Market Insight

[Display Dynamics] China moves from the frontier to the center of the smartphone industry

August 24, 2014


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Key findings

  • Chinese smartphone makers have been rapidly expanding their shares in the emerging markets.
  • A large number of smartphone vendors and IDH/ODM companies in China are offering products that meet the needs of low-income consumers around the world. 
  • The competitiveness of Chinese smartphone manufacturers lies in the “red supply chain” consisting of Chinese companies. 
  • The success of parts and materials suppliers will be determined by whether they can fully support Chinese smartphone companies. 

 

Don’t forget the collapse of the companies who once took the lead

As recent as in 2003, big name companies in the global mobile phone industry included Nokia Oyj, Motorola Mobility, Samsung Electronics Co., Sony Ericsson Mobile Communications AB, LG Electronics Inc., Siemens AG, Alcatel SA, Philips Electronics, Panasonic Corp., NEC Corp., Sagem SA, Sharp Corp., Kyocera Corp., and Sanyo Electric Co.. However, only a few of them such as Samsung, LG, and Sony, are currently operating independent smartphone business units. Nokia was taken over by Microsoft Corp., Motorola by Google Inc. and then by Lenovo Group Ltd., Siemens by BenQ Corp., and Alcatel by TCL Corp.. They have all gone only leaving behind their brands. Looking back at the circumstances surrounding them more closely, they seemed to have lacked understanding of the emerging markets and been ignorant of how to apply what they had in an innovative way. 

By early 2000, when mobile communication technology was transitioning from a 2G network to a 3G, the key to determine the competitiveness of handset makers was an ability to employ core telecommunications technology, such as baseband and radio frequency (RF) chips. Ironically, Samsung, which lagged far behind others in such core technologies, grew at a remarkable pace by preemptively employing a folder form factor, color LCD, camera, and MP3 player, which are not directly related to “telecommunications.” 

 

Black mobile phone laid the groundwork for the growth of the Chinese smartphone industry

In 2005, a government license was required for a company to make and sell mobile phones in China. There were also a host of strict regulations and norms to follow. Hence, those without the license but still wanting to supply mobile phones gathered in Shenzhen, formed an exclusive ecosystem, and made so-called black mobile phones, or copy phones that looked just like well-known brand phones. They sold such unauthorized replicas mainly in China and some developing countries, and the replicas were everywhere in China, taking a heavy toll on Chinese local phone makers including Lenovo, Ningbo Bird Co., TCL, Sichuan Changhong Electric Co., Hisense Electric Co., and CECT. The rapid rise of black mobile phones even threatened the existence of then the fledgling independent design house (IDH) (After the government license for making and selling of mobile phone was scrapped in 2007, everyone could freely make mobile phones and the term black mobile phone was replaced by Shanzhai, which refers to phones made by small-sized companies.).

In the middle of 2006, I visited CEC Wireless, an IDH founded on the mobile phone research and development center acquired from Philips, and its CEO Xiaohua Wu told me, “All mainstream mobile phone makers are suffering severely from the presence of black mobile phones right now, but black mobile phones are actually helping to form an independent eco system in China, for which I bet we will thank them someday.” CEC Wireless went out of business in July 2007 due to financial strain, but the CEO’s words came true as the black mobile phone makers that used to be lowly regarded have served as a foundation for the growth of the Chinese smartphone industry today and are now threatening others around the globe. 

 

Chinese smartphone companies know what consumers want

Some say that the Chinese copy phone makers survived because they effectively evaded taxes and patent royalties. But the actual reason may be that they’ve had the understanding of the consumers’ wants and needs as well as the ability to provide appropriate products at an affordable price and at the right time. They have introduced a phone that looks like an expensive sports car; a phone equipped with a high-power speaker as farmers and construction workers have wanted; a phone with 15-day stand-by time for long haul truck drivers; a gold-plated phone to satiate the vanity of users; a phone that can hold up to two or three SIM cards; a phone capable of receiving analogue TV signal; a phone that can be used as a computer web cam; a phone made in the shape of a cigarette box; a phone for self-defense purpose that can be used as a stun gun; and a phone for the elderly that has a ten-key button three to four times larger than a regular one. These phones may seem ridiculous to the eyes of the leading global mobile phone makers, but they are what black mobile phone makers have come up with based on their understanding of the consumers’ needs. Why won’t the global players make such products? 

China has a large population and hence a large domestic market. The differing extent to which urban and rural areas are modernized, the income gap between white and blue collar workers, and regional differences in the way of living and climate make it impossible for one single company to satisfy the needs of all consumers. These regional, class, and environmental differences have offered a rich test bed for Chinese smartphone makers when setting up a strategy for markets like India, Latin America, and Africa. For instance, all the smartphones sold by Bangalore-based Karbonn Mobiles India Pvt. are supplied by smartphone original design manufacturers (ODM) located in Shenzhen, China. Likewise, one of the top three smartphone companies in Africa, Tenco Telecom Ltd., originally started off as one of the Shanzhai companies in China. These explain how Chinese companies could dominate the emerging markets.

