Huawei Aims High, Despite Obstacles to Growth

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Huawei is likely one of the least-known of China’s growing fleet of large multinational corporations — but it’s aiming to get much bigger in the coming few years. The global telecommunications equipment maker, which is based in the southern Chinese industrial city of Shenzhen, has gradually expanded its reach — first as a supplier of networking infrastructure to developing markets and most recently as a maker of smartphones — to become the second-biggest telecom equipment maker in the world. The company’s biggest claim to fame may be the uproar that ensued when it attempted to buy server technology firm 3Leaf Systems in the U.S. in 2011. Huawei ultimately abandoned the acquisition after a U.S. government panel moved to block the deal on national security grounds.

Huawei officials have said those concerns were unfounded, and are now pushing ahead with an ambitious plan to double the company’s revenue by expanding internationally as it advances into the market for tablets and other consumer goods over the next decade.

So far, Huawei’s biggest handicap has been its lack of brand name recognition, especially outside China. Huawei’s focus on consumer products is partly aimed at countering that problem, notes Scott Sykes, Huawei’s vice president for international media affairs. He says Huawei plans to expand the share of sales of consumer products as part of its total revenue to 25% by 2018 from the current 20%. The company also plans to increase its enterprise business, which sells equipment for use in corporate data centers in campus networks to 15% to 20% from the current 5%, while reducing its telecom equipment business revenue to 50% to 60% from the current 75%.

“We started two new businesses three years ago,” Sykes notes. “One is called the consumer business group, which designs smartphones, tablet computers and Wi-Fi devices, and [Internet-delivered television] boxes. It accounted for about 20% of our revenue mix, or $9 billion in 2012.” The enterprise business group is typical of Huawei’s origins as a supplier of network equipment in that it designs storage servers and transaction processing servers and makes communications platforms for corporate virtual private networks (VPNs) and switching technology for corporate campuses.

Despite the hurdles it faces in the U.S. market, Huawei is doing well, Sykes says. “We are a more than $35 billion company, and had an 11% increase in our revenue in 2013. We anticipate that in the next five years we will grow by a compound annual of 10%. If we achieve that, by 2018 we will be a $70 billion [revenue] company.

Huawei has no choice but to grow organically, unlike Lenovo which became the top personal computer maker in the world in 2013 after its acquisition of IBM’s PC business in 2005. Lenovo announced in January a proposed $2.91 billion purchase of Google’s Motorola Mobility handset business.

“M&A is challenging. Maybe one out of every 100 [mergers] is successful.” –Scott Sykes

“M&A is challenging. Maybe one out of every 100 [mergers] is successful,” Sykes says. “We think for us, our company, our style, and what will work well with us is to grow organically in the coming five years as we did in the last 26 years. Actually, in the next five to 10 years we will not do any major M&A activities.” Regardless of how it grows, Huawei is expanding quickly internationally. In 2012, revenue from outside China accounted for 66.7% of the firm’s total sales.

As it moves up the “value chain,” a shift from nuts and bolts telecom systems to higher margin consumer products like smartphones and tablets could help Huawei make a “great leap” in terms of brand recognition and profits, according to Benjamin Cavender, a principal and senior analyst on the electronics sector at China Market Research Group, based in Shanghai, “If they could make the consumer side of the business a lot bigger, I could see that kind of growth. They have a lot of room to grow with their handsets and tablets. They have a lot of room to grow with the network software side of the business,” he adds, noting that Huawei may be able to double revenue in the coming five to six years, though he views a goal of 14.5% annual growth as “a little bit optimistic.”

Lagging Behind

Despite Huawei’s aspirations in the smartphone market, the company lags way behind Apple and Samsung, though in some quarters of the past year it ranked number three in sales — from a start of zero sales in 2010. According to Sykes, the company’s smartphone sales jumped to 52 million units in 2013 from 32 million in 2012 and 20 million in 2011. “Our goal is to sell 80 million smartphones this year,” he says. While Huawei’s ability to take on competitors such as Lenovo and LG has been notable, the gap remains huge: Apply and Samsung are selling between 60 million and 80 million smartphones in a single quarter, which is more than Huawei has sold yet in a year.

According to January figures from IDC, a U.S. IT research firm, Huawei maintained its number three market share position in 2013 at 4.9%, up from 4% in 2012. Samsung claimed a 31.3% share and Apple had a 15.3% share, while LG and Lenovo controlled 4.8% and 4.5% of the market, respectively.

Despite that progress, Huawei is still working on some quality issues, Cavender notes. “They are like a lot of other Chinese smartphone companies, trying to figure out how to go from the cheap mass market to having premium products, too,” he says. “They put as much technology as they can put into the phones: a big screen, a fast processor, fast RAM. But the parts do not necessarily work well together.”

