From the shards of the shanzhai, the rise of China handsets

Good times for China’s handset sector: the latest is that four of the top five brands in Asia-Pacific markets are Chinese.

But the counterpoint to the emergence of players such as Huawei, Lenovo and Coolpad is the demise of the pirate, or shanzhai market.

The shanzhai era now looks like a classic transition period in an emerging economy. A tiny number of shanzhai players are growing into genuine brands. The vast majority are gone or fast disappearing.

A report by Sohu IT recently found that of an estimated 6,000 or so vendors at the market peak seven years ago, only a few hundred are left.

What’s most interesting is the reasons cited - such as declining price of mid-range phones, greater enforcement of copyright laws and changing consumer tastes. In various ways these all connect back to the growing success of the genuine brands.

What appears to have sparked the almost total collapse of the market was a credit squeeze in the supply chain early this year.

Shanzhai handsets emerged in the mid-2000s. By making use of the extensive electronics supply chain in Guangdong, shanzhai firms could make fake versions of brand name phones for as little 100 yuan.

When Sohu IT reporters paid a visit to Huaqiang North Rd, or 'Electronics St', in Shenzhen, they found just the shards of the shanzhai trade.

Of the five once-thriving retail malls, only one remains, Mingtong Digital City, now barely covering a single floor. Where it once charged 100,000 yuan a month in rent, stallholders today pay just 3000 yuan.

According to Sohu, the crisis began at the start of the year, when sales fell off a cliff and returns began piling up, creating a cash crunch in the supply chain. 

These firms weren't flush to start with. Typically, a shanzhai business could start up with just 600,000 yuan ($9,800). It had to pay cash for the Mediatek chipset, the camera lens and the display, but everything else came on credit. Now the battery, mould and packaging firms all require upfront payment.

The result, according to a manager of one store, is that as many as 800 bosses of knockoff firms are doing a runner each month.

The biggest factor is probably price. Shanzhai phones are caught in a pincer. On the one side, mid-range Samsung phones have come down in price and are now available for 2000 yuan or so. From the other side, local brands like Huawei and ZTE are cutting their own prices.

Another is the limitations of the shanzhai firms themselves – the shoddy quality and limited warranties, the inability build a brand or establish an online presence.

Then there's the increased vigilance of brand owners and authorities, both in China and abroad.

Consumer tastes are changing, too. Shanzhai sales in third tier Chinese cities, which were the biggest source of domestic demand, have plunged and these markets are now dominated by emerging Chinese brands like Gionee.

Of course, the arrival of the smartphone, and in particular Android, has been disruptive simply because of the degree of difficulty in developing them compared to feature phones.

Finally, there’s the safety issue. Apart from being unable to supply SAR measurement, there’s the sheer physical danger of shanzhai equipment.

Even at home, China handset brands battle for acceptance

 

Led by Huawei and ZTE, Chinese handset players might be exporting to the world, but they can’t make  the A-list in their home market.

Domestic brands have virtually a zero market share above the key 3000 yuan ($489) threshold, according China’s biggest mobile phone retailer D.Phone.

That applies even to Huawei and ZTE, both in the worldwide smartphone top 5 and both betting heavily on building global handset brands, Beijing newspaper Jing Hua says in this analysis (zh).

Huawei’s Ascend P6, just launched in a high-profile event in London, is on sale at €449 (3600 yuan) in Europe, yet Chinese consumers can buy it for a mere 2688 yuan. At this price the product has no profit margin, according to Huawei handset chief Richard Yu.

ZTE last year priced its Nubia Z5 at 3456 yuan and the titanium version at 7890 yuan, but neither sold well.

In a frank admission (and that might invite the attention of regulators in other markets), Lenovo vice president Feng Xing acknowledges that:

... managers from leading brands like Huawei, Coolpad, ZTE and Lenovo often get together, and the central topic of discussion is how to make products profitable.

Against this, the optimistic view is that the sector has come a long way. Sun Changxu, an analyst at market research firm ESM China, points out that ten years ago, when domestic brands briefly dominated the device market, they were mostly using Korean solutions.

“But now Chinese enterprises can design and build extremely good products, making them much more competitive.”

But in the eyes of demanding Chinese consumers, that's not enough. “[T]heir understanding of brands is mostly embodied in face and price. A high price embodies quality and brand," says another analyst, Yang Haifeng.

Behind Huawei's handset numbers

Huawei made an eye-catching improvement in the handset rankings in the last quarter, but it has still fallen short of its own hefty expectations.

The Chinese firm ranked no. 3 in smartphones and no. 5 overall in IDC’s latest quarterly survey of mobile phone sales. It shipped 10.8m smartphones in the fourth quarter, 90% more than it sold in Q4 2011, and 15.8m phones in total, 13.7% higher.

But even though it improved full-year sales by 9.3% to $7.8 billion,  the consumer division still missed its full-year target of $9 billion. And it looks like it will struggle to meet the $15 billion sales goal for 2015 that the unit set last year.

Richard Yu, the head of Huawei’s consumer business, told Chinese business news site yicai.com operating profit was up 40% but “we missed the target we set at the beginning of the year.”

And while Huawei's Ascend smartphone brand is getting traction, Yu’s team appears still focused on the ODM and operator white labal markets.

One un-named executive is quoted as saying “we need to clearly recognise that commercial success is the key, instead of illusory pursuit of the so-called ‘global brand.’”

For all this, let's bear in mind that Huawei only made the top end of the table in the final quarter of 2012. It ranks outside the top five in both smartphones and handsets for the full year. There's a lot riding on how it stacks up in this quarter.

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