China's Telecom-Gear Makers, Once Laggards at Home, Pass Foreign Rivals

BEIJING -- Chinese telecom-equipment companies Huawei Technologies Co. and ZTE Corp. have long been laggards in their home market, despite success elsewhere around the globe. But now, thanks to government support for new wireless technology and an aggressive strategy of deeply undercutting competitors on price, the two are beating out rivals in the world's biggest cellular market by subscribers.

Huawei and ZTE are now ahead of big foreign firms like Telefon AB L.M. Ericsson, Alcatel-Lucent SA and Nokia Siemens Networks in the scramble for an estimated $59 billion of spending over the next three years on new third-generation wireless networks. So-called 3G technology enables high-speed data services such as wireless video and Web surfing.

With some 659 million mobile subscribers, China was already vital for global telecom-equipment companies, and the rollout of 3G is making it even more important at a time when sales growth in many big markets is weak.

China's Ministry of Industry and Information Technology estimates that 170 billion yuan, or about $25 billion, will be spent on 3G networks in China this year, nearly half the 400 billion yuan in spending it projects through 2011.

Analysts say Huawei and ZTE will likely double their combined market share to more than half of China's 3G revenue over the next several years, from just 25% to 35% of the revenue from construction of China's existing wireless network.
"Huawei and ZTE's prices are lower, and they're offering good technology," says Zhang Jun, analyst for research firm Wedge MKI LLC in Beijing.

Among the big foreign companies, Mr. Zhang says, Ericsson's market share has remained roughly stable, while those of Alcatel-Lucent and Nokia Siemens, a joint venture of Nokia Corp. and Siemens AG, are declining.

Huawei, founded in 1988, and ZTE, founded in 1985, were too small to be serious competitors when China began building its existing wireless network in the early 1990s. Established foreign players like Ericsson won the lion's share of those early contracts, establishing close relationships with China's state-owned telecom carriers.

Huawei and ZTE were forced to focus overseas because "the domestic market was sewn up," says Duncan Clark, chairman of BDA China, a Beijing-headquartered research firm.

The Chinese companies poured much of their efforts into developing 3G technology, which countries in Europe and Asia started rolling out early this decade. Now, Huawei and ZTE are undercutting competitors' prices by as much as half for 3G equipment in China, according to analysts and industry executives.

Although specific pricing information isn't publicly disclosed by the companies, analysts say the Chinese vendors have lower costs and are more interested in building market share than in profits. "This is a period to grab market share [in China], and that's more important to them now than profitability," says Zhang Chenhao, analyst for consulting firm JL McGregor & Co. in Shanghai.

The cost for research and development personnel can be six times more for European telecom equipment vendors than for Huawei, said Jim Wu, an ex-Huawei executive who headed the company's human resources, research and development departments several years ago.

Analysts also say that both companies have access to large credit lines from China's state-owned banks and possible other perks such as low-cost land. Last month, ZTE announced it received a $15 billion credit line from China Development Bank to finance its projects; the bank says it has made similar loans to Huawei in the past.

And Huawei, which is unlisted, has more flexibility to operate at lower profit margins without coming under shareholder pressure. The company is officially majority-owned by its employees, although the exact ownership structure is opaque.
Huawei says the impression that the company offers extremely low prices comes from the way it bundles its products and services. Ross Gan, a Huawei spokesman, declined to say exactly how the company charges its clients but says the company makes profit in areas other than on sales of network base stations, like "subsequent network expansion and solution upgrades."

A ZTE spokesman said the company's overall costs are "indeed comparatively lower, due to many reasons," including lower personnel costs compared with competitors and investment in technologies that help ZTE cut production costs further.
Last year Huawei reported revenue of $17 billion, up 36% from 2007 and more than six times its sales five years earlier. ZTE reported a 27% increase in revenue in 2008 to 44.3 billion yuan.

Foreign executives acknowledge that they are feeling the pinch from local rivals, but they say they don't aim to compete on price. Sean Dolan, president of Alcatel-Lucent Asia Pacific, said the company will compete by focusing on services. He said the company is looking ahead to the next generation of mobile technology, called 4G, which could be adopted several years from now.

This month Huawei will deploy a network for China Unicom (Hong Kong) Ltd. in major cities including Beijing, Shanghai and Guangzhou. Huawei also has won 17.5% of China Mobile Ltd.'s second-phase projects, by number of transceivers, the company says. ZTE's contracts so far include a 1.3 billion yuan deal to supply China Telecom Corp. with equipment and services.