers might wish to roam in and out of China. Chinese equipment-makers would enjoy a boost to their sales and would not have to pay licensing fees to foreign vendors.

But TD-S took much longer to develop than expected. The government delayed issuing China’s 3G licences because it wanted to ensure that TD-S would be used for at least one of the country’s 3G networks. After years of uncertainty it reorganised China’s various mobile and fixed-line operators into three giant groups in 2008, in preparation for the introduction of 3G. But by this time Huawei and ZTE were doing well in foreign markets without any help from TD-S, and the global telecoms industry was already looking towards 4G networks, based on the LTE standard. Huawei is at the forefront of LTE development: the world’s first LTE mobile connection was made using the company’s equipment in June this year. But TD-S has had so much political capital invested in it that the Chinese government could not give up on it. So when at last it awarded 3G licences in January this year it required China Mobile, the world’s largest operator by subscriber numbers, to use TD-S to build its 3G network.

Because of its size, China Mobile is arguably the only operator on Earth that could establish a new technological standard on its own, but even this giant seems unable to make a success of TD-S. In a recent filing with financial regulators the company admitted that “we have encountered and may continue to encounter challenges in the deployment of our 3G services” and that “we may not be able to effectively and economically deliver our 3G services based on this technology.” The main problem is the lack of TD-S handsets: existing models must be completely redesigned to work with TD-S networks. China Mobile had hoped to have 10m TD-S subscribers by the end of 2009, but by the end of June it had signed up only 959,000. Of these, says Mr Zhuang, only half are using TD-S handsets. The other half are using the TD-S network to provide a mobile-broadband connection for laptops, which seems a more promising market until more TD-S handsets become available. The prospect that TD-S will be adopted outside China, never bright, has now faded altogether.

Although China Mobile, Huawei and ZTE continue to talk up TD-S, they have already devised a face-saving exit strategy: to promote a new variety of LTE, called TD-LTE, which with enough hand-waving can claim to be derived in some respects from TD-S. “The reality is that they are two completely different, incompatible technologies, but it’s a nice way to get away from TD-S, by claiming it’s an upgrade or an evolution,” says Mr Thelander. China Mobile now requires all suppliers of 3G equipment to support smooth evolution to LTE, says Mr Jotischky.

Vodafone and Verizon Wireless are taking part in efforts to make TD-LTE work smoothly with the mainstream LTE standard. (Vodafone owns a small stake in China Mobile and would like a single global 4G standard to make roaming easier and increase economies of scale.) If TD-LTE can then be rolled into the main LTE standard, so that LTE handsets work well on Chinese TD-LTE networks, China Mobile will escape being hobbled by an inferior home-grown technology motivated by political aims. In the meantime it must push ahead with TD-S as best it can.

Both Huawei and ZTE, along with other Chinese equipment-makers such as Datang, received government funds to support the development of TD-S. But “by the time the TD-S cake was baked—and it never really tasted that good—Huawei and ZTE had racked up impressive and unexpected gains,” says Duncan Clark of BDA. Huawei, which did the minimum necessary to support TD-S, has emerged as the strongest, whereas Datang has been far less successful abroad. So it is difficult to argue that the TD-S project has helped make Chinese firms more internationally competitive.

One source of concern about Huawei is its opaque ownership. The company is privately held, and Mr Zhou insists that it is entirely employee-owned. But its military culture, and the fact that its founder, Ren Zhengfei, is a former army officer, have led to persistent rumours that it has close ties with the army. Moreover, its ownership structure may be complicated by its history of joint ventures, says Mr Clark.

The big two Chinese vendors are relatively weak in services compared with their Western rivals, though both are pushing ahead as fast as they can. Being able to offer services in conjunction with network equipment is becoming more important as operators, in India and elsewhere, outsource their network operation to reduce costs. As network gear becomes commoditised, services offer higher margins and long contracts, notes Mr Thelander. Like many people in the industry, he believes that only Ericsson and Huawei are sure to be around in a decade’s time. A senior executive at one large mobile operator says he sometimes awards contracts to non-Chinese vendors, even if their prices are a little higher, in order to maintain choice and competition in the market.

As Huawei goes up against Ericsson in network equipment, ZTE hopes to move up in handsets. At the moment many of its handsets are sold by mobile operators (including Vodafone and T-Mobile) under their own brands, customised to the operators’ specifications. ZTE says it is willing to work with operators, but is also preparing to push its own brand more vigorously, particularly in western Europe. To succeed, it will need to produce some desirable, high-specification handsets. So far, says Mr Thelander, “I haven’t seen anything that’s wowed me.” But then only a few years ago the Chinese vendors’ network equipment was seen as not very exciting.