I had recently returned from a 10-day trip to China where I had the opportunity to visit the Great Wall of China. When I arrived in Beijing, Google had been down for the last few weeks. Like all foreigners, I had to use the Chinese equivalent for searches and maps. The Great Wall was initially built to keep out the Mongolians from entering China. It seems that foreign businesses today are also facing their own obstacles to compete directly in the Chinese local market. The Chinese government is protecting the domestic companies from foreign competition and assisting the domestic companies to create national champions.
Foreign competition: can they overcome the “Great Wall”?
China’s technology is lagging in comparison to its global peers. The question is: how does China catch up? It is my understanding that China has an “invest and protect” strategy. This week the State Council announced the “National Integrated Circuitry Industry Development Outline” with plans to create an investment fund to assist the semiconductor supply chain in innovation. The intent of the program is to create national technology champions. Companies in the program will have access to capital, tax credits and the establishment of a national risk management system of intellectual property rights to accelerate the innovation of technology.
In addition, China has a protectionist strategy in regards to domestic technology and may phase out global competition in the long term. We have heard on numerous public conference calls that IBM and Cisco’s business in China is structurally challenged. From my conversations this past week, I think that Chinese companies are very hesitant to purchase foreign goods. For example, many U.S. technology companies’ product sales are down in the range of 10% to 20% year over year. I expect this trend to continue and China will aggressively develop the technology themselves.
China’s “invest and protect” strategy is laying a foundation to further develop the technology ecosystem. As this country moves up the value chain, the days of “Made in China” will turn into a new model of "Made by China”. I believe it will be increasingly more difficult for foreign competition to overcome the “Great Wall”.
With a gross merchandise volume (GMV) of $250 billion and revenues of $8 billion, Alibaba is clearly the national champion in e-commerce. Throughout the week, most companies that I met with had immense respect for this company. It’s an enabler of the “Great Wall” and supports domestic interests. For example, Alibaba is a large employer and purchaser of domestic hardware in China, a company that offers cloud services, and at the core of its business model, is changing consumers purchasing behaviour. Its management team has done a ton of work in preparation for their upcoming IPO. It would be a national disappointment if its IPO failed.
Xiaomi: the next disruptive force in smartphones
Xiaomi will be the next disruptive force in smartphones. Xiaomi is a Chinese smartphone company that has one of the best performing smartphones in the market selling at a fraction of the cost of Apple and Samsung. Xiaomi’s low end smartphone, Hongmi, retails for 799 RMB. To put this in context, a knockoff Samsung Galaxy 3 sold for 1000 RMB two years ago and a real version sells for $400 at Telus today (refer to the chart below to see how far the Chinese have come in respect to smartphone technology). While many companies that I met with benefited from the “Great Wall”, Xiaomi does not care about this obstacle and has global aspirations. I am in the opinion that smartphones are commodities and the company that can produce the best phone at the lowest cost will be a disruptive force to reckon with. Xiaomi has the potential to become the third largest smartphone company next year.
TD LTE the home grown China 4G wireless standard
TD LTE is China’s domestic 4G technology. After speaking with many of the Chinese carriers, there is a sense of urgency to roll out the home grown 4G wireless technology. In fact, there is expected to be more than 500,000 wireless base stations to be deployed this year. The Chinese telecom equipment companies are protected by the “Great Wall”. As expected Huawei and ZTE have dominant market share in TD LTE wireless equipment. I expect to see upside in the spending of wireless infrastructure in China for the remainder of the year.