Given its lack of a track record and poor brand recognition, quality problems are doubly problematic for Huawei. “A lot of consumers say, ‘Why should we buy an expensive phone from Huawei if the quality is not that good? They should be selling cheaper phones…,’” Cavender notes.

But he adds that the company should keep working to get better rather than abandoning ship. In a few years, Cavender predicts that Huawei will manage to sort out the quality issue and be well placed to expand. Already, Huawei is strong in third or fourth-tier provincial cities in China, where consumers may lack the wherewithal to buy an iPhone or a Samsung Galaxy but still hanker after the latest gadgets. In those markets, “Huawei starts looking very good, because [consumers] can still get a phone with a big screen and Android applications. It becomes a pretty good low-cost alternative,” Cavender says.

In seeking to close the gap with the market leaders, Huawei is hiring talent from other global companies such as Nokia, according to Duncan Clark, chairman of the telecom investment advisory and consulting company BDA China Ltd., and a senior advisor to the “China 2.0″ initiative at the Stanford Graduate School of Business. “It is still a challenge to become a major consumer brand. It may take years, but do not underestimate Huawei,” he says.

One of the biggest difficulties Huawei faces is how it sells consumer products in the U.S. — for example, where the company’s smartphones must be purchased on the Internet, says Clark. “In the U.S., you get a phone along with the contract, so people only know what AT&T [or another cellular service provider] will sell them. That is where Huawei struggles a bit; they have not figured out how to do the marketing or retail side of it,” Cavender says.

National Security or Protectionism?

One way to counter this problem would be to bring in more foreign expertise, especially for marketing, observers note. Although Huawei’s telecom equipment business is global, and about a quarter of the company’s 140,000 employees are foreigners, the firm has no non-Chinese on its board of directors or in other senior posts. “We are still new in terms of international expansion, which began 16 years ago,” Sykes states.

Huawei is “like a lot of other Chinese smartphone companies, trying to figure out how to go from the cheap mass market to having premium products, too.” –Benjamin Cavender

Not all analysts agree on the importance of having non-Chinese top executives. “I think Huawei is a real global company because it has spent a lot of time and money on research and development,” notes Ryoji Nakagawa, a professor at Ritsumeikan University in Kyoto who specializes in the Chinese IT industry and economy. “They are one of top companies in terms of applied new patents. Most of Toyota’s board of directors is Japanese and there are mostly Koreans with Samsung. If you say that you have to have multinational top management to be a global company, Toyota and Samsung are not global companies.”

Huawei’s identity is something like a split personality, says Cavender. On the IT infrastructure side, for companies building networks or storing data, people know Huawei, he notes. “But if you are a consumer, you would not think of it as a global company, mainly because of what they are doing with their consumer products, since they are much stronger in China than in other markets.”

Gaining a foothold in the all-important U.S. consumer goods market could help Huawei surmount its difficulties with selling telecom equipment. “Once they are accepted more as a consumer brand, it will be much more difficult for the U.S. Congress or anybody to say Huawei should not be here, or they should not be doing this here or they cannot have this contract, because people will look at them as being more like Sony, Samsung, Apple or another consumer electronics company,” Cavender points out.

The company’s most damaging setback came in 2012, when a U.S. House Intelligence Committee report encouraged U.S. companies not to partner with Huawei. Chairman Mike Rogers, a Republican from Michigan, cited serious concerns about Huawei and ZTE, another telecom equipment company based in southern China, and their alleged connections to the Chinese government. Some U.S. lawmakers called Huawei a potential national security threat and recommended that U.S. telecom carriers avoid using the Chinese firm’s equipment. “They are in the communications industry. [Information technology] is always very sensitive, and [Huawei] lacks transparency,” says Wharton management professor Marshall Meyer.

Huawei has made no secret that its founder and CEO, Ren Zhengfei, was a former People’s Liberation Army (PLA) official. “He was a construction engineer with no military rank and he was in the PLA for nine years, from 1978 to 1983,” explains Sykes. “The PLA disbanded the engineering core, so he was laid off. He has never since had any connection with the PLA.” Given the military service records of other prominent CEOs, Sykes notes that the concerns over Ren’s background appear to be a “double standard.” Tomoo Marukawa, a professor at the Institute of Social Sciences at Tokyo University, agrees. “I think that the U.S. uses the fact that CEO Ren had military experience as a security concern is groundless. South Korea has a draft system, and if you applied the same logic, all South Korean companies could have security issues,” adds Marukawa, a Chinese industry and economics specialist.

