How the U.S. Ban on ZTE Could Disrupt Telecom Supply Chains

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Wharton's Marshall Meyer and Minyuan Zhao, and Stanford's Richard Dasher discuss the U.S. ban on exports to ZTE.

The recent U.S. ban on exports to Chinese telecommunications equipment and smartphone maker ZTE could sink the company and disrupt the global supply chain for the industry, according to experts at Wharton and Stanford. The crackdown also has given rise to calls in China to develop more domestic suppliers and reduce dependency on foreign vendors.

In April, the U.S. Commerce Department barred ZTE from purchasing components from American companies for seven years, after the company was found to have violated a 2017 settlement agreement that included a record $1.19 billion in fines for shipping telecom equipment to Iran and North Korea, which face U.S. sanctions. In particular, the U.S. government said ZTE had agreed to discipline employees involved in the shipments, but it gave them bonuses instead.

“It’s been a long time coming,” Richard Dasher, director of the U.S.-Asia Technology Management Center at Stanford University, said in an interview on the Knowledge@Wharton show, which airs on SiriusXM channel 111. (Listen to the full podcast using the player at the top of this page.) The violations have gone on for years, and the U.S. is cracking down hard due to ZTE’s “continued misleading statements and cover-ups and falsifications of data to investigators.” While U.S. companies that sell to the Chinese manufacturer would lose revenue in the short run, “the company that’s really in danger is ZTE itself,” he said.

ZTE, one of the world’s largest telecom equipment makers, reportedly buys more than a quarter of its components from U.S. companies, and it sources 70% of its smartphone chips from Qualcomm. At stake also is ZTE’s continued access to Google’s mobile operating system, Android. ZTE holds 12% of the U.S. smartphone market, added Wharton management professor emeritus Marshall Meyer on the radio show.

“In the weeks and months to come, you’ll see the Chinese government starting to make more investments in semiconductor technology.” –Richard Dasher

Following the ZTE ban, China’s president Xi Jinping and Chinese internet companies Alibaba and Tencent called for the development of “core technology in the information field” in the country to reduce dependence foreign suppliers. This sentiment could escalate as the U.S. Justice Department reportedly is now investigating Chinese tech giant Huawei, the largest telecoms equipment maker in the world, for similar violations.

Soul-searching in China

But the ZTE crackdown — and the Chinese response to it — differs from prior conflicts. Meyer said the U.S. approach to past violations generally had been to impose or threaten tariffs, which he likened to “dirty bombs. You throw them somewhere and there are all kinds of consequences and all kinds of collateral damage, and at the end it’s not really clear anyone’s better off by doing this.” In contrast, “the action against ZTE is like precise munition — a really smart bomb.”

The Chinese response to the ZTE ban — a move which would typically result mainly in anti-U.S. rhetoric — was also different. For example, China’s State-owned Assets Supervision and Administration Commission of the State Council (SASAC) criticized ZTE as “stupid and passive,” and noted that its actions could endanger the welfare of other Chinese companies, Meyer said.

The Chinese public also, unusually, has had a moment of soul searching. “Most of the [online] discussion was like, ‘How can we be so stupid? We’re so used to … operating in the gray area. Time to get out of it. Time to grow up,’” said Wharton management professor Minyuan Zhao, who joined Dasher and Meyer on the radio show. “You’ve got to follow the rules. You’ve got to be more transparent.”

Impact on Supply Chains, Huawei

However, the biggest impact of the ban is not on individual companies but the global telecom supply chain, Zhao said. For the past 30 years, companies have made strategic decisions assuming this supply chain would be stable. But if that assumption is challenged, then companies would have to take strategic steps to hedge their risks and ensure they can always access key components by developing their own supply. “I think the impact will be large in the long run,” she said.

But Zhao acknowledged that it’s also easier said than done. “China has a long way to go,” she said. To replicate a global supply chain will take a long time because of the many parts that are needed to be manufactured. Moreover, it’s not as efficient as purchasing components from existing vendors, and the final product also might not be as good. “There’s a fear that if China is really determined to develop [its own telecom supply chain] we’re going to see the next Great Leap Forward (a failed campaign to industrialize China’s economy in the mid-20th century). And we know how the Great Leap Forward ended.”

“The action against ZTE is like precise munition — a really smart bomb.” –Marshall Meyer

If China decides to strike out on its own, the world could end up with competing systems, Dasher said. “You will have the China side and you’ll have the U.S. side,” he said. “And where the rest of the world winds up is going to make a big difference in terms of what American industry can do.” Meanwhile, there’s “a long-term kind of movement toward isolationism inside China now as well as in the U.S.,” he said. “In the weeks and months to come, you’ll see the Chinese government starting to make more investments in semiconductor technology.”

The ban on ZTE comes in an environment of strong anti-China rhetoric from the Trump administration and a string of actions including anti-dumping duties on imports from China of steel wheels, aluminum foil and large diameter welded pipes. The Commerce Department has stated that the ZTE punishment is “a regulatory action and is unrelated to any ongoing trade-related actions.” But Zhao said some Chinese remain skeptical that the ban is not part of the larger trade war.

When it comes to Huawei, any punitive action will cause a much bigger splash than ZTE. “It’s going to be huge,” said Zhao, noting that Huawei derives 60% of its revenue overseas. Huawei has been developing its own cell phone chips, so it’s less reliant on foreign vendors for those. But Huawei’s main business is telecom equipment, which uses many foreign suppliers. It’s not practical for the company to develop its own components since telecom equipment can be very specialized. And many of these components don’t have big enough markets to sell to that would justify the cost of making them.

Added Meyer: “Huawei is in a very different position than ZTE. They have huge domestic [market] share, huge international share that’s growing. They may be furthest along in developing proprietary technology.” As such, he agrees with Dasher that two systems could develop in the world. If that happens, “the consequence for the consumer … isn’t good” because there will be fewer choices and prices are going to rise, he said. However, the exact impact is hard to judge because national security considerations also come into play.

Balancing Security with Trade

To be sure, national security isn’t a new concern for the U.S. But what’s different this time is that this concern over safety “is now driving the whole economic considerations of trade,” Dasher said. Earlier this year, both AT&T and Verizon decided not to support Huawei phones over national security concerns, and so did retail chain Best Buy. Security threats were also the reason why Trump disallowed Singapore-based Broadcom from buying Qualcomm in March.

“The global configuration of the 5G network championed by a Chinese company is considered a strategic threat” by the U.S. –Minyuan Zhao

Dasher argued that the U.S. needs to be more balanced in its approach. “You need a really favorable approach to world trade that is going to support the economic activities at the same time as you enforce the security side,” he said. “Now, you see security taking over, and good relationships forged over the years on the trading side are all being questioned. This applies to our best allies and non-allies.”

Zhao said the U.S. also could be concerned about “economic security” — or protecting its industries — not just national security. “The global configuration of the 5G network championed by a Chinese company is considered a strategic threat” by the U.S., she said. China holds a narrow lead in the development of 5G systems in the world, followed by South Korea and the United States, according to a report by U.S. wireless industry trade group CTIA. The 5G technology is the next step up from 4G, allowing for wireless connections that could be tens of times faster.

But Zhao said one silver lining is that this time around, the Chinese public is not mostly calling for wholesale boycotts of U.S. products as retaliation for the ZTE ban and Huawei investigation. “People are not crying out, ‘Let’s ban American products,’” she said. “It’s more about competition between the two big nations and the kind of strategic struggle we have” with each other.

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