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DECEMBER 13, 2005

News Analysis

By Bruce Einhorn

Why China Is Tops in Tech Gear

Critics say it became the world's No. 1 tech exporter through unfair advantages, but a closer look reveals a far more complex picture

Beijing-bashers, take note: You now have another reason to rail against China. On Dec. 12, the Organization for Economic Cooperation & Development (OECD) announced that China has surpassed the U.S. to become the world's No.1 exporter of tech gear.

The news rounds out a year when Chinese high-tech companies raised their profile worldwide: Lenovo, China's top computer brand, took over IBM's (IBM ) PC division. Huawei Technologies, the leading Chinese telecom- and networking-equipment maker, accelerated its overseas expansion. And ZTE, Huawei's cross-town rival in the southern city of Shenzhen, won new customers in developing markets in Asia and Africa, while also teaming up with Cisco Systems (CSCO ).

What's behind this success? For Beijing's many critics in Washington, the answer is easy: China cheats. Whether it's by depressing its currency's value or by stealing and copying American ideas, the argument goes, the Chinese simply don't play fair. So, the critics reckon, it's no wonder China has become the world's biggest exporter of electronics. An unfair argument? Here's a look behind the hype to see what has driven China's climb.

Are all of those high-tech exports really Chinese? Or are they made by companies based elsewhere that have shifted manufacturing to China?
About 60% of China's exports come from foreign-invested enterprises, says Oded Shenkar, a professor at Ohio State University's Fisher College of Business and the author of The Chinese Century: The Rising Chinese Economy and its Impact on the Global Economy, the Balance of Power, and Your Job. "The reality is that the higher up you go on the technology ladder, the higher the proportion of foreign players," Shenkar says.

He notes that about one-third of China's $60 billion in foreign direct investment last year was for technology-manufacturing ventures. "If you talk about high-tech exports, a lot of it is driven by foreign companies." Not long ago, for instance, Taiwan was the global center for notebook PC manufacturing. Today, Taiwanese companies such as Quanta Computer and Compal Electronics are still leaders in notebooks, but all have moved their production to low-cost mainland factories near Shanghai and Hong Kong.

Aren't the Taiwanese the exception?
No. The same holds true for computer- and phone-makers from the U.S. Dell (DELL) produces PCs at a factory in the southeastern city of Xiamen not only for China but also for export to Japan. The U.S. giant is now building a second factory across the street from the first Xiamen plant. When that's completed, one plant in the complex will be producing machines solely for export.

And Motorola (MOT) has a total of $3.6 billion invested in China. It just opened a new facility in Chengdu, the capital of western Sichuan Province. And Moto has expanded its factories in Hangzhou, near Shanghai, and in Shenzhen, adjacent to Hong Kong. It's no wonder, then, that China is No. 1. Indeed, what's surprising is that it has taken so long for it to get to this position.

If so much of the money comes from abroad, are foreigners behind China's high-tech companies?
Most of the managers at the big-name Chinese IT exporters are locals who rose up through the ranks domestically. But for the smaller companies in booming sectors such as chip design and e-commerce, the entrepreneurs are Chinese who have studied in the West and returned to the mainland.

They're called "sea turtles," a pun on the Mandarin word for "returnees." Some 7.5% of the PhD degrees in science and tech in the U.S. are awarded to Chinese citizens, Shenkar says. And more of them are returning home after getting their degrees, now that there's more opportunity in China. Today, about 25% of the Chinese return, says Shenkar, up from 15% a few years ago.

Are Chinese winning the export game because they have an unfair advantage at home?
It used to be that some Chinese tech companies did do well locally because they enjoyed government backing. But the Chinese market for PCs, cell phones, and consumer electronics has become extremely open and competitive, especially in the four years since China joined the World Trade Organization.

Consider the cell-phone market. Dozens of different companies -- both foreign and domestic -- are vying for the attention of China's 400 million cell users. "The market is overpopulated with cell-phone brands," says Michael Tatelman, the Beijing-based general manager for North Asia of Motorola's mobile-devices division. "It's ripe for consolidation. Nowhere else in the world are there so many brands. The number of mobile-phone brands in the market is unsustainable."

How successful have Chinese tech brands been so far?
It's too early to give an answer on the Lenovo/IBM deal. But many other Chinese companies that have tried to leverage their domestic success to build a global business haven't exactly prospered. Phone makers Ningbo Bird and TCL have struggled this year as their market share for handsets inside China has plunged and high-profile plans to plant a flag abroad have fizzled.

France's Alcatel (ALA) pulled out of a joint venture with TCL this year, less than 12 months after forming the partnership. And TCL's TV joint venture with France's Thomson Multimedia (TMS ) has had a difficult time getting started, too.

So in the Chinese cell-phone business, it's back-to-the-future time. Nokia (NOK ) and Motorola are once again at the top of the heap, and the locals are foundering. Not that the foreigners want to seem like sore winners. "You will see some really strong China brands in this market, and some of them will go global," says a gracious Tatelman of Motorola. But before that happens, a lot of Chinese phone makers will likely go belly-up.

If the Chinese are so good at high-tech hardware, why isn't China also a software power?
One reason China ranks at the top of the tech-exporter list is that the OECD doesn't include software in its calculations. Throw that into the mix and China falls, because the mainland has no software companies that can compare to hardware powers such as Lenovo and Huawei. For years, Beijing has sought to build up the software industry. But with piracy rates of about 90%, it's monumentally difficult for software companies to make the kind of money they need to grow into global powers.

And it doesn't help that the country's rulers are so concerned about clamping down on dissenting voices. "China still has a problem with how it deals with information," says Shenkar. "When you devote a lot of energy to how you can use the Internet to control your population, maybe you don't think enough of how you can apply it in business."

In which areas may we see China next overtake the U.S. in tech exports?
The Chinese government wants a semiconductor industry. Right now, China depends on foreigners for most of its chip needs -- and on Intel (INTC ) and AMD (AMD ) for effectively all of its microprocessors. Beijing has been supporting the growth of local players, and China now has several foundries, or make-to-order chipmakers, that are winning business.

The biggest is Shanghai-based Semiconductor Manufacturing International Corp., which is listed on Nasdaq and now owns a big chip fab [factory]in Tianjin that used to be Motorola's (MOT ). But the foundry business is rough, and with the industry going through a correction this year, it's been tough for anyone other than world leader Taiwan Semiconductor Manufacturing Co. to make money.

China is also trying hard to develop its own microprocessor, with engineers from the Chinese Academy of Science working on a project, code-named the Godson. AMD in October promised to transfer some microprocessor know-how to the Science and Technology Ministry and to Peking University [the school in the capital that still uses the old-fashioned way of Romanizing the name Beijing], but don't expect either AMD or Intel to face any serious competition from the Chinese for many years to come.

Einhorn is a correspondent in BusinessWeek's Hong Kong bureau