Sykes says the issue with Huawei is more one of politics and fear of rising Chinese power. “We are still present in the U.S. and we are available and willing to serve telecommunication companies in the U.S.,” Sykes states. “We are present in 140 countries in the world and serve 500 telecom operators. We have been in business for 26 years and there has never been a security issue of any kind regarding our telecom equipment. The challenges we face about the network equipment business in the U.S. is about trade protectionism and geopolitics. It is not about our equipment because we have an impeccable track record.”

Bad Timing

Against the background of recent reports of U.S. National Security Agency (NSA) surveillance through telecom networks around the globe, the Huawei issue appears overblown, experts and analysts say.

“It is still a challenge to become a major consumer brand. It may take years, but do not underestimate Huawei.” –Duncan Clark

“The NSA case weakened the case against Huawei somewhat,” Clark notes. “I do not think it is a network infrastructure company we need to worry about, but it’s more about the network operators. I think it is harder to make a case for a global conspiracy about Huawei.” If anything, attention should be focused on Internet companies or telephone or satellite operators, he adds. “That is where you tap. For me it would be like complaining to the pipe maker about water pressure.”

According to Cavender, firms like Huawei — whether or not they had ties with the government or the PLA — “get dragged into [politics] because they are high profile tech companies.” Huawei’s decision to locate its U.S. headquarters next to an American naval base was poorly considered, though, he says. “It is more like a timing and perception issue. The timing was bad because China and the U.S. were already having a back-and-forth about other topics, so they were kind caught in the middle.”

Even if the security issues are disregarded, though, Huawei faces other challenges in selling to the U.S. The company’s Chinese share-ownership program, available to the 74,000 Chinese nationals employed at Huawei, could be viewed as an unfair trade advantage in that it helps keep wage costs low, says Meyer. “Why are their costs so low and their prices so competitive?” he asks. “They borrow money from the China Development Bank and other Chinese banks, but they borrow from the CDB heavily. The combination of the two gives them access to low-cost funds and their cash cost of operations is well below those of their competitors.”

Huawei officials contest that view, saying the firm’s wage regime and borrowing conditions differ little from other major companies. Huawei’s share options program is in addition to wages and bonuses, which are competitive, notes Sykes. Employees have to buy the shares, he adds. As for financing, 25 of the 35 banks Huawei works with are located outside of China, and the company also funnels profit back into research and development. “We take normal commercial loans from the biggest banks in the world, on normal payment terms and at the normal Libor rate,” Sykes states. “We also take loans from Chinese banks but they are normal loans at normal rates; nothing special, no advantage.”

Sykes also disputes complaints that Huawei is not transparent about its ownership structure. “We are a 100% employee-owned company, and even though we have no regulatory obligation to disclose anything because we are a private company, we do it anyway because it is important to be open and transparent,” he says. Since 2000, Huawei has been reporting its annual results, and its annual reports are similar to those of any public company, he adds.

While it struggles to expand its business in the U.S., Huawei is bound to continue growing quickly both in emerging markets and developed countries, Cavender says. In the developing world, telecom networks remain a big seller, while Huawei will keep trying to sell network solutions in Western Europe. Still, the company will also be pushing hard on the consumer side, he says. “What we are going to see is a lot more aggressive product iterations. Whereas in the past they did four or five new phones a year, they might increase that amount and have a faster development cycle and focus on more premium products as well,” Cavender notes. “That is where you will see a big push for consumer products in some of Asian counties, such as India, Vietnam, Cambodia and Laos, and the U.S., Europe and the Middle East. That is where we are going to see the big growth. It is possible to see 30% to 40% growth on the consumer side per year.”

To achieve that, though, Huawei needs to work on its marketing, Cavender says. “Both Apple and Samsung can put together a very nice-looking package. They understand how to market to consumers and they are able to develop not just hardware but also software.” Huawei’s experience in China, where consumers are less focused on software because they often only use pirated applications, puts the firm at a disadvantage in competing in that area, he adds. A bigger challenge will be in achieving the sort of catchy, alluring designs that a company like Apple has cultivated over many years. “Will Huawei be able to create dominant design products, which would change the existing concept of the product?” asks Nakagawa of Ritsumeikan University. For now, the question stands unanswered.

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One Comment So Far

Kevin Horne

“As it moves up … from nuts and bolts telecom systems to higher margin consumer products like smartphones and tablets could help Huawei make a “great leap” in terms of … profits” Ooooops, hold on there. A company that is way way late to the category growth cycle (we are now in shakeout on both phones and tablets) PLUS has zero consumer brand recognition believes it will make “higher” margins? With a magic wand or accountant maybe….