The US Department of Commerce Bureau of Industry and Security chaired End-User Review Committee (ERC) recently imposed trade restrictions on ZTE Corp. which may make it difficult or impossible for the company to buy products or components from US based suppliers. The ERC amended the Export Administration Regulations (EAR) entity list to include ZTE for what it determined to be actions contrary to US interests of national security and foreign policy. The entity list is essentially a “blacklist” of individuals and companies on which trade restrictions are placed. The ERC points to two specific documents which highlight ZTE’s forming of “detached” companies in order to allegedly skirt US export control laws and illicitly re-export controlled items to sanctioned countries.
ZTE is one of the leading global smartphone suppliers and according to the last published IHS Semiconductor Share at Handset OEMs report, obtains about 62% of its core handset IC components from US companies such as Qualcomm, Skyworks, and Qorvo. If the US government doesn’t allow these companies to sell product to ZTE for its handset business it could financially harm both sides as these suppliers generally depend upon sales from a few high volume customers and losing ZTE would increase concentration of other already large clients such as Apple and Samsung.
Suppliers such as those above can generally apply for a license to sell products to companies on the entity list, however the ERC has issued a license review policy with a “presumption of denial” in addition to not issuing any exemptions from the licensing requirement in this case, potentially making it difficult or seemingly impossible for the aforementioned suppliers to conduct business with ZTE.
ZTE was the world’s 8th largest mobile phone supplier in 2015. If the company faces components supply constraints due to the recent ERC ruling, it could derail product launches, and lead to a lot of wasted research and development cost as the company wouldn’t be able to obtain components to support devices in various stages of development.
The trade restrictions could be disastrous to the ZTE smartphone business. As a result of the decision ZTE may choose to source more of its components through companies located outside of the US such as MediaTek and Tsinghua Unigroup (Spreadtrum). These suppliers already account for about 41% of ZTE’s annual spend on digital baseband according to the IHS report cited above. Being limited to the use of only the suppliers outside of the US would require a significant re-design effort and place ZTE behind in certain market segments, especially at the high-end of the smartphone market.
The ERC ruling, if enacted, would render ZTE’s phone production supply chain inactive as supplies for critical components dry up for effected models using US supplier parts. ZTE has options to appeal the ruling and would likely vehemently fight the ruling through legal channels. The Chinese government will also likely petition in favor of ZTE, potentially forcing partisan debate on the matter of US and Chinese trade relations. The next week of diplomacy and legal maneuvering will be critical as to how this crisis plays out.