 

Abandoned feature phones and low-income buyers

As the smartphone market grows rapidly, mobile phone companies have quit manufacturing feature phones over the past several years, focusing on smartphones. Even Nokia mobile phone division, which was taken over by Microsoft, is known to be planning to exit from the feature phone business, signaling that it may concentrate more on the smartphone business so as to reap higher average selling prices and profitability. But in effect, it has turned out that the global mobile companies that have withdrawn from the feature phone business are giving away the market to Chinese companies. 

Consumers in emerging markets who generally have low income and suffer from poor telecommunications infrastructure and high phone bills do not need expensive smartphones, but low-end cell phones. Also, as there are not  many consumers willing to afford a tablet and a smartphone at the same time, Chinese companies have come up with a tablet PC with phone features that only costs $120, which is basically a 7-inch tablet worth less than $100 embedded with a communication module. 

At the 3GSM World Congress (currently Mobile World Congress, or MWC) held in Barcelona, Spain in early 2005, Motorola and mobile-industry trade group GSM Association (GSMA) jointly unveiled a feature phone worth $30, targeting consumers in the developing world. Considering that low-end feature phones at that time cost around $60, a $30 price tag was exceptionally low, and  about 40 million units of the $30-model called C115 featuring a monochrome super twisted nematic LCD (STN-LCD) display was sold only in one year. Ten years have passed since then, and leading global smartphone companies have completely withdrawn from the feature phone market, no longer caring the needs of low-income consumers in the emerging markets. Why have they given away the emerging markets to their Chinese counterparts by shying away from developing smartphones affordable for low-income consumers? Now, they watch Chinese companies are expanding shares rapidly in those markets and they are trying to find measures to counter the threat. In a sense, it is inevitable that the global mobile phone companies are struggling now in the low-end segment of the emerging markets. Not all consumers around the world can comfortably afford to a smartphone worth over $500. 

 

Growth of Chinese smartphone makers and emergence of “red supply chain”

The rapid growth of Chinese smartphone makers has been giving the global smartphone brands a hard time. But more vulnerable to the threat is the parts supply chain. 

A while ago, I met with an official from Media Tek Inc.’s baseband division and asked him how many new smartphone and feature phone models came out every year in China. To my surprise, he answered it was impossible to compile statistics. Other people might give different answers to this question depending on their circumstances, but judging from the answers from those engaged in related industries in China, it is estimated to be somewhere between 1,500 and 2,000 units (maybe there is no definite answer to the question). 

The smartphone has a very short development and sales cycle. If more than 1,000 new models are to be developed over a short period, Chinese smartphone makers having an ecosystem comprising numerous small- and medium-sized enterprises located close to each other would be better and more efficient in doing so rather than a couple of giants. Therefore, it is understandable that there are so many small- and medium-sized producers of touch panels, LCD modules, cases, printed circuit boards (PCB), battery modules, connectors, and camera modules in China. In this light, the birth of the so-called red supply chain, or a vertical supply chain consisting only of such Chinese companies, is inevitable.

The problem is that existing global mobile phone companies are rushing to these companies to buy parts at a lower cost, and the purchase volume from China is significantly increasing. The more dependent they are on the cheaper parts from China, the more difficult for parts makers elsewhere such as in Japan, Korea, and Taiwan, to do business. The more competitive the Chinese part suppliers become, the higher the chances are that Chinese smartphone makers become more competitive as well. This could mean a hardship not only for the smartphone makers elsewhere, but also for the parts suppliers who work with them. 

What if parts makers in countries other than China actively attended to the needs of Chinese smartphone makers and supported them in the early days of the Chinese smartphone industry around 2011? Then, parts suppliers would have been safe from the difficulties that the global smartphone makers have been experiencing. 

 

What should parts makers do?

There are no clear-cut answers to this question. However, if there is a parts maker with a strong belief that Chinese smartphone makers, in the near future, will become part of the mainstream smartphone industry, following suit of Samsung, LG, HTC Corp., and other newly rising Asian handset makers, it should start providing whatever support Chinese smartphone makers might need now before it’s too late. 

Also, it is highly recommended to take the trouble of visiting local smartphone outlets in the suburban areas of Beijing, Shanghai, Shenzhen, or Guangzhou once in a while. Soon it will be possible to find out that the phones sold there are different from the ones sold in a downtown store, with unfamiliar brand names, low price tags, and low-end functionality. And there may be an answer. 

 

 

 

 

 

Geography
China
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